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 JUNE 30, 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
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(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
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (561) 547-9499
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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 August 11, 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 - June 30, 2004..................3
Condensed Consolidated Statements of Operations -
Three months and six months ended June 30, 2004 and 2003..............4
Condensed Consolidated Statements of Cash Flows -
Six months ended June 30, 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..............................................19
Part II. Other Information
Item 1. Legal Proceedings....................................................20
Item 2. Changes in Securities and Use of Proceeds............................20
Item 6. Exhibits and Reports on Form 8-K.....................................20
Signatures....................................................................21
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Puradyn Filter Technologies Incorporated
Condensed Consolidated Balance Sheet
June 30, 2004
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 204,305
Accounts receivable, net of allowance for uncollectible accounts of $6,411 357,177
Inventories 1,253,333
Prepaid expenses and other current assets 324,390
------------
Total current assets 2,139,205
Property and equipment, net 635,515
Deferred financing costs, net 203,767
Other noncurrent assets 107,597
------------
Total assets $ 3,086,084
============
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable $ 311,130
Accrued liabilities 547,219
Current portion of capital lease obligation 4,285
Deferred revenue 46,303
------------
Total current liabilities 908,937
Capital lease obligation, less current portion 12,940
Notes payable to stockholder 3,501,900
Stockholders' deficit:
Preferred stock, $.001 par value:
Authorized shares - 500,000; none issued and outstanding --
Common stock, $.001 par value:
Authorized shares - 30,000,000; 17,452,164 issued and outstanding 17,452
Additional paid-in capital 35,647,778
Notes receivable from stockholders (1,016,294)
Accumulated deficit (35,938,801)
Accumulated other comprehensive loss (47,828)
------------
Total stockholders' deficit (1,337,693)
------------
Total liabilities and stockholders' deficit $ 3,086,084
============
See accompanying notes.
3
Puradyn Filter Technologies Incorporated
Condensed Consolidated Statements of Operations
For the Three Months and Six Months Ended June 30, 2004 and 2003
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net sales $ 627,320 $ 313,036 $ 1,240,724 $ 1,065,494
Costs and expenses:
Cost of products sold 645,586 478,773 1,275,252 1,159,698
Salaries and wages 403,283 465,573 812,269 911,592
Selling and administrative 380,020 401,562 774,195 895,852
Stock based compensation (33,881) 95,289 237,222 129,170
------------ ------------ ------------ ------------
1,395,008 1,441,197 3,098,938 3,096,312
------------ ------------ ------------ ------------
Loss from operations (767,688) (1,128,161) (1,858,214) (2,030,818)
Other income (expense):
Interest income 12,995 12,724 27,134 25,448
Interest expense (67,618) (81,397) (155,635) (144,089)
------------ ------------ ------------ ------------
Total other expense, net (54,623) (68,673) (128,501) (118,641)
------------ ------------ ------------ ------------
Net loss $ (822,311) $ (1,196,834) $ (1,986,715) $ (2,149,459)
============ ============ ============ ============
Basic and diluted loss per common
share $ (0.05) $ (0.08) $ (0.12) $ (0.14)
============ ============ ============ ============
Weighted average common shares
outstanding 17,452,164 15,683,702 17,102,823 15,673,663
============ ============ ============ ============
See accompanying notes.
4
Puradyn Filter Technologies Incorporated
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2004 and 2003
(Unaudited)
Six months Ended
June 30,
2004 2003
----------- -----------
Operating activities
Net cash used in operating activities $(1,598,703) $(1,923,592)
----------- -----------
Investing activities
Purchases of property and equipment (60,319) (42,038)
----------- -----------
Net cash used in investing activities (60,319) (42,038)
----------- -----------
Financing activities
Proceeds from exercise of stock options 10,000 42,666
Proceeds from private placement, net of expenses 1,964,480 --
Proceeds from notes payable to stockholder 500,000 1,501,900
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 (1,977) (2,135)
----------- -----------
Net cash provided by financing activities 472,503 1,542,431
----------- -----------
Effect of exchange rate changes on cash and cash
equivalents (4,006) (28,946)
----------- -----------
Decrease in cash and cash equivalents (1,190,525) (452,145)
Cash and cash equivalents at beginning of period 1,394,830 633,024
----------- -----------
Cash and cash equivalents at end of period $ 204,305 $ 180,879
=========== ===========
Supplemental cash flow information
Cash paid for interest $ 87,087 $ 58,028
=========== ===========
Noncash investing and financing activities
Warrants issued for deferred financing and capital
raising costs $ 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
June 30, 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
and six-month periods ended June 30, 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
2,933,570 for the three-month and six-month periods ended June 30, 2004 and
2,743,137 for the three-month and six-month periods ended June 30, 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 June 30, 2004:
Raw materials $ 859,084
Finished goods 394,249
----------
$1,253,333
==========
Deferred Financing Costs
The Company capitalizes financing costs and amortizes them using the
straight-line method, which approximates the effective interest method, over the
term of the related debt. Amortization of deferred financing costs is included
in interest expense and totaled approximately $34,000 and $45,000 for the
three-months ended June 30, 2004 and 2003, respectively, and approximately
$72,000 and $83,000 for the six-months ended June 30, 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 deferred financing
costs of $214,400 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 June 30, 2004 was
approximately $422,000.
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.
7
Stock options and warrants issued to consultants and other non-employees as
compensation for services provided to the Company are accounted for based on the
fair value of the services provided or the estimated fair market value of the
option or warrant, whichever is more reliably measurable in accordance with SFAS
123 and EITF 96-18, Accounting for Equity Investments That are Issued to Other
Than Employees for Acquiring or in Conjunction with Selling Goods or Services.
The related expense is recognized over the period the services are provided.
Pro forma information regarding net loss and loss per common share as if the
Company had accounted for its employee stock options under the fair value method
of SFAS 123 is presented below. For purposes of pro forma disclosure, the
estimated fair value of the options is amortized to expense over the options'
vesting period. The Company's pro forma information is as follows:
Three Months Ended June 30, Six Months Ended June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net loss as reported $ (822,311) $(1,196,834) $(1,986,715) $(2,149,459)
Stock-based employee compensation
cost (intrinsic value method) -- -- -- --
Fair value method stock option
expense (266,508) (262,473) (624,922) (616,918)
----------- ----------- ----------- -----------
Pro forma net loss $(1,088,819) $(1,459,307) $(2,611,637) $(2,766,377)
=========== =========== =========== ===========
Loss per common share:
Basic and diluted loss as reported $ (0.05) $ (0.08) $ (0.12) $ (0.14)
Basic and diluted loss pro forma $ (0.06) $ (0.09) $ (0.15) $ (0.18)
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.
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 $41,000, are included in the
accompanying condensed consolidated balance sheet as of June 30, 2004.
8
The following table shows the changes in the aggregate product warranty
liability for the six-months ended June 30, 2004:
Balance as of December 31, 2003 $ 42,573
Less: Payments made (24,796)
Change in prior period estimate (1,526)
Add: Provision for current period warranties 24,733
--------
Balance as of June 30, 2004 $ 40,984
========
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, Puradyn Filter Technologies, Ltd. (Ltd).
Comprehensive loss as of June 30, 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 and six-months ended
June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
--------- ----------- ----------- -----------
Net loss $(822,311) $(1,196,834) $(1,986,715) $(2,149,459)
--------- ----------- ----------- -----------
Other comprehensive income (loss):
Foreign currency translation adjustment 3,833 (5,215) (4,006) (28,946)
--------- ----------- ----------- -----------
Total other comprehensive income (loss) 3,833 (5,215) (4,006) (28,946)
--------- ----------- ----------- -----------
Comprehensive loss $(818,478) $(1,202,049) $(1,990,721) $(2,178,405)
========= =========== =========== ===========
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 $1,599,000
and $1,924,000 during the six-months ended June 30, 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
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 June 30, 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.
9
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. In March 2004, the Company had repaid $2.0
million of the $5.0 million it had drawn from 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. In May 2004 and in July 2004, the
Company made draws of $500,000, respectively.
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 ($2.5 million as of June 30, 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 $1.47 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.
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 all or 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 (see Note 2).
The Company incurred related offering costs of approximately $21,000.
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
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.
10
4. STOCK OPTIONS
During the six-months ended June 30, 2004 and 2003, employees of the Company
exercised 10,000 and 43,775, respectively, of common stock options. The Company
received $10,000 and $42,666, respectively, in cash proceeds in exchange for the
shares issued.
During the three-month and six month periods ended June 30, 2004, the Company
recognized a credit to operations of approximately $34,000 and $26,000,
respectively, (under the intrinsic value method), relating to outstanding
variable option awards, which is included in stock based compensation expense
for the three-month and six-month periods ended June 30, 2004. During the
three-month and six-month periods ended June 30, 2003, the Company recognized
approximately $95,000 and $129,000, respectively, of compensation expense
relating to variable option awards, which is included stock based compensation
expense. At June 30, 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 retired 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 stock based compensation
expense for the six-month period ended June 30, 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 June 30, 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. Both of
the lines allow for discretionary principal payments, which add to the
availability of additional funds that the Company may draw. In May 2004, the
Company drew $500,000, leaving an outstanding balance payable of approximately
$3.5 million as of June 30, 2004. In July 2004, an additional draw of $500,000
was made.
For the three-months ended June 30, 2004 and 2003, the Company recorded
approximately $32,000 and $35,000, respectively, and for the six-months ended
June 30, 2004 and 2003, the Company recorded approximately $82,000 and $59,000,
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.
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.
11
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.
On May 27, 2004, the Company filed responses to the interrogatories. The Court
sent notices to certain current and one former employee of the Company to take
depositions in August 2004. 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, as described in Notes 2 and 3. 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 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 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 can be extended, provided that oil analysis verifies the oil is
clean.
13
This strategy includes focus on:
o The expansion of existing strategic relationships and development of
new relationships and partnerships to further sales growth and gain
distribution strength in order to accelerate product acceptance
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
and benefits 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 equipment. 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 and 2004, 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 JUNE 30, 2004 COMPARED TO THE
THREE-MONTHS ENDED JUNE 30, 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 June 30, 2004 to the three-months
ended June 30, 2003:
(In thousands) Three Months Ended June 30,
-------------------------------
2004 2003 Change
------- ------- -----
Net sales $ 627 $ 313 $ 314
------- ------- -----
Costs and expenses:
Cost of products sold 645 479 166
Salaries and wages 403 466 (63)
Selling and administrative 380 402 (22)
Stock-based compensation (34) 95 (129)
------- ------- -----
Total costs and expenses 1,394 1,442 (48)
------- ------- -----
Other (expense) income:
Interest income 13 13 --
Interest expense (68) (81) 13
------- ------- -----
Total other expense (55) (68) 13
------- ------- -----
Net loss $ (822) $(1,197) $ 375
======= ======= =====
NET SALES
Net sales increased by approximately 100% from approximately $313,000 in 2003 to
approximately $627,000 in 2004. The increase is attributable to the addition of
several new distributors both domestically and internationally, as well as an
increase in sales to one of the Company's largest customers, whose sales for the
three-month period ended June 30, 2004 increased approximately 213% over the
comparable period in 2003.
In addition, during the three-months ended June 30, 2003, the Company, in
accordance with the requirements of SFAS 48 and SAB 104, recorded a provision
for sales returns of approximately $146,000 related to a product enhancement
exchange, which was not required to correct any product quality or performance
issues. The revenue was recognized upon reshipment of the enhanced product,
which occurred in the third quarter of 2003. Excluding the effect of the sales
return allowance recorded in 2003, net sales increased approximately 37%, or
$168,000.
Sales to two customers accounted for approximately 17% and 15% (for a total of
32%) of the consolidated net sales for the three-months ended June 30, 2004. For
the three-months ended June 30, 2003, one customer accounted for approximately
41% of the consolidated net sales. The UK subsidiary's sales increased by
approximately 11% for the three-month period ended June 30, 2004 compared to the
three-month period ended June 30, 2003.
COST OF PRODUCTS SOLD
Cost of products sold increased by approximately 35% from approximately $479,000
in 2003 to approximately $645,000 in 2004. The majority of this increase,
approximately $102,000, is due to the fact that during the three-month period
ended June 30, 2003, the Company recorded a provision for sales returns and the
related cost deferral, related to a product enhancement exchange (see Net Sales
above). Excluding the effect of the deferred cost recorded in 2003, cost of
products sold increased approximately 11%, or $64,000, which is due to the 37%
increase in net sales (see Net Sales above). The disproportionate increase in
net sales compared to that of cost of products sold is attributable to several
factors, which include: a reduction in direct laborers, changes in the
allocation rates of manufacturing overhead and a significant reduction in
product sales returns.
SALARIES AND WAGES
Salaries and wages decreased approximately $63,000, or 14%. This decrease is the
result of a net reduction of four employees, representing approximately a
$66,000 decrease, which was offset by vacation accrual and employee salary
adjustments.
15
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses decreased by approximately $22,000, or 5%,
due primarily to a temporary reduction of advertising in trade publications.
STOCK-BASED COMPENSATION
The Company recorded a credit to operations of approximately $34,000 for the
three-months ended June 30, 2004 and approximately $95,000 of stock based
compensation expense for the three-months ended June 30, 2003, representing a
decrease of approximately $129,000, 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.
INTEREST EXPENSE
Interest expense decreased by approximately $13,000, or 16%, as a result of the
change in the amortization period for the deferred financing costs, due to the
extension of the payback date to December 31, 2005, of the notes payable to
stockholder. The Company pays interest monthly on the notes payable to
stockholder at the prime rate, which was 4% as of June 30, 2004.
RESULTS OF OPERATIONS FOR THE SIX-MONTHS ENDED JUNE 30, 2004 COMPARED TO THE
SIX-MONTHS ENDED JUNE 30, 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 six-months ended June 30, 2004 to the six-months
ended June 30, 2003:
(in thousands) Six Months Ended June 30,
-----------------------------------
2004 2003 Change
------- ------- -----
Net sales $ 1,241 $ 1,065 $ 176
------- ------- -----
Costs and expenses:
Cost of products sold 1,275 1,160 115
Salaries and wages 813 911 (98)
Selling and administrative 774 896 (122)
Stock-based compensation 237 129 108
------- ------- -----
Total costs and expenses 3,099 3,096 3
------- ------- -----
Other income (expense):
Interest income 27 26 1
Interest expense (156) (144) (12)
------- ------- -----
Total other expense (129) (118) (11)
------- ------- -----
Net loss $(1,987) $(2,149) $ 162
======= ======= =====
NET SALES
Net sales increased by approximately 17% from approximately $1,065,000 in 2003
to approximately $1,241,000 in 2004. The majority of this increase is due to the
fact that during the six-month period ended June 30, 2003, the Company, in
accordance with the requirements of SFAS 48 and SAB 104, recorded a provision
for sales returns of approximately $146,000 related to a product enhancement
exchange, which was not required to correct any product quality or performance
issues. The revenue was recognized upon reshipment of the enhanced product,
which occurred in the third quarter of 2003. Excluding the effect of the sales
return allowance recorded in 2003, net sales increased by approximately 2%, or
approximately $30,000.
16
Sales to two customers individually accounted for approximately 21% and 17% (for
a total 38%) and 30% and 19% (for a total of 49%) of net sales for the
six-months ended June 30, 2004 and 2003, respectively. The UK subsidiary's sales
increased by approximately 17% for the six-month period ended June 30, 2004
compared to the six-month period ended June 30, 2003.
COST OF PRODUCTS SOLD
Cost of products sold increased by approximately 10%, or approximately $115,000,
from approximately $1,160,000 in 2003 to approximately $1,275,000 in 2004. The
majority of this increase, approximately $102,000, is due to the fact that
during the six-month period ended June 30, 2003, the Company recorded a
provision for sales returns and the related cost deferral, related to a product
enhancement exchange (see Net Sales above). Excluding the effect of the deferred
cost recorded in 2003, cost of products sold increased approximately 1%, or
$13,000.
SALARIES AND WAGES
Salaries and wages decreased approximately $98,000, or 11%. This decrease is the
result of a net reduction of four employees, representing approximately a
$134,000 decrease, which was offset by vacation accrual and employee salary
adjustments.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses decreased by approximately 14% from
approximately $896,000 for the six months ended June 30, 2003 to approximately
$774,000 for the six months ended June 30, 2004, due primarily to a reduction in
spending in the sales and marketing department, reduced patent expense due to
higher costs in the first quarter of 2003 for new applications that were
initiated, and reduced consulting and other costs related to the International
Standardization Organization (ISO) 9001:2000 certification incurred during the
six-months ended June 30, 2003.
STOCK-BASED COMPENSATION
The Company recorded approximately $237,000 and $129,000, respectively, of stock
based compensation expense for the six-months ended June 30, 2004 and 2003,
related to certain variable equity awards and other stock based compensation.
The increase of approximately $108,000 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 retired 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 and recorded the corresponding
charge of approximately $263,000 to compensation expense. This expense was
offset by approximately a $155,000 decrease in stock-based compensation expense
related to variable awards, resulting in a credit to operating expenses of
approximately $26,000 for the six-months ended June 30, 2004. 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 $12,000 as a result of a larger
average outstanding balance of the notes payable to stockholder. The Company
pays interest monthly on the notes payable to stockholder at the prime rate,
which was 4% as of June 30, 2004.
17
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2004, the Company had cash and cash equivalents of approximately
$204,000. For the six-month period ended June 30, 2004, net cash used in
operating activities was approximately $1,599,000, which primarily resulted from
the net loss of approximately $1,987,000. Net cash used in investing activities
was approximately $60,000 for the purchase of property and equipment. Net cash
provided by financing activities was approximately $473,000 for the period, due
to net proceeds from the stockholder loan. The $2.0 million of capital raised
during the period ended June 30, 2004 from the Company's private placement was
offset by the repayment of $2.0 million of the stockholder 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 June 30, 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 June 30, 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 June
30, 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 June 30, 2004, the
Company had drawn $3.0 million of the available funds and repaid $2.0 million of
the loan on the second line. Both of the lines allow for discretionary principal
payments, which add to the availability of additional funds that the Company may
draw. In July 2004, the Company drew an additional $500,000.
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
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 was 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.
18
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 June 30, 2004, the Company had working capital of approximately $1.2 million
and its current ratio (current assets to current liabilities) was 2.35 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 recent 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 all or
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.
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 June 30, 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 June 30, 2004.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Certain litigation involving the Company is described in the Company's Form
10-KSB for the year ended December 31, 2003. Subsequent to the filing of such
Form 10-KSB, no material developments have occurred with respect to such
litigation except on May 27, 2004, the Company filed answers to the
interrogatories presented by the plaintiff's counsel. The Court sent notices to
certain current and one former employee of the Company to take depositions in
August 2004.
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 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Act, as amended
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Act, as amended
32 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C., as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
20
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: August 11, 2004
-------------------------------------
Lisa M. De La Pointe, Chief Financial Officer
21