U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-QSB
(Mark one)
{x} QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended MARCH 31, 2004
{ } TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (No Fee Required)
For the transition period from ________________ to ________________
Commission file number 0-29192
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PURADYN FILTER TECHNOLOGIES INCORPORATED
--------------------------------------------------------------------------------
(Name of small business issuer in its charter)
Delaware 14-1708544
-------- -----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2017 High Ridge Road, Boynton Beach, Florida 33426
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (561) 547-9499
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that Puradyn Filter Technologies Incorporated was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes { x } No { }
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
As of May 14, 2004, there were 17,452,164 shares of registrant's common stock
outstanding, par value $.001.
Puradyn Filter Technologies Incorporated
Index to Quarterly Report on Form 10-QSB
Part I. Financial Information Page
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheet - March 31, 2004 ............................... 3
Condensed Consolidated Statements of Operations - Three months ended
March 31, 2004 and 2003 ............................................................. 4
Condensed Consolidated Statements of Cash Flows - Three months ended
March 31, 2004 and 2003 ............................................................. 5
Notes to Condensed Consolidated Financial Statements ................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 3. Controls and Procedures ............................................................. 18
Part II Other Information
Item 1. Legal Proceedings ................................................................... 18
Item 2. Changes in Securities and Use of Proceeds ........................................... 18
Item 3. Default Upon Senior Securities ...................................................... 18
Item 4. Submission of Matters to a Vote of Security Holders ................................. 18
Item 5. Other Information ................................................................... 18
Item 6. Exhibits and Reports on Form 8-K .................................................... 19
Signatures .................................................................................. 20
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Puradyn Filter Technologies Incorporated
Condensed Consolidated Balance Sheet
March 31, 2004
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 724,529
Accounts receivable, net of allowance for uncollectible accounts of $7,932 288,943
Inventories 1,112,857
Prepaid expenses and other current assets 271,323
------------
Total current assets 2,397,652
Property and equipment, net 663,772
Deferred financing costs, net 237,729
Other noncurrent assets 107,597
------------
Total assets $ 3,406,750
============
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable $ 270,108
Accrued liabilities 552,178
Current portion of capital lease obligation 4,172
Deferred revenue 37,437
------------
Total current liabilities 863,895
Capital lease obligation, less current portion 14,055
Notes payable to stockholder 3,001,900
Stockholders' deficit:
Preferred stock, $.001 par value:
Authorized shares - 500,000; none issued and outstanding --
Common stock, $.001 par value:
Authorized shares - 30,000,000; 17,452,164 issued and outstanding 17,452
Additional paid-in capital 35,681,910
Notes receivable from stockholders (1,004,310)
Accumulated deficit (35,116,490)
Accumulated other comprehensive loss (51,662)
------------
Total stockholders' deficit (473,100)
------------
Total liabilities and stockholders' deficit $ 3,406,750
============
See accompanying notes.
3
Puradyn Filter Technologies Incorporated
Condensed Consolidated Statements of Operations
For the Three Months Ended March 31, 2004 and 2003
(Unaudited)
Three Months Ended
March 31,
2004 2003
------------ ------------
Net sales $ 613,403 $ 752,457
Costs and expenses:
Cost of products sold 629,667 683,664
Salaries and wages 408,985 446,019
Selling and administrative 394,175 491,551
Stock-based compensation 271,103 33,881
------------ ------------
1,703,930 1,655,115
------------ ------------
Loss from operations (1,090,527) (902,658)
Other income (expense):
Interest income 14,139 12,724
Interest expense (88,016) (62,691)
------------ ------------
Total other income (expense) (73,877) (49,967)
------------ ------------
Net loss $ (1,164,404) $ (952,625)
============ ============
Basic and diluted loss per common share $ (0.07) $ (0.06)
============ ============
Weighted average common shares outstanding 16,753,483 15,663,513
============ ============
See accompanying notes.
4
Puradyn Filter Technologies Incorporated
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2004 and 2003
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
2004 2003
----------- -----------
OPERATING ACTIVITIES
Net cash used in operating activities $ (635,029) $(1,144,457)
----------- -----------
INVESTING ACTIVITIES
Purchases of property and equipment (36,457) (17,026)
----------- -----------
Net cash used in investing activities (36,457) (17,026)
----------- -----------
FINANCING ACTIVITIES
Proceeds from exercise of stock options 10,000 12,666
Proceeds from private placement 2,000,000 --
Proceeds from notes payable to stockholder -- 1,000,000
Payments on notes payable to stockholder (2,000,000) --
Proceeds from short term loan payable to officer -- 100,000
Payments on short term loan payable to officer -- (100,000)
Payment of capital lease obligations (976) (920)
----------- -----------
Net cash provided by financing activities
9,024 1,011,746
----------- -----------
Effect of exchange rate changes on cash and cash
equivalents (7,839) (23,731)
----------- -----------
Decrease in cash and cash equivalents (670,301) (173,468)
Cash and cash equivalents at beginning of period 1,394,830 633,024
----------- -----------
Cash and cash equivalents at end of period $ 724,529 $ 459,556
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 51,264 $ 21,831
=========== ===========
NONCASH INVESTING AND FINANCING ACTIVITIES
Receivable from stock option exercise $ -- $ 20,000
=========== ===========
Warrants issued for deferred financing and capital $ 112,500 $ 212,500
=========== ===========
Common stock options issued in lieu of officer cash bonus $ -- $ 80,000
=========== ===========
See accompanying notes.
5
Puradyn Filter Technologies Incorporated
Notes to Condensed Consolidated Financial Statements
March 31, 2004
(Unaudited)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim information and with the instructions to Form 10-QSB
and Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. In the opinion of management, all
adjustments consisting of a normal and recurring nature considered necessary for
a fair presentation have been included. Operating results for the three-month
period ended March 31, 2004 may not necessarily be indicative of the results
that may be expected for the year ending December 31, 2004.
For further information, refer to Puradyn Filter Technologies Incorporated's
(the Company) consolidated financial statements and footnotes thereto included
in the Form 10-KSB for the year ended December 31, 2003.
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (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 for the Company to the first interim or annual
period ending after December 15, 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.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the condensed consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
Basic and Diluted Loss Per Share
SFAS No. 128, Earnings Per Share, requires a dual presentation of basic and
diluted earnings per share. However, because of the Company's net losses, the
effect of outstanding stock options and warrants would be anti-dilutive and,
accordingly, is excluded from the computation of diluted loss per share. The
number of such shares excluded from the computation of loss per share totaled
2,908,570 and 2,587,137 for the three months ended March 31, 2004 and 2003,
respectively.
6
Inventories
Inventories are stated at the lower of cost or market using the first in, first
out (FIFO) method. Production costs, consisting of labor and overhead, are
applied to ending inventories at a rate based on estimated production capacity
and any excess production costs are charged to cost of products sold. Provisions
have been made to reduce excess or obsolete inventories to their net realizable
value.
Inventories consisted of the following at March 31, 2004:
Raw materials $ 766,495
Finished goods 346,362
----------
$1,112,857
==========
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 $37,788 and $37,686 for the three-months ended
March 31, 2004 and 2003, 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 were 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 remaining
balance of deferred financing costs for the $2.5 million commitment
prospectively over the extended payback period. On February 2, 2004 the payback
period for both the $2.5 and $3.5 million commitments was extended to December
31, 2005 (see Note 2), resulting in the addition of approximately $94,000 of
related deferred financing costs. Effective February 2, 2004, the Company began
amortizing the remaining balance of deferred financing costs for both the
$2.5 and $3.5 million commitments prospectively over the extended payback
period. Accumulated amortization of deferred financing costs as of March 31,
2004 and 2003, was $388,421 and $214,353, respectively.
Stock Option Plans
The Company accounts for its stock-based compensation plans under Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25) and FASB Interpretation No. 44, Accounting for Certain Transactions
involving Stock Compensation (FIN 44), and provides pro forma disclosures of the
compensation expense determined under the fair value provisions of SFAS No. 123,
Accounting for Stock-Based Compensation (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, in situations where 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
7
Than Employees for Acquiring or in Conjunction with Selling Goods or Services.
The related expense is recognized over the period the services are provided.
Pro forma information regarding net loss and loss per common share as if the
Company had accounted for its employee stock options under the fair value method
of SFAS 123 is presented below. For purposes of pro forma disclosure, the
estimated fair value of the options is amortized to expense over the options'
vesting period. The Company's pro forma information is as follows:
Three Months Ended
March 31,
2004 2003
-------------- --------------
Net loss as reported $ (1,164,404) $ (952,625)
Stock-based employee compensation cost (intrinsic
value method) -- --
Fair value method stock option expense (358,415) (354,445)
-------------- --------------
Pro forma net loss
$ (1,522,819) $ (1,307,070)
============== ==============
Loss per common share:
Basic and diluted loss as reported $ (0.07) $ (0.06)
Basic and diluted loss pro forma $ (0.09) $ (0.08)
Weighted average fair value per option granted
during the period(1)
$ 1.86 $ 1.34
Assumptions:
Average Risk Free Interest Rate 3.08% 1.70%
Average Volatility Factor 1.078 1.218
Expected Dividend Yield 0% 0%
Expected Life (in years) 5 4
(1) A Black-Scholes option-pricing model was used to develop the fair
values of the options granted.
Revenue Recognition
The Company recognizes revenue from product sales to customers, distributors and
resellers when products that do not require further services or installation by
the Company are shipped, when there are no uncertainties surrounding customer
acceptance and when collectibility is reasonably assured in accordance with
Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements
(SAB 104), as amended and interpreted. Cash received by the Company prior to
shipment is recorded as deferred revenue. Sales are made to customers under
terms allowing certain limited rights of return and other limited product and
performance warranties for which provision has been made in the accompanying
condensed consolidated financial statements.
Amounts billed to customers in sales transactions related to shipping and
handling, represent revenues earned for the goods provided and are included in
net sales. Costs of shipping and handling are included in cost of products sold.
Product Warranty Costs
As required by FASB Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45), the Company is including the following disclosure applicable to
its product warranties.
8
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, related to the replacement of warranty products, and
accrued warranty expense of approximately $42,000, are included in the
accompanying condensed consolidated balance sheet as of March 31, 2004.
The following table shows the changes in the aggregate product warranty
liability for the three-months ended March 31, 2004:
Balance as of December 31, 2003 $ 42,573
Less: Payments made (12,320)
Change in prior period estimate (891)
Add: Provision for current period warranties 12,370
---------
Balance as of March 31, 2004 $ 41,732
=========
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. 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 loss as of March 31, 2004 and
2003 is not shown net of taxes because the Company's deferred tax asset has been
fully offset by a valuation allowance.
Comprehensive loss consisted of the following for the three-months ended March
31, 2004 and 2003:
Three Months Ended
March 31,
2004 2003
----------- -----------
Net loss $(1,164,404) $ (952,625)
Other comprehensive loss:
Foreign currency translation adjustment (7,839) (23,731)
----------- -----------
Comprehensive loss $(1,172,243) $ (976,356)
=========== ===========
Reclassifications
Certain prior period amounts have been reclassified to conform to the current
period presentation.
2. ISSUES AFFECTING LIQUIDITY AND MANAGEMENT'S PLANS
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. The Company has sustained losses since
inception in 1987 and used net cash in operations of approximately $635,000 and
$1,144,000 during the three-months ended March 31, 2004 and 2003, 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.
On March 28, 2002 and March 14, 2003, respectively, 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 and an additional $3.5 million
through December 31, 2003. Under the terms of the agreements, the Company can
9
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 March 31, 2004), payable monthly and were to become due and
payable on December 31, 2003 and December 31, 2004, respectively, or upon a
change in control of the Company or consummation of any other financing over
$3.0 million or over $7.0 million in the aggregate. In March 2003, the payback
date for the first agreement was extended to December 31, 2004.
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
$7.0 million over the $3.5 million raised in the Company's recent private
placement offering; or until such time as the Company is operating within
sufficient cash flow parameters, as defined, to sustain its operations; or until
a disposition of the Company occurs. As of March 31, 2004, the Company had drawn
a total of $5.0 million of the available funds and repaid $2.0 million. Both of
the lines allow for discretionary principal payments, which add to the
availability of additional funds that the Company may draw.
In addition, as part of the February 2, 2004 amendment described above, the
second agreement was amended to allow the Company to draw the remaining
available balance ($3.0 million as of March 31, 2004) through December 31, 2004.
In consideration for the amendments, as well as for efforts 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 3).
In December 2003, the Company issued 750,000 shares of common stock for gross
proceeds of $1.5 million from its recent private placement offering
(approximately $1.46 million net of related expenses) to a third party investor.
In March 2004, an additional 1.0 million shares of common stock were issued to
the same investor for gross proceeds of $2.0 million (approximately $1.98
million net of related expenses.) The $2.0 million of gross proceeds was 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.
There is no assurance that the Company will raise any additional proceeds from
future private placements. Subscriptions for the current private placement
expired on April 30, 2004.
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, the funds received from its
recent 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 and/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. COMMON STOCK
On March 12, 2004, the Company received gross cash proceeds of $2.0 million from
the sale of 1.0 million shares of common stock from its private placement
offering, which expired on April 30, 2004. The funds were 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 recorded related offering costs
of approximately $20,000.
On February 2, 2004, the two binding funding agreements with a stockholder, who
is also a Board member, were amended (see Note 2). In consideration for the
amendments, as well as for efforts in obtaining private placement funding,
the Company granted the stockholder 150,000 fully vested common stock purchase
warrants. The fair value of the warrants was estimated at the date of grant
using a Black-Scholes option pricing model with the following assumptions: risk
10
free interest rate of 2.43%, volatility factor of the expected market price of
the Company's common stock of .526, a dividend yield of zero, and a weighted
average expected life of 3 years. The warrants have an exercise price of $2.00,
which was equal to quoted market value on the date of grant. 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 2003 consolidated
balance sheet in Form 10-KSB, and recorded a deferred charge of $93,750 in
February 2004 for the amendments to the commitment agreements, which is being
amortized over the repayment period of 23 months.
4. STOCK OPTIONS
During the three-months ended March 31, 2004 and 2003, employees of the Company
exercised 10,000 and 33,775, respectively, of common stock options. The Company
received $10,000 and $12,666, respectively, in cash proceeds in exchange for the
shares issued. The Company received $20,000 of proceeds in April of 2003 related
to stock option exercises that were transacted in the three-month period ended
March 31, 2003.
During the three-month periods ended March 31, 2004 and March 31, 2003, the
Company recognized compensation expense (under the intrinsic value method) of
approximately $8,000 and $34,000, respectively, relating to outstanding variable
option awards. At March 31, 2004, approximately 212,000 awards subject to
variable accounting remained outstanding with an average exercise price of
$0.47.
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 recorded approximately $263,000 of compensation
expense related to this modification, which is included in the accompanying
condensed consolidated statement of operations for the three-month period ended
March 31, 2004.
5. NOTES PAYABLE TO STOCKHOLDER
As of December 31, 2003, the Company had drawn an aggregate of approximately
$5.0 million from the two available lines-of-credit, which are provided by a
stockholder, who is also a Board Member, of the Company (see Notes 2 and 3).
Amounts drawn bear interest at the prime rate (4% as of March 31, 2004) payable
monthly and become due and payable on December 31, 2005; or until such time as
the Company has raised an additional $7.0 million over the $3.5 million raised
in the Company's recent private placement offering; or until such time as the
Company is operating within sufficient cash flow parameters, as defined, to
sustain its operations; or until a disposition of the Company occurs. In March
2004, the Company repaid $2.0 million of the outstanding balance, using the
funds received from the private placement, which expired in April 2004, leaving
an outstanding balance of approximately $3.0 million as of March 31, 2004. Both
of the lines allow for discretionary principal payments, which add to the
availability of additional funds that the Company may draw.
For the three-months ended March 31, 2004 and 2003, the Company recorded
approximately $49,500 and $24,000, respectively, of interest expense related to
the notes payable to stockholder, which is included in interest expense in the
accompanying condensed consolidated statements of operations.
11
6. COMMITMENTS AND CONTINGENCIES
MALT LITIGATION
In connection with the Company being granted worldwide manufacturing and
marketing rights for certain of the Purifiner products, a royalty agreement was
entered into with a term equal to the life of the related patents or any
improvements thereto. Pursuant to this royalty agreement, the owner of the
patents was to receive 5% of the net unit sale price of all covered Purifiner
products, as defined. Additionally, 1% of the net sales price of replacement oil
filter elements was to be paid as a royalty on certain Puradyn filters for the
use of the U.S. Purifiner trademark. The Company is no longer retaining the
Purifiner patents or trademarks and accordingly is not renewing them upon
expiration.
In May 1994, the Company and the patent owner entered into a settlement
agreement relating to royalties under which the patent owner was entitled to a
minimum annual royalty of $24,000, payable in monthly installments of $2,000. In
February 1997, the patent owner filed an action against the Company for
nonpayment of approximately $20,000 of royalties claimed by him, seeking a
permanent injunction against the Company's manufacturing and selling of the
covered Purifiner products. On March 2, 1999, the trial court ruled that the
patent owner was not entitled to any injunctive relief but was entitled to
$20,169 in past royalties, which the Company paid. The patent owner filed a
motion for additional damages and attorney fees and on December 13, 2000, the
Court found the patent owner was entitled to an additional $15,505. The Company
appealed that judgment but 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. There have been no new developments subsequent
to the discovery requests. 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 incurred in connection with the performance of its services under the
agreement. The agreement excludes the capital raised by the Company in December
2003 and March 2004. No equity capital has been raised pursuant to this
agreement through the date of this filing.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations included in the
Company's Form 10-KSB for the year ended December 31, 2003.
Other than historical and factual statements, the matters and items discussed in
this Quarterly Report on Form 10-QSB are forward-looking statements that involve
risks and uncertainties. Actual results of the Company may differ materially
from the results discussed in the forward-looking statements. Certain factors
that could contribute to such differences are discussed with the forward-looking
statements throughout this report. 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.
General
The Company was formed in 1987 and was inactive until it commenced
limited operations in 1991 when it obtained worldwide manufacturing and
marketing rights to the Purifiner(R) product, now called the PURADYN(R) Bypass
Oil Filtration System or the "PURADYN" system.
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
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 industry. 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 offering
substantial end-user savings related to oil maintenance costs
o An alternative solution to the rising costs and increasing
dependence on foreign oil
o Compliant with existing and reasonably foreseeable
environmental regulations
In 2001, the Company 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. With this foundation established we are more focused on
large potential key customers and segments of the industry that would benefit
most from the advantages of a nationwide distribution network.
Additionally, we began to refocus our sales and marketing efforts to
target areas and issues specific to the bypass oil filtration industry. These
efforts include identifying customer needs and educating the customer on the
total benefits of our system concerning oil maintenance costs and procedures,
specifically, that oil does not need to be changed on a regular basis and the
drain interval is extended, provided that oil analysis verifies the oil is
clean.
This strategy includes focus on:
o The expansion of existing strategic relationships
13
o Continued 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 customer evaluations to ensure the salient
aspects of our system are addressed on a timely basis
o Converting customer evaluations into sales, both immediate and
long term
The Company directly and/or with the assistance of its sales
representatives, warehouse distributors, dealers or other agents, markets its
products primarily to national accounts. Our sales policy includes 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.
While this is a long-term and ongoing commitment, we believe we have
achieved a limited amount of industry acceptance. We also 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.
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.
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 as amended and interpreted. Cash received by
the Company prior to shipment is recorded as deferred revenue. Sales are made to
certain customers under terms allowing certain limited rights of return and
other limited product and performance warranties for which provision has been
made in the accompanying condensed consolidated financial statements. Management
believes, based on past experience and future expectations, that such limited
return rights and warranties will not have a material adverse effect on the
Company's financial statements.
14
RESULTS OF OPERATIONS FOR THE THREE-MONTHS ENDED MARCH 31, 2004 COMPARED TO THE
THREE-MONTHS ENDED MARCH 31, 2003
The following table sets forth the amount of increase or decrease represented by
certain items reflected in the Company's condensed consolidated statements of
operations in comparing the three-months ended March 31, 2004 to the
three-months ended March 31, 2003:
(In thousands) Three Months Ended March 31,
-------------------------------------
2004 2003 Change
------- ------- -------
Net sales $ 613 $ 752 $ (139)
------- ------- -------
Costs and expenses:
Cost of products sold 630 684 (54)
Salaries and wages 409 446 (37)
Selling and administrative 394 491 (97)
Stock-based compensation 271 34 237
------- ------- -------
Total costs and expenses 1,704 1,655 49
------- ------- -------
Other (expense) income:
Interest income 14 13 1
Interest expense (88) (63) (25)
------- ------- -------
Total other (expense) income (74) (50) (24)
------- ------- -------
Net loss $(1,165) $ (953) $ (212)
======= ======= =======
NET SALES
Net sales decreased by approximately 18% from approximately $752,000 in 2003 to
approximately $613,000 in 2004. The primary reason for the decrease in sales is
the slower than anticipated movement of product sold to the largest customer
during the three-month period ended March 31, 2003. Because of this, sales to
this customer for the three-month period ended March 31, 2004 have decreased
significantly. Net sales for the three-month period ended March 31, 2004
excluding sales to this customer, have increased by approximately $166,000, or
37% over net sales for the same period in 2003. The increase is primarily due to
increased purchases from the Company's top three customers as well as purchases
from several new distributors.
Sales to three customers accounted for approximately 27%, 17% and 11% of the
consolidated net sales for the three-months ended March 31, 2004. For the
three-months ended March 31, 2003, two customers accounted for approximately 41%
and 10% of the consolidated net sales. The UK subsidiary's sales increased by
approximately 25% for the three-month period ended March 31, 2004 compared to
the three-month period ended March 31, 2003.
COST OF PRODUCTS SOLD
Cost of products sold decreased by approximately 8% from approximately $684,000
in 2003 to approximately $630,000 in 2004. The decrease is primarily due to the
18% decrease in net sales. Based on current sales volumes, the Company is unable
to fully utilize its production capacity. Because of this, the decrease in cost
of products sold is not proportionate to the decrease in sales.
SALARIES AND WAGES
Salaries and wages decreased approximately $37,000, or 8%. This decrease is the
result of a net reduction of three employees, representing approximately a
$68,000 decrease, which was offset by an increase in the vacation accrual as
well as salary increases.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses decreased by approximately $97,000, or 20%,
due primarily to a reduction in spending in the sales and marketing department
as well as reduced patent expense due to costs incurred for new applications
that were initiated in the three-month period ended March 31, 2003.
STOCK-BASED COMPENSATION
The Company recorded stock based compensation expense of approximately $271,000
and $34,000 for the three-months ended March 31, 2004 and 2003, respectively,
related to certain variable equity awards and other stock based compensation.
The increase of approximately $237,000 is due to the extension in March 2004 of
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
15
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 and recorded the corresponding
charge to compensation expense. 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.
INTEREST EXPENSE
Interest expense increased by approximately $25,000 as a result of an increase
in the outstanding balance of the stockholder notes payable. The Company pays
interest monthly on the notes payable to stockholder at the prime rate, which
was 4% as of March 31, 2004.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2004, the Company had cash and cash equivalents of
approximately $725,000. For the three-month period ended March 31, 2004, net
cash used in operating activities was approximately $635,000, which primarily
resulted from the net loss of approximately $1,165,000. Net cash used in
investing activities was approximately $36,000 for the purchase of property and
equipment. Net cash provided by financing activities was approximately $9,000
for the period, due to the exercise of employee stock options. The $2.0 million
of capital raised during the period ended March 31, 2004 from the Company's
private placement was offset by the repayment of $2.0 million of the shareholder
loans.
The Company has incurred net losses each year since its inception and
has relied on the sale of its stock from time to time and loans from third
parties and from related parties to fund its operations.
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 March 31, 2004) 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 $3.0 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 March 31, 2004, 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 March 31, 2004) 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 $7.0 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
March 31, 2004, the Company had drawn $2.5 million of the available funds and
repaid $2.0 million of the loan. 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 $7.0 million over the amount raised during the Company's
recent 2004 private
16
placement offering, the Company is operating within sufficient cash flow
parameters, as defined, or a disposition of the Company occurs; 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 recent private placement to a third party
investor, initiated in November 2003, with gross proceeds of approximately $1.5
million, 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 1.0 million shares of common stock for $2.0 million. The
funds were 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 future
private placements. Subscriptions for the current private placement expired on
April 30, 2004.
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 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 incurred in connection with the performance of its services
under the agreement. The agreement excludes the above capital raised in December
2003 and March 2004. No equity capital has been raised pursuant to this
agreement through the date of this filing.
At March 31, 2004, the Company had working capital of approximately
$1.5 million and its current ratio (current assets to current liabilities) was
2.78 to 1. 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 and/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's wholly owned subsidiary, Ltd., moved to new office space
in September 2003 by assuming the existing lease, which expires in August 2004,
at which time they will negotiate a new lease.
Consistent with industry practices, the Company may accept product
returns or provide other credits in the event that a distributor holds excess
inventory of the Company's products. The Company's sales are made on credit
terms, which vary depending on the nature of the sale. The Company believes it
has established sufficient reserves to accurately reflect the amount or
likelihood of product returns or credits and uncollectible receivables. However,
there can be no assurance that actual returns and uncollectible receivables will
not exceed the Company's reserves.
Sales of the Company's products will depend principally on end user
demand for such products and acceptance of the Company's products by original
equipment manufacturers ("OEMs"). The oil filtration industry has historically
been competitive and, as is typically the case with innovative products, the
ultimate level of demand for the Company's products is subject to a high degree
of uncertainty. Developing market acceptance, particularly worldwide, for the
Company's existing and proposed products will require substantial marketing and
sales efforts and the expenditure of a significant amount of funds to inform
customers of the perceived benefits and cost advantages of its products.
Impact of Inflation
Inflation has not had a significant impact on the Company's operations.
However, any significant decrease in the price for oil or labor, environmental
compliance costs, and engine replacement costs could adversely impact the
Company's end users cost/benefit analysis as to the use of the Company's
products.
17
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Puradyn Filter Technologies Incorporated's Chief Executive Officer and
Chief Financial Officer have evaluated the Company's disclosure controls and
procedures as of March 31, 2004, and they concluded that these controls and
procedures are effective.
(b) Changes in Internal Controls
There are no significant changes in internal controls or in other
factors that could significantly affect these controls subsequent to March 31,
2004.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 12, 2004, the Company received gross cash proceeds of $2.0
million from the sale of 1.0 million shares of common stock at $2.00 per share
to a third party investor. Subscriptions for the private placement expired on
April 30, 2004. The funds were 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. Inasmuch as the third party investor was highly sophisticated, had
access to current public information concerning the Company, could bear the
financial risk of the investment, and had agreed to acquire the shares for
investment purposes, the transaction was exempt from registration under Section
4 (2) of the Securities Act of 1933.
On February 2, 2004, in consideration for the amendments of the two
binding funding agreements with a stockholder, who is also a Board member, as
well as for efforts in obtaining private placement funding, the Company granted
the stockholder 150,000 fully vested common stock purchase warrants. The
warrants have an exercise price of $2.00, which was equal to quoted market value
on the date of grant.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K.
(1) A Report on Form 8-K was filed on March 16, 2004, reporting under
Item 5, that the Company executed a subscription agreement with an
accredited investor.
19
SIGNATURES
In accordance with the requirements of the Exchange Act, Puradyn Filter
Technologies Incorporated caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PURADYN FILTER TECHNOLOGIES INCORPORATED
(Registrant)
By /s/ Lisa M. De La Pointe Date: May 14, 2004
----------------------------------------
Lisa M. De La Pointe, Chief Financial Officer
20