UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended:
March 31, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE EXCHANGE ACT
For the transition period from __________________ to ________________
Commission file number
0-21151
PROFILE TECHNOLOGIES, INC.
---------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
DELAWARE 91-1418002
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2 Park Avenue, Suite 201
Manhasset, New York 11030
------------------- -----
(Address of Principal (Zip Code)
Executive Office)
516-365-1909
------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of May 1, 2006, the number of shares outstanding of the issuer's common
stock, the only class of common equity was 12,346,445.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [ X ]
TABLE OF CONTENTS
Description Page Number
----------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheet (Unaudited) -
At March 31, 2006..................................................3
Statements of Operations (Unaudited) -
Three Months Ended and Nine Months Ended March 31, 2006 and 2005...4
Statements of Cash Flows (Unaudited) -
Nine Months Ended March 31, 2006 and 2005..........................5
Statements of Stockholders' Deficit (Unaudited) -
Nine Months Ended March 31, 2006 ..................................6
Notes to Financial Statements (Unaudited)...............................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................13
Item 3. Controls and Procedures..........................................21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds......21
Item 3. Defaults Upon Senior Securities..................................22
Item 4. Submission of Matters to a Vote of Shareholders..................22
Item 5. Other Information................................................22
Item 6. Exhibits.........................................................22
SIGNATURES......................................................................24
CERTIFICATIONS
2
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements.
PROFILE TECHNOLOGIES, INC.
Balance Sheet
(unaudited)
March 31,
2006
------------
Assets
Current assets:
Cash $ 499,075
Prepaid expenses and other current assets 14,023
------------
Total current assets 513,098
Equipment, net of accumulated depreciation of $542,637 3,929
Deferred financing fees 910
Other assets 1,550
------------
Total assets $ 519,487
============
Liabilities and Stockholders' Deficit
Current Liabilities:
Accounts payable $ 169,460
Notes payable to stockholders 57,500
Current portion of convertible debt 107,500
Deferred wages 707,636
Accrued professional fees 186,150
Accrued interest 2,232
Other accrued expenses 23,644
------------
Total current liabilities 1,254,122
Long-term convertible debt, net of unamortized discount of $67,388 112
Stockholders' deficit:
Common stock, $0.001 par value. Authorized 25,000,000
shares; issued and outstanding 10,584,445 shares 10,584
Common stock issuable; 694,000 shares 694
Additional paid-in capital 11,894,799
Accumulated deficit (12,640,824)
------------
Total stockholders' deficit (734,747)
Commitments, contingencies and subsequent events
------------
Total liabilities and stockholders' deficit $ 519,487
============
See accompanying notes to financial statements.
3
PROFILE TECHNOLOGIES, INC.
Statements of Operations
(unaudited)
For the three months ended For the nine months ended
March 31, March 31,
2006 2005 2006 2005
------------ ------------ ------------ ------------
Revenue $ -- $ -- $ -- $ --
Cost of revenues -- -- -- --
------------ ------------ ------------ ------------
Gross profit -- -- -- --
------------ ------------ ------------ ------------
Operating expenses:
Research and development 56,852 207,926 303,718 245,455
General and administrative 158,891 169,633 494,335 540,310
------------ ------------ ------------ ------------
Total operating expenses 215,743 377,559 798,053 785,765
------------ ------------ ------------ ------------
Loss from operations (215,743) (377,559) (798,053) (785,765)
Interest expense 12,300 19,113 237,632 158,062
------------ ------------ ------------ ------------
Net loss $ (228,043) $ (396,672) $ (1,035,685) $ (943,827)
============ ============ ============ ============
Basic and diluted net loss per share $ (0.02) $ (0.07) $ (0.12) $ (0.17)
Weighted average shares outstanding used to
calculate basic and diluted net loss per share 10,544,723 5,795,705 8,811,991 5,657,508
See accompanying notes to financial statements.
4
PROFILE TECHNOLOGIES, INC.
Statements of Cash Flows
(unaudited)
For the nine months ended
March 31,
2006 2005
----------- -----------
Cash flows from operating activities:
Net loss $(1,035,685) $ (943,827)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 3,706 5,885
Accreted discount on convertible debt 106 31
Amortization of convertible debt discount included in interest expense 197,945 100,000
Accrued interest on convertible debt converted to equity 370 522
Accrued interest on notes payable to stockholders converted to equity 114,777 --
Amortization of debt issuance costs 10,450 4,530
Equity issued for services 85,850 252,500
Changes in operating assets and liabilities:
Prepaid expenses and other current assets 3,628 (4,689)
Other assets 865 --
Accounts payable (26,905) 10,421
Deferred wages 68,510 208,116
Accrued professional fees 18,000 18,000
Accrued interest (101,120) 31,472
Other accrued expenses 3,050 (2,827)
----------- -----------
Net cash used in operating activities (656,453) (319,866)
Cash flows from financing activies:
Allocated proceeds from issuance of convertible debt -- 56,023
Allocated proceeds from issuance of warrants attached to convertible debt -- 101,977
Common stock issuance costs (110,750) --
Allocated proceeds from issuance of common stock 377,806 --
Allocated proceeds from issuance of warrants attached to issuance of common stock 771,694 --
Proceeds from issuance of notes payable to stockholders 89,733 174,000
Repayments of note payable to stockholders -- (48,270)
----------- -----------
Net cash provided by financing activities 1,128,483 283,730
----------- -----------
Increase (decrease) in cash 472,030 (36,136)
Cash at beginning of period 27,045 59,813
----------- -----------
Cash at end of period $ 499,075 $ 23,677
=========== ===========
Supplemental disclosure of cash flow information:
Debt discount recorded for beneficial conversion feature $ -- $ 56,023
Cash paid for interest $ 10,652 $ 16,751
Convertible debt and related accrued interest converted into 456,740 and 201,044 shares of
common stock during the nine months ended March 31, 2006 and 2005, respectively $ 228,369 $ 100,522
Notes payable to stockholder converted into 2,322,446 shares of common stock
during the nine months ended March 31, 2006 $ 1,161,223 $ --
Accrued interest on notes payable to stockholder converted into 229,554 shares of common stock
during the nine months ended March 31, 2006 $ 114,777 $ --
See accompanying notes to financial statements.
5
PROFILE TECHNOLOGIES, INC.
Statements of Stockholders' Deficit
For the Nine Months Ended March 31, 2006
(unaudited)
Common Stock Common Stock Issuable
--------------------------- ----------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
Balance at June 30, 2005 5,925,705 $ 5,926 45,000 $ 45
Common stock issued related to the 2005 Offering 45,000 45 (45,000) (45)
Issuance of common stock warrants and options
for services -- -- -- --
Issuance of common stock upon conversion
of stockholder loan and accrued interest to equity 2,552,000 2,552 -- --
Issuance of common stock upon conversion
of convertible debt to equity 456,740 456 -- --
Issuance of common stock warrants related to
the 2005 Offering -- -- -- --
Issuance of common stock related to the
2005 Offering 1,605,000 1,605 -- --
Common stock issuance costs -- -- -- --
Common stock issuable related to the 2005
Offering -- -- 694,000 694
Net loss -- -- -- --
------------ ------------ ------------ ------------
Balance at March 31, 2006 10,584,445 $ 10,584 694,000 $ 694
============ ============ ============ ============
Table continues below.
Total
Additional Stockholders'
Paid-in Accumulated Equity
Capital Deficit (Deficit)
------------ ------------ ------------
Balance at June 30, 2005 $ 9,271,137 $(11,605,139) $ (2,328,031)
Common stock issued related to the 2005 Offering -- -- --
Issuance of common stock warrants and options
for services 85,850 -- 85,850
Issuance of common stock upon conversion
of stockholder loan and accrued interest to equity 1,273,448 -- 1,276,000
Issuance of common stock upon conversion
of convertible debt to equity 227,913 -- 228,369
Issuance of common stock warrants related to
the 2005 Offering 771,694 -- 771,694
Issuance of common stock related to the
2005 Offering 376,201 -- 377,806
Common stock issuance costs (110,750) (110,750)
Common stock issuable related to the 2005
Offering (694) -- --
Net loss -- (1,035,685) (1,035,685)
------------ ------------ ------------
Balance at March 31, 2006 $ 11,894,799 $(12,640,824) $ (734,747)
============ ============ ============
See accompanying notes to financial statements.
6
PROFILE TECHNOLOGIES, INC
March 31, 2006
Notes to Financial Statements (Unaudited)
1. Description of Business
Profile Technologies, Inc. (the "Company"), was incorporated in 1986 and
commenced operations in fiscal year 1988. The Company is in the business of
inspecting pipelines for corrosion and is in the final stages of researching and
developing a patented, non-destructive and non-invasive, high speed scanning
process, using electro magnetic waves to remotely inspect buried, encased and
insulated pipelines for corrosion.
2. Basis of Presentation
The unaudited interim financial statements and related notes of the Company
have been prepared pursuant to the instructions to Form 10-QSB. Accordingly,
certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted pursuant to such instructions.
The preparation of financial statements requires the Company to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues,
and expenses. On an on-going basis, the Company evaluates its estimates,
including contract revenue recognition and impairment of long-lived assets.
Actual results and outcomes may differ materially from these estimates and
assumptions.
The financial statements and related notes should be read in conjunction
with the audited financial statements and notes thereto included in the
Company's annual report on Form 10-KSB for the year ended June 30, 2005. The
information furnished reflects, in the opinion of management, all adjustments,
consisting of only normal recurring items, necessary for fair presentation of
the results of the interim periods presented. Interim results are not
necessarily indicative of results for a full year.
3. Liquidity
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. The Company incurred cumulative losses
of $12,640,824 through March 31, 2006 and had negative working capital of
$741,024 as of March 31, 2006. Additionally, the Company has expended a
significant amount of cash in developing its technology and patented processes.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management recognizes that in order to meet the Company's
capital requirements, and continue to operate, additional financing, including
seeking industry-partner investment through joint ventures or other possible
arrangements, will be necessary. The Company is evaluating alternative sources
of financing to improve its cash position and is undertaking efforts to raise
capital. If the Company is unable to raise additional capital or secure
additional revenue contracts and generate positive cash flow, it is unlikely
that the Company will be able to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
4. Summary of Significant Accounting Policies
Cash
Cash includes highly liquid investments with original maturities of three
months or less.
Fair Value of Financial Instruments
The Company has the following financial instruments: cash, accounts
payable, notes payable to stockholders, and convertible debt. The carrying value
of these instruments, other than the convertible debt, approximates fair value
based on their liquidity. The fair value of the convertible debt was determined
as the excess of the proceeds over the fair value of the warrants.
7
Deferred Financing Fees
The Company records costs incurred related to debt financings as deferred
financing fees and amortizes, on a straight-line basis, the costs incurred over
the life of the related debt. The amortization is recognized as interest in the
financial statements. Upon conversion into equity or extinguishment of the
related debt, the Company recognizes any unamortized portion of the deferred
financing fees as interest expense.
Contract Revenue Recognition
The Company recognizes revenue from service contracts using the percentage
of completion method of accounting. Contract revenues earned are measured using
either the percentage of contract costs incurred to date to total estimated
contract costs or, when the contract is based on measurable units of completion,
revenue is based on the completion of such units. This method is used because
management considers total cost or measurable units of completion to be the best
available measure of progress on contracts. Because of the inherent
uncertainties in estimating costs, it is at least reasonably possible that the
estimates used may change in the near term.
Anticipated losses on contracts, if any, are charged to earnings as soon as
such losses can be estimated. Changes in estimated profits on contracts are
recognized during the period in which the change in estimate is known.
Cost of revenues include contract costs incurred to date as well as any
idle time incurred by personnel scheduled to work on customer contracts.
The Company records claims for additional compensation on contracts upon
revision of the contract to include the amount to be received for the additional
work performed. Contract costs include all direct material and labor costs and
those indirect costs related to contract performance, such as indirect labor,
supplies, tools and repairs, and depreciation costs. Selling, general, and
administrative costs are charged to expense as incurred. Service contracts
generally extend no more than six months.
Research and Development
Research and development costs are expensed when incurred. During the three
and nine months ended March 31, 2006 the Company incurred $56,852 and $303,718,
respectively, on research and development activities. During the three and nine
months ended March 31, 2005 the Company incurred $207,926 and $245,455,
respectively, on research and development activities.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company reviews long-lived assets, such as equipment and intangibles,
for impairment at least annually or whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to estimated undiscounted future cash flows expected
to be generated by the asset. If the carrying amount of an asset exceeds its
estimated future cash flows, an impairment charge is recognized by the amount by
which the carrying amount of the asset exceeds the fair value of the asset.
Valuation of Warrants and Options
The Company estimates the value of warrants and option grants using a
Black-Scholes pricing model based on management assumptions regarding the
warrant and option lives, expected volatility, and risk free interest rates.
5. Stock Based Compensation
Prior to January 1, 2006, the Company accounted for stock-based awards
under the intrinsic value method, which followed the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. The intrinsic value method of accounting resulted in
compensation expense for stock options to the extent that the exercise prices
were set below the fair market price of the Company's stock at the date of
grant.
As of January 1, 2006, the Company adopted SFAS No. 123(R) using the
modified prospective method, which requires measurement of compensation cost for
all stock-based awards at fair value on date of grant and recognition of
8
compensation over the service period for awards expected to vest. The fair value
of stock options is determined using the Black-Scholes valuation model, which is
consistent with the Company's valuation techniques previously utilized for
options in footnote disclosures required under SFAS No. 123, Accounting for
Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure. Such value is recognized as expense
over the service period. To date, all stock option grants have been fully vested
upon grant.
The application of SFAS 123(R) had the following effect on net loss as
reported:
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------- --------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Net loss:
As reported $ (228,043) $ (396,672) $(1,035,685) $ (943,827)
Plus: stock-based employee compensation
expense included in reported net loss -- -- -- --
Less: stock based compensation expense
determined under fair value based method
for all employee awards -- (1,255,965) (352,000) (1,255,965)
----------- ----------- ----------- -----------
Net loss $ (228,043) $(1,652,637) $(1,387,685) $(2,199,792)
----------- ----------- ----------- -----------
Net loss per share
Basic and diluted - as reported $ (0.02) $ (0.07) $ (0.12) $ (0.17)
Basic and diluted - pro forma $ (0.02) $ (0.29) $ (0.16) $ (0.39)
6. Net Loss Per Share
Basic net loss per share is computed by dividing the net loss by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed by dividing the net loss by the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. As the Company had a net loss attributable to common shareholders in
each of the periods presented, basic and diluted net loss per share are the
same.
Excluded from the computation of diluted net loss per share for the three
and nine months ended March 31, 2006, because their effect would be
antidilutive, are options and warrants to acquire 10,204,818 shares of common
stock with a weighted-average exercise price of $1.12 per share. Also excluded
from the computation of diluted net loss per share for the three and nine months
ended March 31, 2006 are 350,000 shares of common stock that may be issued if
investors exercise their conversion right under the Debentures related to the
2003 Offering as discussed in Note 8 because their effect would be antidilutive.
Excluded from the computation of diluted net loss per share for the three
and nine months ended March 31, 2005, because their effect would be
antidilutive, are options and warrants to acquire 5,664,818 shares of common
stock with a weighted-average exercise price of $1.44 per share. Also excluded
from the computation of diluted net loss per share for the three and nine months
ended March 31, 2005 are 806,000 shares of common stock that may be issued if
investors exercise their conversion right under the Debentures related to the
2003 Offering as discussed in Note 8 because their effect would be antidilutive.
For the three and nine months ended March 31, 2006 and 2005, additional
potential dilutive securities that were excluded from the diluted net loss per
share computation are the exchange rights discussed in Note 9 that could result
in options to acquire up to 223,000 shares of common stock with an exercise
price of $1.00 per share at March 31, 2006 and 2005.
For purposes of earnings per share computations, shares of common stock
that are issuable at the end of a reporting period are included as outstanding.
9
7. Notes Payable - Stockholders
In April 2002, the Company issued a non-interest bearing bridge note
payable to an officer of the Company in the amount of $7,500. The note is
payable in full when the Company determines it has sufficient working capital to
do so. On September 29, 2002, the officer who was owed the $7,500 died.
The Company has entered into various loan agreements with Murphy Evans,
President, a director and stockholder of the Company. On March 6, 2003, the
Company's Board of Directors approved the Loan Amendment and Promissory Note
(the "Amended Evans Loan") between the Company and Murphy Evans. The Amended
Evans Loan aggregates all previous debt and supersedes and replaces all of the
terms of the previous loans with Mr. Evans, including any conversion features.
The Amended Evans Loan bears interest on the aggregate principal balance at a
rate of 5% per annum, payable on June 30 and December 31 of each year, with the
principal balance due and payable in full on December 31, 2003. The Amended
Evans Loan is exempt from registration under Section 4(2) of the Securities Act.
During the nine months ended March 31, 2006, Mr. Evans loaned the Company
an additional $89,733 pursuant to the terms of the Amended Evans Loan. During
the nine months ended March 31, 2006, Mr. Evans converted the entire then
outstanding $1,161,223 of principal and $114,777 of accrued interest of the
Amended Evans Loan pursuant to the terms of the 2005 Offering as defined below.
Accordingly, Mr. Evans received 2,552,000 shares of common stock and warrants to
purchase 2,552,000 shares of common stock at an exercise price of $0.75 per
share. The warrants are exercisable any time prior to the fifth anniversary from
the date of grant.
Interest expense related to the Amended Evans Loan was $579 and $16,449 for
the three and nine months ended March 31, 2006, respectively. Interest expense
related to the Amended Evans Loan was $12,059 and $33,955 for the three and nine
months ended March 31, 2005, respectively.
In September 2002, the Company entered into two non-interest bearing bridge
loans in the respective principal amounts of $40,000 and $10,000 (the
"Stockholder Loans") payable to two stockholders of the Company. The terms of
the Stockholder Loans provide for payment at such time as the Company determines
it has sufficient working capital to repay the principal balances of the
Stockholder Loans. The Stockholder Loans are convertible into 57,142 and 14,286
equity units, respectively, at any time prior to re-payment. Each equity unit is
comprised of one share of the Company's common stock, with a detachable 5-year
warrant to purchase one additional share at an exercise price of $1.05 per
share. Neither stockholder has converted either Stockholder Loan into equity
units.
On June 19, 2003, the Board of Directors approved a promissory note (the
"2003 Gemino Note") in the principal amount of $34,047 payable to Henry E.
Gemino, the Chief Executive Officer, Chief Financial Officer and a director and
stockholder of the Company. From time to time, Mr. Gemino loaned the Company
additional money and the Company repaid various amounts under the terms of the
2003 Gemino Note. The 2003 Gemino Note bears interest at the rate of 5% per
annum, payable on June 30 and December 31 of each year. During the year ended
June 30, 2005, the Company repaid the then outstanding principal balance of
$48,270 and accrued interest to Mr. Gemino. Interest expense related to the 2003
Gemino Note was $0 for the three and nine months ended March 31, 2006. Interest
expense related to the 2003 Gemino Note was $32 and $892 for the three and nine
months ended March 31, 2005, respectively.
The following is a summary of notes payable to stockholders as of March 31,
2006:
Deceased Officer Note 7,500
Stockholder Loans 50,000
-------
Total $57,500
=======
10
8. Convertible Debt
On June 19, 2003, the Board of Directors approved the offering (the "2003
Offering") of $1,000,000 in convertible debentures (the "Debentures"). The
Debentures are convertible into that number of shares of the Company's common
stock equal to the amount of the converted indebtedness divided by $0.50 per
share. The Debentures bear interest at a rate of 5% per annum, payable
quarterly. Delinquent interest payments bear interest at a rate of 12% per
annum. The Company is required to redeem each Debenture on the 5th anniversary
of the date of the Debenture. The Company may, in its discretion, redeem any
Debenture at any time prior to the mandatory redemption date of the Debenture by
providing no less than 60 days' prior written notice to the holder of the
Debenture. Certain events of default will result in the Debentures being
redeemable by the Company upon demand of the holder.
Upon the purchase of, and for each $0.50 of the Debenture's principal
amount, the Company issued to each investor a warrant (the "Warrant") to
purchase one (1) share of the Company's common stock at an exercise price of
$0.75 per share. The Warrants are exercisable at any time prior to the 5th
anniversary date of the redemption of the Debenture.
Warrants issued in connection with the 2003 Offering were recorded based on
their relative fair value as compared to the fair value of the debt at issuance.
The relative fair value of the warrants was recorded as paid-in capital,
estimated at $0 and $101,977 for the three and nine months ended March 31, 2005,
respectively. The fair value of the warrants issued during the three and nine
months ended March 31, 2005, was determined based on an option pricing model
with the following assumptions: warrant lives of 10 years, risk free interest
rates ranging from 4.14% to 4.30%, volatility of 120%, and a zero dividend
yield. The intrinsic value of the Debentures results in a beneficial conversion
feature that reduces the book value of the convertible debt to not less than
zero. Accordingly, the Company recorded a discount of $0 and $56,023 during the
three and nine months ended March 31, 2005, respectively, on the convertible
debt issued under the 2003 Offering. The Company amortizes the discount using
the effective interest method over the five-year life of the Debentures.
During the quarter ended March 31, 2005, the Board of Directors terminated
the 2003 Offering. As of the closing date of the 2003 Offering, the Company had
raised $503,000 from the 2003 Offering.
During the three and nine months ended March 31, 2006, one and six
investors, respectively, exercised their conversion right under the terms of the
Debentures. Accordingly, the carrying value of the convertible debt was
reclassified as equity upon conversion. Since the convertible debt instruments
include a beneficial conversion feature, the remaining unamortized discount of
$7,991 and $197,945 at the conversion date was recognized as interest expense
during the three and nine months ended March 31, 2006, respectively.
During the three and nine months ended March 31, 2005, none and five
investors, respectively, exercised their conversion right under the terms of the
Debentures. Accordingly, the carrying value of the convertible debt was
reclassified as equity upon conversion. Since the convertible debt instruments
include a beneficial conversion feature, the remaining unamortized discount of
approximately $0 and $100,000 at the conversion date was recognized as interest
expense during the three and nine months ended March 31, 2005, respectively.
As of March 31, 2006, accrued interest on the Debentures was $2,232. The
Company recorded interest expense related to the accretion of the discount on
the Debentures and amortization of the convertible debt discount as a result of
the conversions discussed above of $8,039 and $198,051 for the three and nine
months ended March 31, 2006, respectively. The Company recorded interest expense
related to the accretion of the discount on the Debentures and amortization of
the convertible debt discount as a result of the conversions discussed above of
$17 and $100,031 for the three and nine months ended March 31, 2005,
respectively. As of March 31, 2006 the carrying value of the long-term portion
of the Debentures was $112, net of unamortized debt discount of $67,388.
9. Deferred Wages and Accrued Professional Fees
To reduce cash outflows, certain of the Company's employees, officers,
consultants, and directors have agreed to defer a portion of their salaries and
professional fees until the Company has sufficient resources to pay the amounts
owed or to exchange such amounts into options as described below. At March 31,
2006, the Company has accrued $893,786 related to the deferred payment of
salaries and professional fees of which $707,636 is included under deferred
wages and $186,150 in accrued professional fees. On March 18, 2002, the Board
11
approved a conversion right on all deferred wages and accrued professional fees
deferred as of March 18, 2002. Pursuant to this conversion right, employees,
officers, consultants, and directors may elect to convert $1.00 of fees owed to
them as of March 18, 2002 for an option to purchase two shares of the Company's
common stock, at an exercise price of $1.00 per share for a term of five years.
Deferred salaries and fees as of March 18, 2002 were $111,500, resulting in the
potential issuance of 223,000 options under the terms mentioned above. No
conversions have occurred to date. At March 18, 2002, there was no intrinsic
value associated with these exchange rights. As such, no additional compensation
cost was recorded.
10. Common Stock
On January 19, 2005, the Board of Directors approved the offering (the
"2005 Offering") of 2,000,000 units (the "Units") for a total offering price of
$1,000,000, consisting of shares of common stock and attached warrants. On
November 21, 2005, the Board of Directors approved an increase in the number of
Units to 6,000,000 Units for a total offering price of $3,000,000. The purchase
price of one Unit is $0.50. Each Unit consists of one share of common stock and
a warrant to purchase one share of common stock at an exercise price of $0.75
per share. The warrants are exercisable at any time prior to the fifth
anniversary from the date of grant.
During the nine months ended March 31, 2006, the Company raised $1,149,500
under the terms of the 2005 Offering. Accordingly, the Company issued 2,299,000
shares of common stock and warrants to purchase up to 2,299,000 shares of common
stock at an exercise price of $0.75 per share.
The Company engaged a brokerage firm to help in the fund raising efforts of
the 2005 Offering. Pursuant to the terms of the agreement with the brokerage
firm, the Company will pay the brokerage firm a ten percent cash commission on
all funds that the brokerage firm helps raise. Additionally, the Company will
issue warrants to purchase shares of common stock at $0.75 per share equal to
ten percent of the total warrants issued in connection with the 2005 Offering.
The warrants may be exercised up to five years from the date of issuance, which
is the date the proceeds are received under the 2005 Offering. During the three
and nine months ended March 31, 2006, the Company incurred $39,400 and $110,750,
respectively, of fees to be paid in cash to the brokerage firm and issued
warrants to purchase 78,800 and 221,500, respectively, shares of common stock.
During the three and nine months ended March 31, 2006, the Company recorded
$100,076 and $207,260, respectively, as a reduction to paid-in capital for the
fair value of the warrant grants. The fair value of the warrants issued to the
brokerage firm during the three months ended March 31, 2006 were estimated using
the Black-Scholes option pricing model with the following weighted average
assumptions: expected volatility of 151.04%, risk-free interest rate of 4.82%,
expected lives of five years, and a 0% dividend yield. The fair value of the
warrants issued to the brokerage firm during the nine months ended March 31,
2006 were estimated using the Black-Scholes option pricing model with the
following weighted average assumptions: expected volatility ranging from 151.04%
to 376.15%, risk-free interest rates ranging from 4.14% to 4.82%, expected lives
of five years, and a 0% dividend yield.
11. Subsequent Events
Subsequent to March 31, 2006, and as of May 1, 2006, the Company has raised
$534,000 and issued 1,068,000 shares of common stock and warrants to purchase up
to 1,068,000 shares of common stock in accordance with the terms of the 2005
Offering. Additionally, pursuant to an agreement with a brokerage firm, the
Company has incurred $29,800 of commission related fees and issued warrants to
purchase 59,600 shares of common stock at $0.75 per share.
On May 1, 2006, The Board approved the extension of the expiration date of
all outstanding warrants held by officers and directors as of May 1, 2006 that
originally expired on or before May 1, 2011. In consideration of ongoing efforts
to achieve business objectives of the Company, the Board extended the expiration
date of these warrants until May 1, 2011. The Company will account for the
modification of these terms in accordance with FASB Statement No. 123(R),
Share-Based Payment and EITF Issue No. 96-18 Accounting for Equity Instruments
that are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services in which the modification results in a new
measurement date and therefore, a new measurement of compensation cost at the
date of modification. The Company is still evaluating the impact of this
modification on the Company's financial statements.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Business Overview
Profile Technologies, Inc. (the "Company"), a Delaware corporation, was
incorporated in 1986 and commenced operations in fiscal year 1988. The Company
is in the business of inspecting pipelines for corrosion and is in the final
stages of researching and developing a patented, non-destructive and
non-invasive, high speed scanning process using electro magnetic waves to
remotely inspect buried, encased and insulated pipelines for corrosion (the "EMW
Inspection Process").
During the summer of 1998, the Company completed work on its first
commercial contract with ASCG Inspection, Inc. testing British Petroleum
pipelines at approximately 100 road and caribou crossings located on the North
Slope of Alaska. During the summer of 1999, the Company continued work testing
pipelines under a contract with another large multi-national oil company related
to the inspection of approximately 250 below-grade pipelines. During the summer
of 2000, the Company expanded its Alaska efforts by testing a total of 372
below-grade pipelines. In 2001, the Company completed the testing of
approximately 441 pipelines in Alaska. In 2002 and 2003, the Company inspected
364 and 250 below-grade pipelines, respectively.
As a result of the Company's experience in Alaska and in response to
regulatory changes that occurred in 2003, the Company decided to improve its
buried pipe inspection capabilities to meet the needs of a more significant
portion of the buried-pipe market. The Company refocused its efforts on
improving its current technology to take advantage of this opportunity. These
efforts, which to some degree are still ongoing, refined our technology to
specifically address the buried pipeline market by developing a new pulse (wave
form) that is distorted by electrolysis i.e., active corrosion, in a specific
way. The Company also refined the hardware underlying its inspection process by
making its test system more powerful, portableand useful. Among other things, it
eliminated the need for a cumbersome, external power source.
Industry Overview
Refineries, chemical plants, utilities, natural gas transmission companies
and the petroleum industry have millions of miles of pipeline much of which may
be exposed to harsh and severe environments subjecting such pipeline to higher
incidence of corrosion. As a result of such environments these industries are
continually challenged to ensure that the quality of its pipeline meets
applicable standards established by relevant regulatory bodies to protect
operating personnel and the environment.
When pipeline is not insulated and above ground, external corrosion can be
identified visually. The petroleum and other related industries, however,
insulate much of their piping to conserve energy and to prevent injury to
personnel from high temperature levels on the pipelines. When pipeline is
insulated, corrosion can occur underneath the insulation due to moisture or
corrosive products that find their way through broken or poorly sealed
insulation. Corrosion underneath the insulation of insulated pipelines is very
difficult and costly to locate. In the past, corrosion testing on insulated
pipelines has been conducted on a limited sample basis and relied upon
inspection processes that were both cumbersome and costly.
The two prevalent testing methods used to detect corrosion on insulated
pipelines, X-ray and eddy current, detect defects by analyzing visual image and
decay. These methods require the physical stripping away of the pipeline
insulation to conduct visual inspection, depth gauges, ultrasonics and X-ray are
then used to determine the severity of the visually located corrosion. The
physical removal of insulation required by these methods is costly for various
reasons including the assembly of scaffolding for testing otherwise inaccessible
above ground pipe (particularly in refineries and petrochemical plants) or the
actual dig-up on below ground pipe. The Company's technology enables it to test
pipe segments in a refinery setting for a distance up to three hundred feet and
to use "cherry pickers" instead of costly scaffolding.
Corrosion under the insulation of insulated pipelines presents a very
complicated testing problem because corrosion cannot be easily identified by
statistical sampling. If, for example, a small section of the insulation on a
segment of insulated pipe is removed every ten feet for visual inspection using
eddy current or x-ray techniques, there is no statistical basis to assume that
the external condition of the piping between the removed sections of insulation
is corrosion free.
13
The Company's EMW Inspection Process
The EMW Inspection Process provides a corrosion inspection method which
does not require the inspector to physically remove the pipeline's insulation or
otherwise dig up the pipeline to visually inspect for corrosion. In certain
instances, limited access points to buried pipelines exist for reasons unrelated
to corrosion inspection. As a result, corrosion inspection may be conducted at
these access points. Where such access points are not already available, the EMW
Inspection Process permits the inspection of pipelines with a minimal amount of
disturbance to the coating or insulation on the pipeline. In addition, the EMW
Inspection Process permits corrosion inspection over the entire pipeline, as
opposed to other inspection methods, which only provide for spot point
inspections. Such "spot inspections" are not necessarily accurate in indicating
the overall condition of a pipeline.
The Company has developed two basic EMW Inspection Process techniques,
namely, Dual Pulse or Pulse Propagation Analyzer and Single-Pulse or Calibration
Mark Z. For above-grade piping, the Company has used both the Dual-Pulse and
Single-Pulse techniques to determine the condition of a pipeline segment in the
open field as well as in refineries, chemical plants and power plants. For
below-grade piping under streets and road crossings, the Company has
historically used only the Dual Pulse technique. However, for more than a year,
the Company has been developing new hardware and software to permit the testing
of direct buried pipe from a single location while, at the same time, capturing
data from the pipe traveling in both directions. This new equipment has been
tested at the Company's pipe test facility in Ferndale, Washington, and is now
being field tested on natural gas pipelines in Pennsylvania with the cooperation
and assistance of a host company engaged in the natural gas distribution
business.
Correlating pipeline corrosion information using the Company's technology
requires a combination of state-of-the-art instrumentation plus an understanding
of the physical phenomena that are being measured. Management believes that the
EMW measurement and analysis are on the leading edge of inspection technology.
The Company believes that its technology has at least two significant
competitive advantages. First, it can inspect certain pipelines that are
inaccessible to other testing methods. Second, with respect to facilities that
are accessible to other inspection methods, the Company's technology does not
require the removal of much, if any, insulation, coatings or encasements or
pipeline excavation as a prerequisite to testing. Accordingly the Company's
technology will typically have a lower cost of site preparation that results in
a significant cost advantage. The Company's ongoing research and development
efforts are designed to produce new applications for the Company's technology in
the oil, natural gas and other industries.
The New Test Set
To position the Company to address the buried pipeline market, the Company
redesigned and improved the hardware underlying the EMW Inspection Process. The
new hardware (the "New Test Set") provides a different pulse waveform
specifically tailored to the buried pipe environment. This waveform has
increased low frequency energy content, which enables efficient wave propagation
through sand, soil, and moist earth.
The New Test Set is smaller than the previous more cumbersome generation
hardware used in Alaska. The New Test Set weighs less than 12 pounds, including
the data acquisition digitizer and battery power supply. The New Test Set can be
hand-carried and operated by a single person and no longer requires an
oscilloscope or a gasoline powered AC generator which were necessary with the
previous generation hardware. This portable system is designed to allow testing
of both underground and above-grade pipelines with one test set.
As noted above, initial testing of the new buried-pipe inspection hardware
has been completed at the Company's Ferndale, Washington pipe test facility, and
is now being tested on natural gas pipelines in Pennsylvania. In addition, the
Company plans to do additional field testing in Washington state in May on the
facilities of two companies that have agreed to verify test results by digging
up sections of line.
14
The results of all these tests should provide the Company with critical
information as to the detection capabilities of its new hardware in different
"real world" conditions and accelerate the commercial deployment of the
Company's new hardware and software.
Although several important milestones have been achieved in the testing of
the Company's new hardware and software, there can be no assurance that the
field testing portion of this testing program can be funded or that the new
hardware and software can be successfully tested and deployed on a commercial
basis. Failure to do so could have a serious and material effect on the business
and financial condition of the Company.
Regulatory Environment
A combination of federal, state, and industry rules combine to regulate
corrosion protection. The U.S. Department of Labor, operating through the
Occupational Safety and Health Administration has jurisdiction over numerous
plants and facilities containing corrosion protected pipeline that, if breached,
could cause serious bodily injury or death to on-site workers. The U.S.
Department of Transportation has jurisdiction over interstate natural gas and
hazardous liquids pipelines. Counterpart state agencies have jurisdiction over
intrastate natural gas and hazardous liquids pipelines. In addition, the
American Petroleum Institute has promulgated a comprehensive Piping Inspection
Code which requires that extensive corrosion testing be done by all members
(which includes the vast majority of the petroleum and petrochemical
industries). As a result of extensive regulation and testing requirements, the
industry is faced with the requirement to engage in extensive testing for
corrosion. In 1993, the American Petroleum Institute imposed stricter test
standards for corrosion under the insulation on pipelines.
The American Petroleum Institute testing standard adopted in 1993, in
essence, mandates either the stripping of larger amounts of coating or using an
alternate system that will identify corrosion under the insulation without
stripping the coating on suspected and unsuspected pipe. Because of the enormous
cost involved in using the stripping and visual testing process, the Company
believes that the industry will be receptive to an alternate testing system that
is reliable and less costly. The Company believes that its EMW Inspection
Process provides an alternate testing system that could be widely accepted by
the industry. However, while the Company has obtained some commercial contracts
and prospects for expanded commercial contracts in the future appear strong,
there can be no assurance that such acceptance will continue to grow or that
competitors will not develop newer and better technologies.
On December 15, 2003, the U.S Department of Transportation ("DOT") issued
regulations under the Pipeline Safety Improvement Act of 2002 requiring
regulated companies to gather baseline integrity data on pipelines in so-called
"high consequence areas" ("HCA's") (e.g., populated areas) initially over a
ten-year period and then every seven years thereafter. Based on consultations
with industry representatives, the Company believes that its new buried pipe
inspection hardware will provide such regulated companies with a superior tool
for gathering the baseline integrity data required under the DOT regulations.
Employees
Pending the commercial deployment of its new hardware and the receipt of
new contracts, and in an effort to reduce its out-of-pocket expenses to the
lowest practicable level, the Company furloughed all of its field crews. If and
when commercial contracts are obtained, the Company may re-hire former crew
personnel or may hire and train new crews.
Intellectual Property
Throughout its development stage, the Company has filed and continues to
file patents in order to protect the proprietary nature of its technology. The
Company's latest patent application, filed on November 25, 2005, incorporates
the advances made in the design, fabrication and testing of the new buried-pipe
inspection hardware and software.
15
Revenues
The Company derives revenue solely from the sale of the EMW inspection
technology service. The Company relies solely upon several employees, including
the Chief Executive Officer and the Chief Operating Officer to conduct the
Company's sales activities.
The Company did not have revenues during the three and nine months ended
March 31, 2006 and 2005, respectively.
Sales and Marketing
The Company's sales and marketing strategy has been to position the
Company's EMW inspection process as the method of choice to detect pipeline
corrosion where the pipelines are either inaccessible to other inspection tools
or much more costly to inspect with tools other than the Company's EMW
technology. Pipelines are commonly found in refinery and chemical plants (such
as insulated, overhead pipes), natural gas distribution systems (such as pipes
buried in city streets), and natural gas transmission systems (such as road,
bridge and stream crossings and concrete-encased pipes).
As described above, the Company has fabricated new buried pipe inspection
hardware and is actively seeking industry and other financing sources in order
to rigorously field test that hardware (initial testing having been completed in
Ferndale, WA). In order to obtain additional revenue generating contracts, the
Company intends to emphasize the reliability of its buried pipeline testing
method, the flexibility of the method's application, and its cost effectiveness
as compared to other methods. The Company intends to concentrate its fiscal year
2006 marketing efforts on the pipeline and utility buried pipe inspection
markets in the lower-48 states, particularly in "high consequence areas" as
defined in the federal Department of Transportation's regulations ("HCAs").
However, there can be no assurance that the Company will be successful in
concentrating its marketing efforts for the EMW technology on natural gas
utility and pipeline markets.
Results of Operations
The Company's operating results depend exclusively on its ability to market
its EMW inspection technology services. If the Company is not able to automate
completely the EMW inspection process and fully implement its new technology,
the Company may not be able to obtain future contracts to sell or license its
EMW technology. Since the Company's revenues are derived solely from sales of
its EMW technology, any failure to obtain future contracts will have a material
adverse effect on the business and financial condition of the Company.
The Company did not generate any revenues during the three and nine months
ended March 31, 2006 and 2005, respectively, as the Company was engaged solely
in the redevelopment and improvement of its testing hardware and software.
The Company did not have any cost of revenues for the three and nine months
ended March 31, 2006 and 2005, respectively. The Company did not have any
employees working in the field because the Company did not have any revenue
generating contracts during these periods.
Research and development expenses for the three months ended March 31, 2006
were $56,852 as compared to $207,926 for the three months ended March 31, 2005.
The decrease of $151,074 is substantially due to the Company recording $174,000
for the fair value of 200,000 stock options granted to a consultant during the
three months ended March 31, 2005. Offsetting this decrease in equity related
compensation is an increase of approximately $25,000 during the three months
ended March 31, 2006 for compensation paid to two consultants and a scientist to
continue focusing increased efforts on the design, fabrication, and testing of
the Company's new hardware.
Research and development expenses for the nine months ended March 31, 2006
were $303,718 as compared to $245,455 for the nine months ended March 31, 2005.
The increase of $58,263 is substantially the result of the Company retaining the
services of two consultants and a scientist during the nine months ended March
31, 2006, to focus increased efforts on the design, fabrication, and testing of
16
the Company's new hardware. Research and development related consulting fees
were approximately $150,129 for the nine months ended March 31, 2006 as compared
to approximately $13,500 for the nine months ended March 31, 2006. Offsetting
the increase in the cash related consulting fees are the value of the stock
options granted to one of the consultants and the scientist. Included in
research and development for the nine months ended March 31, 2006, is $75,750
for the fair value of 75,000 options granted to one of the consultants and the
scientist as partial compensation for their past services rendered. Included in
research and development during the nine months ended March 31, 2005 is $174,000
for the fair value of 200,000 stock options granted to the scientist as partial
compensation for past services rendered.
General and administrative expenses for the three and nine months ended
March 31, 2006 were $158,891 and $494,335, respectively, as compared to $169,633
and $540,310, respectively, for the three and nine months ended March 31, 2005.
The decrease of $10,742 for the three months ended March 31, 2006 as compared to
the three months ended March 31, 2005 is the result of a general reduction of
operating expenditures as the Company continues to focus on controlling its
overall burn rate.
The decrease in general and administrative expenses of $45,975 for the nine
months ended March 31, 2006 as compared to the nine months ended March 31, 2005
is the result of a general reduction of operating expenditures as the Company
continues to focus on controlling its overall burn rate. Contributing to the
decrease in general and administrative expenses was a decrease in professional
fees of approximately $7,400 and a decrease in insurance premiums of
approximately $4,400 for the nine months ended March 31, 2006 as compared to the
nine months ended March 31, 2005.
Loss from operations for the three and nine months ended March 31, 2006 was
$215,743 and $798,053, respectively, as compared to $377,559 and $785,765,
respectively, for the three and nine months ended March 31, 2005. In general,
loss from operations decreased for the three months ended March 31, 2006 as
compared to the three months ended March 31, 2005 primarily as a result of the
decrease in equity compensation recorded for the stock options granted to the
scientist during the three months ended March 31, 2005 as compared to the three
months ended March 31, 2006. In general, loss from operations remained
relatively flat for the nine months ended March 31, 2006 as compared to the nine
months ended March 31, 2005 as a result of an increase in research and
development activities, offset by reductions in professional fees and other
operating expenses as discussed above.
Interest expense for the three and nine months ended March 31, 2006 was
$12,300 and $237,632, respectively, as compared to $19,113 and $158,062,
respectively, for the three and nine months ended March 31, 2005. The decrease
of $6,816 for the three months ended March 31, 2006 as compared to the three
months ended March 31, 2005 is substantially the result of Mr. Evans converting
the remaining outstanding principal balance of his 5% interest bearing Amended
Evans Loan on January 10, 2006, thereby reducing the outstanding principal
balance on the Amended Evans Loan and the corresponding interest expense
incurred by the Company of approximately $11,480. Additionally, interest expense
related to the 5% interest bearing Debentures decreased by approximately $2,700
for the nine months ended March 31, 2006 as compared to the three months ended
March 31, 2005 as a result of investors who previously exercised their
conversion right, converting their Debentures to equity, thereby reducing the
outstanding principal balance on the Debentures. These decreases in interest
expense are offset by an increase in interest expense related to investors who
exercised their conversion right in accordance with the terms of the 2003
Offering. During the three months ended March 31, 2006, approximately $8,000 of
unamortized discount was recognized as interest expense upon conversion by one
investor. During the three months ended March 31, 2005, none of the investors
exercised their conversion right in accordance with the terms of the 2003
Offering. Hence, there was no unamortized discount recorded as interest expense
during the three months ended March 31, 2005.
The increase of $79,570 for the nine months ended March 31, 2006 as
compared to the nine months ended March 31, 2005 is substantially the impact of
investors exercising their conversion right in accordance with the terms of the
2003 Offering. Six investors exercised their conversion right during the nine
months ended March 31, 2006 as compared to five investors during the nine months
ended March 31, 2005. The unamortized discount recognized as interest expense
upon conversion was approximately $198,000 during the nine months ended March
31, 2006 as compared to approximately $100,000 during the nine months ended
March 31, 2005. This increase is offset by a decrease in interest expense on the
Amended Evans Loan of approximately $17,500 for the nine months ended March 31,
2006 as compared to the nine months ended March 31, 2005 as a result of Mr.
Evans converting the remaining outstanding principal balance of his loan during
the nine months ended March 31, 2006.
17
Liquidity and Capital Resources
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. The Company incurred cumulative losses
of $12,640,824 through March 31, 2006 and had negative working capital of
$741,024 as of March 31, 2006. Additionally, the Company has expended a
significant amount of cash in developing its technology and patented processes.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management recognizes that in order to meet the Company's
capital requirements, and continue to operate, additional financing, including
seeking industry-partner investment through joint ventures or other possible
arrangements, will be necessary. The Company is evaluating alternative sources
of financing to improve its cash position and is undertaking efforts to raise
capital. If the Company is unable to raise additional capital or secure
additional revenue contracts and generate positive cash flow, it is unlikely
that the Company will be able to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
Deferred Wages and Accrued Professional Fees
To reduce cash outflows, certain of the Company's employees, officers,
consultants, and directors have agreed to defer a portion of their salaries and
professional fees until the Company has sufficient resources to pay the amounts
owed or to exchange such amounts into options as described below. At March 31,
2006, the Company has accrued $893,786 related to the deferred payment of
salaries and professional fees of which $707,636 is included under deferred
wages and $186,150 in accrued professional fees. On March 18, 2002, the Board
approved a conversion right on all deferred wages and accrued professional fees
deferred as of March 18, 2002. Pursuant to this conversion right, employees,
officers, consultants, and directors may elect to convert $1.00 of fees owed to
them as of March 18, 2002 for an option to purchase two shares of the Company's
common stock, at an exercise price of $1.00 per share for a term of five years.
Deferred salaries and fees as of March 18, 2002 were $111,500, resulting in the
potential issuance of 223,000 options under the terms mentioned above. No
conversions have occurred to date. At March 18, 2002, there was no intrinsic
value associated with these exchange rights. As such, no additional compensation
cost was recorded.
Convertible Debt
On June 19, 2003, the Board of Directors approved the offering (the "2003
Offering") of $1,000,000 in convertible debentures (the "Debentures"). The
Debentures are convertible into that number of shares of the Company's common
stock equal to the amount of the converted indebtedness divided by $0.50 per
share. The Debentures bear interest at a rate of 5% per annum, payable
quarterly. Delinquent interest payments bear interest at a rate of 12% per
annum. The Company is required to redeem each Debenture on the 5th anniversary
of the date of the Debenture. The Company may, in its discretion, redeem any
Debenture at any time prior to the mandatory redemption date of the Debenture by
providing no less than 60 days' prior written notice to the holder of the
Debenture. Certain events of default will result in the Debentures being
redeemable by the Company upon demand of the holder.
Upon the purchase of, and for each $0.50 of the Debenture's principal
amount, the Company issued to each investor a warrant (the "Warrant") to
purchase one (1) share of the Company's common stock at an exercise price of
$0.75 per share. The Warrants are exercisable at any time prior to the 5th
anniversary date of the redemption of the Debenture.
Warrants issued in connection with the 2003 Offering were recorded based on
their relative fair value as compared to the fair value of the debt at issuance.
The relative fair value of the warrants was recorded as paid-in capital,
estimated at $0 and $101,977 for the three and nine months ended March 31, 2005,
respectively. The fair value of the warrants issued during the three and nine
months ended March 31, 2005, was determined based on an option pricing model
with the following assumptions: warrant lives of 10 years, risk free interest
rates ranging from 4.14% to 4.30%, volatility of 120%, and a zero dividend
yield. The intrinsic value of the Debentures results in a beneficial conversion
feature that reduces the book value of the convertible debt to not less than
zero. Accordingly, the Company recorded a discount of $0 and $56,023 during the
three and nine months ended March 31, 2005, respectively, on the convertible
debt issued under the 2003 Offering. The Company amortizes the discount using
the effective interest method over the five-year life of the Debentures.
18
During the quarter ended March 31, 2005, the Board of Directors terminated
the 2003 Offering. As of the closing date of the 2003 Offering, the Company had
raised $503,000 from the 2003 Offering.
During the three and nine months ended March 31, 2006, one and six
investors, respectively, exercised their conversion right under the terms of the
Debentures. Accordingly, the carrying value of the convertible debt was
reclassified as equity upon conversion. Since the convertible debt instruments
include a beneficial conversion feature, the remaining unamortized discount of
$7,991 and $197,945 at the conversion date was recognized as interest expense
during the three and nine months ended March 31, 2006, respectively.
During the three and nine months ended March 31, 2005, none and five
investors, respectively, exercised their conversion right under the terms of the
Debentures. Accordingly, the carrying value of the convertible debt was
reclassified as equity upon conversion. Since the convertible debt instruments
include a beneficial conversion feature, the remaining unamortized discount of
approximately $0 and $100,000 at the conversion date was recognized as interest
expense during the three and nine months ended March 31, 2005, respectively.
As of March 31, 2006, accrued interest on the Debentures was $2,232. The
Company recorded interest expense related to the accretion of the discount on
the Debentures and amortization of the convertible debt discount as a result of
the conversions discussed above of $8,039 and $198,051 for the three and nine
months ended March 31, 2006, respectively. The Company recorded interest expense
related to the accretion of the discount on the Debentures and amortization of
the convertible debt discount as a result of the conversions discussed above of
$17 and $100,031 for the three and nine months ended March 31, 2005,
respectively. As of March 31, 2006 the carrying value of the long-term portion
of the Debentures was $112, net of unamortized debt discount of $67,388.
Common Stock
On January 19, 2005, the Board of Directors approved the offering (the
"2005 Offering") of 2,000,000 units (the "Units") for a total offering price of
$1,000,000, consisting of shares of common stock and attached warrants. On
November 21, 2005, the Board of Directors approved an increase in the number of
units to 6,000,000 units for a total offering price of $3,000,000. The purchase
price of one Unit is $0.50. Each Unit consists of one share of common stock and
a warrant to purchase one share of common stock at an exercise price of $0.75
per share. The warrants are exercisable at any time prior to the fifth
anniversary from the date of grant.
During the nine months ended March 31, 2006, the Company raised $1,149,500
under the terms of the 2005 Offering. Accordingly, the Company issued 2,299,000
shares of common stock and warrants to purchase up to 2,299,000 shares of common
stock at an exercise price of $0.75 per share.
The Company engaged a brokerage firm to help in the fund raising efforts of
the 2005 Offering. Pursuant to the terms of the agreement with the brokerage
firm, the Company will pay the brokerage firm a ten percent cash commission on
all funds that the brokerage firm helps raise. Additionally, the Company will
issue warrants to purchase shares of common stock at $0.75 per share equal to
ten percent of the total warrants issued in connection with the 2005 Offering.
The warrants may be exercised up to five years from the date of issuance, which
is the date the proceeds are received under the 2005 Offering. During the three
and nine months ended March 31, 2006, the Company incurred $39,400 and $110,750,
respectively, of fees to be paid in cash to the brokerage firm and issued
warrants to purchase 78,800 and 221,500, respectively, shares of common stock.
During the three and nine months ended March 31, 2006, the Company recorded
$100,076 and $207,260, respectively, as a reduction to paid-in capital for the
fair value of the warrant grants. The fair value of the warrants issued to the
brokerage firm during the three months ended March 31, 2006 were estimated using
the Black-Scholes option pricing model with the following weighted average
assumptions: expected volatility of 151.04%, risk-free interest rate of 4.82%,
expected lives of five years, and a 0% dividend yield. The fair value of the
warrants issued to the brokerage firm during the nine months ended March 31,
2006 were estimated using the Black-Scholes option pricing model with the
following weighted average assumptions: expected volatility ranging from 151.04%
to 376.15%, risk-free interest rates ranging from 4.14% to 4.82%, expected lives
of five years, and a 0% dividend yield.
19
Other Commitments
The Company's other contractual obligations consist of commitments under an
operating lease and repayment of loans payable to certain officers, directors
and stockholders.
As of March 31, 2006, the Company had outstanding loans payable to certain
officers, directors and stockholders with principal amounts, in the aggregate,
equal to $57,500. The terms of the various notes are described above under "Note
7: Notes Payable - Stockholders."
As of March 31, 2006, the Company has future minimum lease payments of
approximately $19,900 under its operating lease.
Capital will be expended to support operations until the Company can
generate sufficient cash flows from operations. In order for the Company to
generate cash flows from operations, the Company must obtain additional revenue
generating contracts. Management is currently directing the Company's activities
towards obtaining additional service contracts, which, if obtained, will
necessitate the Company attracting, hiring, training and outfitting qualified
technicians. If additional service contracts are obtained, it will also
necessitate additional field test equipment purchases in order to provide the
services. The Company's intention is to purchase such equipment for its field
crews for the foreseeable future, until such time as the scope of operations may
require alternate sources of financing equipment. The Company expects that if
additional contracts are secured, and revenues increase, working capital
requirements will increase. There can be no assurance that the Company's process
will gain widespread commercial acceptance within any particular time frame, or
at all. The Company will incur additional expenses as it hires and trains field
crews and support personnel related to the successful receipt of commercial
contracts. Additionally, the Company anticipates that cash will be used to meet
capital expenditure requirements necessary to develop infrastructure to support
future growth. There can be no assurance that the Company will be able to secure
additional revenue generating contracts to provide sufficient cash.
Pending the deployment of the Company's new hardware and software and the
receipt of new contracts, and in an effort to reduce its out-of-pocket expenses
to the lowest practicable level, the Company has furloughed all of its field
crews. If and when revenue-generating contracts are obtained, the Company will
re-hire former crew personnel or may hire and train new crews. The Company was
not obligated to make any severance payments for salaries, health benefits or
accrued vacation and sick time related to the termination of any of its
employees.
Off Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-QSB contains "forward-looking statements."
These forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Company "believes,"
"anticipates," "expects" or words of similar import. Similarly, statements that
describe the Company's projected future results, future plans, objectives or
goals or future conditions or events are also forward looking statements. Actual
results are inherently difficult to predict. Any such forward-looking statements
are subject to the risks and uncertainties that could cause actual results of
operations, financial condition, acquisitions, financing transactions,
operations, expenditures, expansion and other events to differ materially from
those expressed or implied in such forward-looking statements. Any such
forward-looking statements would be subject to a number of assumptions
regarding, among other things, future economic, competitive and market
conditions generally. Such assumptions would be based on facts and conditions as
they exist at the time such statements are made as well as predictions as to
future facts and conditions, the accurate prediction of which may be difficult
and involve the assessment of events beyond the Company's control.
20
The forward-looking statements contained in this report are based on
current expectations that involve a number of risks and uncertainties. Such
forward-looking statements are based on assumptions that the Company will obtain
or have access to adequate financing to continue its operations, that the
Company will market and provide products and services on a timely basis, that
there will be no material adverse competitive or technological change with
respect to the Company's business, demand for the Company's products and
services will significantly increase, that the Company will be able to secure
additional fee-for-services or licensing contracts, that the Company's executive
officers will remain employed as such by the Company, that the Company's
forecast accurately anticipate market demand, and that there will be no material
adverse change in the Company's operations, business or governmental regulation
affecting the Company or its customers. The foregoing assumptions are based on
judgments with respect to, among other things, future economic, competitive and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the Company's
control. Although the Company believes the expectations reflected in the
forward-looking statements are reasonable, the Company cannot guarantee future
results, levels of activity, performance or achievements.
Item 3. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The term "disclosure controls and procedures" is defined in Rules 13a-15(e)
and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). This term refers to the controls and procedures of a
company that are designed to ensure that information required to be
disclosed by a company in the reports that it files under the Exchange Act
is recorded, processed, summarized, and reported within the required time
periods. Our Chief Executive Officer and our Chief Financial Officer have
evaluated the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this report. They have concluded that, as
of that date, our disclosure controls and procedures were effective at
ensuring that required information will be disclosed on a timely basis in
our reports filed under the Exchange Act.
(b) Changes in Internal Control over Financial Reporting
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the
period covered by this report that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is not aware of any legal proceedings contemplated by any
governmental authority or any other party involving the Company or its
properties. As of the date of this report, no director, officer or affiliate is
a party adverse to the Company in any legal proceeding or has an adverse
interest to the Company in any legal proceedings. The Company is not aware of
any other legal proceedings pending or that have been threatened against the
Company or its properties.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Convertible Debt
On June 19, 2003, the Board of Directors approved the offering (the "2003
Offering") of $1,000,000 in convertible debentures (the "Debentures"). The
Debentures are convertible into that number of shares of the Company's common
stock equal to the amount of the converted indebtedness divided by $0.50 per
share. Upon the purchase of, and for each $0.50 of the Debenture's principal
amount, the Company issued to each investor a warrant (the "Warrant") to
purchase one (1) share of the Company's common stock at an exercise price of
$0.75 per share. The Warrants are exercisable at any time prior to the 5th
anniversary date of the redemption of the Debenture. The 2003 Offering is exempt
from registration under Section 4(2) of the Securities Act.
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During the three months ended March 31, 2006, an investor exercised their
conversion right, pursuant to the terms of the 2003 Offering, and converted
$8,000 of principal pursuant to the terms of the 2003 Offering. Accordingly, the
Company issued 16,000 shares of common stock and warrants to purchase up to
16,000 shares of common stock in accordance with the terms of the 2003 Offering.
Common Stock
On January 19, 2005, the Board of Directors approved the offering (the
"2005 Offering") of 2,000,000 units (the "Units") for a total offering price of
$1,000,000 to accredited investors, as that term is defined by Rule 501 of
Regulation D, consisting of shares of common stock and attached warrants. On
November 21, 2005, the Board of Directors approved an increase in the number of
Units to 6,000,000 Units for a total offering price of $3,000,000. The purchase
price of one Unit is $0.50. Each Unit consists of one share of common stock and
a warrant to purchase one share of common stock at an exercise price of $0.75.
The warrants are exercisable at any time prior to the fifth anniversary from the
date of grant. The 2005 Offering is exempt from registration under Section 4(2)
of the Securities Act.
During the three months ended March 31, 2006, the Company raised $394,000
and issued 788,000 shares of common stock and warrants to purchase up to 788,000
shares of stock in accordance with the terms of the 2005 Offering.
During the three months ended March 31, 2006, Mr. Evans exercised his
conversion right, pursuant to the terms of the Amended Evans Loan, and converted
$512,500 of principal and accrued interest pursuant to the terms of the 2005
Offering. Accordingly, the Company issued 1,025,000 shares of common stock and
warrants to purchase up to 1,025,000 shares of common stock in accordance with
the terms of the 2005 Offering.
Warrants
During the three months ended March 31, 2006, the Company issued a warrant
to a brokerage firm to purchase 78,800 shares of common stock at an exercise
price of $0.75 per share. The warrant may be exercised up to five years from the
date of issuance. These securities were issued in reliance on exemptions from
registration provided by Section 4(2) of the Securities Act.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Shareholders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
The following exhibits are filed with or incorporated by reference into
this report as required by Item 601 of Regulation S-B:
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Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 3.1 Articles of Incorporation (incorporated by reference to
Exhibit 3.1 to the Company's Registration Statement on Form
SB-2 filed with the Commission on May 10, 1996).
Exhibit 3.2 Bylaws of the Company (incorporated by reference to Exhibit
3.3 to the Company's Registration Statement on Form SB-2
filed with the Commission on May 10, 1996).
Exhibit 3.3 Amendment to Certificate of Incorporation (incorporated by
reference to Exhibit A to the Company's Definitive Proxy
Statement filed with the Commission on October 28, 2002).
Exhibit 10.1 Loan Agreement dated May 9, 2002, by and between the Company
and Murphy Evans (incorporated by reference to Exhibit 4.1
to the Company's Quarterly Report on Form 10-QSB filed with
the Commission on May 15, 2002).
Exhibit 10.2 Loan Amendment and Promissory Note dated March 6, 2003, by
and between the Company and Murphy Evans (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report
on Form 10-QSB filed with the Commission on May 20, 2003).
Exhibit 10.3 Lease Agreement dated January 26, 2001 by and between the
Company and Fatum LLC (incorporated by reference to Exhibit
10.4 to the Company's Annual Report on Form 10-KSB filed
with the Commission on October 12, 2004).
Exhibit 10.4 Lease Extension dated February 26, 2003 by and between the
Company and Fatum LLC (incorporated by reference to Exhibit
10.5 to the Company's Annual Report on Form 10-KSB filed
with the Commission on October 12, 2004).
Exhibit 10.5 Royalty Agreement (incorporated by reference to Exhibit 10.1
to the Company's Registration Statement on Form SB-2 filed
with the Commission on May 10, 1996).
Exhibit 10.6 Assignment of Patent Rights (incorporated by reference to
Exhibit 10.2 to the Company's Registration Statement on Form
SB-2 filed with the Commission on May 10, 1996).
Exhibit 10.7 1999 Stock Option Plan (incorporated by reference to Exhibit
10.9 to the Company's Annual Report on Form 10-KSB filed
with the Commission on October 12, 2004).
Exhibit 14.1 Code of Ethics (incorporated by reference to Exhibit 14 to
the Company's Annual Report on Form 10-KSB filed with the
Commission on October 12, 2004).
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of Henry E. Gemino,
as Chief Executive Officer and Chief Financial Officer of
the Company.
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Philip L. Jones,
as Chief Operating Officer and Executive Vice President of
the Company.
Exhibit 32.1 Certification under Section 906 of the Sarbanes-Oxley Act of
2002 by Henry E. Gemino, as Chief Executive Officer and
Chief Financial Officer of the Company.
Exhibit 32.2 Certification under Section 906 of the Sarbanes-Oxley Act of
2002 by Philip L. Jones, as Chief Operating Officer and
Executive Vice President of the Company.
23
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PROFILE TECHNOLOGIES, INC.
-------------------------
(Registrant)
Date: May 9, 2006 /s/ Henry E. Gemino
------------------------------------
Henry E. Gemino
Chief Executive Officer and
Chief Financial Officer
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