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:
December 31, 2005
[ ] 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 ___
As of January 31, 2006, the number of shares outstanding of the issuer's common
stock, the only class of common equity was 10,494,445.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [ X ]
TABLE OF CONTENTS
Description Page Number
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheet (Unaudited) -
At December 31, 2005.............................................3
Statements of Operations (Unaudited) -
Three Months Ended and Six Months Ended December 31, 2005
and 2004.........................................................4
Statements of Cash Flows (Unaudited) -
Six Months Ended December 31, 2005 and 2004......................5
Notes to Financial Statements (Unaudited).............................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................12
Item 3. Controls and Procedures.........................................20
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........................................................23
SIGNATURES....................................................................24
CERTIFICATIONS................................................................25
2
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements.
PROFILE TECHNOLOGIES, INC.
Balance Sheet
(unaudited)
December 31,
2005
------------
Assets
Current assets:
Cash $ 342,649
Prepaid expenses and other current assets 14,251
------------
Total current assets 356,900
Equipment, net of accumulated depreciation of $541,529 5,037
Deferred financing fees 980
Other assets 1,550
------------
Total assets $ 364,467
============
Liabilities and Stockholders' Deficit
Current Liabilities:
Accounts payable $ 183,578
Notes payable to stockholders 479,990
Current portion of convertible debt 107,500
Deferred wages 682,000
Accrued professional fees 180,150
Accrued interest 85,836
Other accrued expenses 27,144
------------
Total current liabilities 1,746,198
Long-term convertible debt, net of unamortized discount of $75,427 73
Stockholders' deficit:
Common stock, $0.001 par value. Authorized 25,000,000
shares; issued and outstanding 8,543,445 shares 8,543
Common stock issuable; 906,000 shares 906
Additional paid-in capital 11,021,528
Accumulated deficit (12,412,781)
------------
Total stockholders' deficit (1,381,804)
Commitments, contingencies and subsequent events
------------
Total liabilities and stockholders' deficit $ 364,467
============
See accompanying notes to financial statements.
3
PROFILE TECHNOLOGIES, INC.
Statements of Operations
(unaudited)
For the three months ended For the six months ended
December 31, December 31,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Revenue $ -- $ -- $ -- $ --
Cost of revenues -- -- -- --
----------- ----------- ----------- -----------
Gross profit -- -- -- --
----------- ----------- ----------- -----------
Operating expenses:
Research and development 189,766 14,659 246,866 37,529
General and administrative 175,138 190,075 335,444 370,677
----------- ----------- ----------- -----------
Total operating expenses 364,904 204,734 582,310 408,206
----------- ----------- ----------- -----------
Loss from operations (364,904) (204,734) (582,310) (408,206)
Interest expense 30,675 33,186 225,332 138,949
----------- ----------- ----------- -----------
Net loss $ (395,579) $ (237,920) $ (807,642) $ (547,155)
=========== =========== =========== ===========
Basic and diluted net loss per share $ (0.05) $ (0.04) $ (0.10) $ (0.10)
Weighted average shares outstanding used to
calculate basic and diluted net loss per share 8,674,869 5,663,966 7,964,459 5,589,911
See accompanying notes to financial statements.
4
PROFILE TECHNOLOGIES, INC.
Statements of Cash Flows
(unaudited)
For the six months ended
December 31,
2005 2004
--------- ---------
Cash flows from operating activities:
Net loss $(807,642) $(547,155)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 2,598 4,206
Accreted discount on convertible debt 57 14
Amortization of convertible debt discount included in interest expense 189,954 100,000
Accrued interest on convertible debt converted to equity 370 522
Accrued interest on notes payable to stockholders converted to equity 30,746 --
Amortization of debt issuance costs 10,380 3,820
Equity issued for services 85,850 35,000
Changes in operating assets and liabilities:
Prepaid expenses and other current assets 3,400 (377)
Other assets 865 --
Accounts payable (12,786) 16,115
Deferred wages 42,874 148,813
Accrued professional fees 12,000 17,570
Accrued interest (17,516) 22,567
Other accrued expenses 6,550 (2,827)
--------- ---------
Net cash used in operating activities (452,300) (201,732)
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
Convertible debt issuance costs -- --
Common stock issuance costs (71,350) --
Allocated proceeds from issuance of common stock 262,408 --
Allocated proceeds from issuance of warrants attached to issuance of common stock 493,092 --
Proceeds from issuance of notes payable to stockholders 83,754 54,000
Repayments of note payable to stockholders -- (40,879)
--------- ---------
Net cash provided by financing activities 767,904 171,121
--------- ---------
Increase (decrease) in cash 315,604 (30,611)
Cash at beginning of period 27,045 59,813
--------- ---------
Cash at end of period $ 342,649 $ 29,202
========= =========
Supplemental disclosure of cash flow information:
Debt discount recorded for beneficial conversion feature $ -- $ 56,023
Cash paid for interest $ 8,269 $ 8,596
Convertible debt and related accrued interest converted into 440,740 and 201,044 shares of
common stock during the six months ended December 31, 2005 and 2004, respectively $ 220,370 $ 100,522
Notes payable to stockholder converted into 1,465,508 shares of common stock
during the six months ended December 31, 2005 $ 732,754 $ --
Accrued interest on notes payable to stockholder converted into 61,492 shares of common stock
during the six months ended December 31, 2005 $ 30,746 $ --
See accompanying notes to financial statements.
5
PROFILE TECHNOLOGIES, INC
December 31, 2005
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. 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, approximate 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.
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.
6
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 six months ended December 31, 2005 the Company incurred $189,766 and
$246,866, respectively, on research and development activities. During the three
and six months ended December 31, 2004 the Company incurred $14,659 and $37,529,
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.
4. Stock Based Compensation
The Company has elected to follow the measurement principles of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for its employee stock
options rather than the alternative fair value accounting provided for by
Statements of Financial Accounting Standards No. 123 (SFAS No. 123), Accounting
for Stock Based Compensation. Compensation cost for stock options issued to
employees is measured as the excess, if any, of the fair market price of the
Company's stock at the date of grant over the amount an employee must pay to
acquire the stock. Had compensation cost for the Company's option and warrant
awards been determined consistent with SFAS No. 123, the Company's net loss
would have been increased to the proforma amounts indicated below:
Three months ended Six months ended
December 31, December 31,
-------------------------- --------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net loss:
As reported $ (395,579) $ (237,920) $ (807,642) $ (547,155)
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 (352,000) -- (352,000) --
----------- ----------- ----------- -----------
Net loss $ (747,579) $ (237,920) $(1,159,642) $ (547,155)
----------- ----------- ----------- -----------
Net loss per share
Basic and diluted - as reported $ (0.05) $ (0.04)$ (0.10) $ (0.10)
Basic and diluted - pro forma $ (0.09) $ (0.04)$ (0.15) $ (0.10)
7
5. 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 six months ended December 31, 2005, because their effect would be
antidilutive, are options and warrants to acquire 9,343,018 shares of common
stock with a weighted-average exercise price of $1.16 per share. Also excluded
from the computation of diluted net loss per share for the three and six months
ended December 31, 2005 are 366,000 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 7 because their effect would be antidilutive.
Excluded from the computation of diluted net loss per share for the
three and six months ended December 31, 2004, because their effect would be
antidilutive, are options and warrants to acquire 3,834,818 shares of common
stock with a weighted-average exercise price of $1.59 per share. Also excluded
from the computation of diluted net loss per share for the three and six months
ended December 31, 2004 are 805,000 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 six months ended December 31, 2005 and 2004,
additional potential dilutive securities that were excluded from the diluted net
loss per share computation are the exchange rights discussed in Note 8 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 December 31, 2005 and 2004.
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.
6. 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 six months ended December 31, 2005, Mr. Evans loaned the
Company an additional $83,754 pursuant to the terms of the Amended Evans Loan.
During the six months ended December 31, 2005, Mr. Evans converted $732,754 of
principal and $30,746 of accrued interest of the Amended Evans Loan pursuant to
the terms of the 2005 Offering. Accordingly, Mr. Evans received 1,527,000 shares
of common stock and warrants to purchase 1,527,000 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.
8
Accrued interest and the outstanding principal balance of the Amended
Evans Loan were $83,453 and $422,490, respectively as of December 31, 2005. Due
to insufficient funds, the Company has not made the interest payments due on the
Amended Evans Loan on June 30 and December 31 of each year and did not repay the
outstanding principal balance. Corresponding interest expense related to the
Amended Evans Loan was $7,136 and $15,870 for the three and six months ended
December 31, 2005, respectively. Corresponding interest expense related to the
Amended Evans Loan was $11,167 and $21,897 for the three and six months ended
December 31, 2004, respectively. All advances from Mr. Evans are convertible
into any debt or equity offerings made by the Company. Mr. Evans has not made
any demand for payment, or exercised any of his remedies, under the Amended
Evans Loan.
On May 9, 2002, the Company cancelled 150,000 warrants held by Mr. Evans
with exercise prices ranging from $3.00 per share to $7.50 per share issued
under the terms of a previous loan with Mr. Evans, and issued to Mr. Evans
150,000 five-year warrants with an exercise price of $1.05 per share, which
expire on May 13, 2007.
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 six months ended December 31, 2005.
Interest expense related to the 2003 Gemino Note was $308 and $860 for the three
and six months ended December 31, 2004, respectively.
The following is a summary of notes payable to stockholders as of
December 31, 2005.
Amended Evans Loan $422,490
Deceased Officer Note 7,500
Stockholder Loans 50,000
--------
Total $479,990
========
9
7. 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 $64,162 and $101,977 for the three and six months ended
December 31, 2004, respectively. The fair value of the warrants issued during
the three and six months ended December 31, 2004, 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
$23,838 and $56,023 during the three and six months ended December 31, 2004,
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 six months ended December 31, 2005, one 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
$19,993 and $189,954 at the conversion date was recognized as interest expense
during the three and six months ended December 31, 2005, respectively.
During the three and six months ended December 31, 2004, four 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 $15,000 and $100,000 at the conversion date was recognized as
interest expense during the three and six months ended December 31, 2004,
respectively.
As of December 31, 2005, accrued interest on the Debentures was $2,383.
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 $20,026 and $190,011 for the three and six
months ended December 31, 2005, 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 $15,011 and $100,014 for the three and six months ended
December 31, 2004, respectively. As of December 31, 2005 the carrying value of
the long-term portion of the Debentures was $73, net of unamortized debt
discount of $75,427.
8. Liquidity and Subsequent Events
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. The Company incurred cumulative losses
of $12,412,781 through December 31, 2005 and had negative working capital of
$1,389,298 as of December 31, 2005. 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
10
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 December
31, 2005, the Company has accrued $862,150 related to the deferred payment of
salaries and professional fees of which $682,000 is included under deferred
wages and $180,150 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.
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 six months ended December 31, 2005, the Company raised
$755,500 under the terms of the 2005 Offering. Accordingly, the Company issued
1,511,000 shares of common stock and warrants to purchase up to 1,511,000 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 six months ended December 31, 2005, the Company incurred $19,700 and
$71,350, respectively, of fees to be paid in cash to the brokerage firm and
issued warrants to purchase 39,400 and 142,700, respectively, shares of common
stock. During the three and six months ended December 31, 2005, the Company
recorded $39,006 and $107,184, 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 December 31, 2005 were
estimated using the Black-Scholes option pricing model with the following
weighted average assumptions: expected volatility of 376.16%, risk-free interest
rate of 4.14%, expected lives of five years, and a 0% dividend yield. The fair
value of the warrants issued to the brokerage firm during the six months ended
December 31, 2005 were estimated using the Black-Scholes option pricing model
with the following weighted average assumptions: expected volatility ranging
from 353.30% to 376.15%, risk-free interest rates ranging from 4.14% to 4.35%,
expected lives of five years, and a 0% dividend yield.
Subsequent Events
Subsequent to December 31, 2005, the Company has raised $55,000 and
issued 110,000 shares of common stock and warrants to purchase up to 110,000
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 $5,500 of commission related fees and issued warrants to purchase
11,000 shares of common stock at $0.75 per share.
11
Subsequent to December 31, 2005, Mr. Evans loaned the Company an
additional $5,979 pursuant to the terms of the Amended Evans Loan. Additionally,
on January 10, 2006, Mr. Evans provided a notice of conversion to the Company to
convert his entire outstanding principal balance of $428,469 and accrued
interest of $84,031 on the Amended Evans Loan pursuant to the terms of the 2005
offering. Accordingly, Mr. Evans will receive 1,025,000 shares of common stock
and warrants to purchase 1,025,000 shares of common stock at an exercise price
of $0.75 per share.
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, portable and 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
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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.
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 uses both the Dual-Pulse and
Single-Pulse techniques to determine the condition of a pipeline segment in the
open field as well as in a refinery, chemical plant or power plant. For
below-grade piping under streets and road crossings, the Company uses only the
Dual Pulse technique. The results of our two basic techniques provide an
assessment of the overall integrity of a pipeline and the location and
classification of electromagnetic anomalies which, in most instances, are
related to external corrosion.
The Single-Pulse Technique
The Single-Pulse technique requires fixing the source location on one
end of a segment of pipeline and adjusting the signal receiver at equal
incremental distances from the source across the length of pipeline segment.
Characteristics of the electromagnetic waves received as a result of wave
propagation, attenuation, and dispersion are analyzed to determine the existence
or absence of electromagnetic anomalies.
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 any insulation, coatings or encasements or pipeline
excavation as a prerequisite to testing. Accordingly it will typically have a
lower cost of site preparation that results in a significant cost advantage.
Research and development efforts will continue to produce new applications for
the Company's technology in the oil, natural gas and other industries.
The Dual-Pulse Technique
The Dual-Pulse technique extracts corrosion related information from
segments of both accessible and inaccessible pipelines underneath the entire
insulation barrier by analyzing the intersection of two electrical current
pulses traveling in opposite directions along the pipeline. This corrosion
related information is extracted without the need for removing the insulation
protecting the pipeline. Through laboratory and field testing the Company has
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established that the electrical response, called characteristic transfer
function ("CTF"), of two intersecting pulses traveling along a pipeline is
uniquely defined with location specific information that relates to the
integrity of the pipeline at the point of intersection. Constructive
interference occurs when the two current impulses run into and interfere with
each other at the point of intersection on a pipeline. The CTF is determined,
not only by the nature and characteristics of the original pulses, but by the
physical characteristics of the pipeline segment in its environment at the point
of intersection.
The EMW Inspection Process was developed to evaluate the condition and
integrity of pipelines. Electro-magnetic pulses are applied at both ends of the
pipe segment being tested. Under computer control, the timing of the pulses is
controlled so that the intersection point of the two pulses moves sequentially
from one end of the pipe to the other end. A unique CTF is obtained for each
intersection point of the pipeline segment being tested on some predetermined
interval, such as, in one foot intervals. When this data is geophysically
displayed, it provides a visual display of data related to the physical
condition of the pipe at each point of intersection. Information can also be
derived using the EMW Inspection Process to determine the condition of the
coating and the effectiveness of the existing corrosion protection system that
is being used to protect each point of intersection. Where there are indications
of problems, closer interval inspection can be performed and/or one of the other
location specific processes used in the industry may be utilized before the
insulation is removed to inspect the pipe condition.
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 20 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 does not require the gasoline
powered AC generator, utility trailer, and external computer data acquisition
system 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.
Initial testing of the new buried-pipe inspection hardware has been
completed at the Company's Ferndale, Washington pipe test facility. The results
of that testing were such that the Company conducted an industry demonstration
of its new hardware and software in December 2005. Representatives of the three
invited companies expressed significant interest, and two of those companies
subsequently agreed to permit the Company to further test and calibrate its new
hardware and software on their facilities. The Company intends to begin this
field work in early March.
The results of that testing should provide the Company with valuable
information as to the detection capabilities of its new hardware in "real world"
conditions.
Although several important milestones have been achieved in the testing
of the Company's new hardware, there can be no assurance that the field testing
portion of this testing program can be funded or that the new hardware 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.
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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.
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 six months ended
December 31, 2005 and 2004, 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 and 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.
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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 six
months ended December 31, 2005 and 2004, 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 six
months ended December 31, 2005 and 2004, 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 and six months ended
December 31, 2005 were $189,766 and $246,866, respectively, as compared to
$14,659 and $37,529 for the three and six months ended December 31, 2004. The
increase of $175,107 and $209,377 for the three and six months ended December
31, 2005, respectively, as compared to the three and six months ended December
31, 2004 is substantially the result of the Company retaining the services of a
consultant and a scientist to focus increased efforts on the design,
fabrication, and testing of the Company's new hardware. Additionally, included
in research and development for the three and six months ended December 31,
2005, is $75,750 for the fair value of 75,000 options granted to the consultant
and the scientist as partial compensation for their past services rendered.
General and administrative expenses for the three and six months ended
December 31, 2005 were $175,138 and $335,444, respectively, as compared to
$190,075 and $370,677, respectively, for the three and six months ended December
31, 2004. The decrease of $14,937 for the three months ended December 31, 2005
as compared to the three months ended December 31, 2004 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 $35,233 for the
six months ended December 31, 2005 as compared to the six months ended December
31, 2004 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 $8,000 and a decrease in insurance premiums
of approximately $2,500 for the six months ended December 31, 2005 as compared
to the six months ended December 31, 2004.
Loss from operations for the three and six months ended December 31,
2005 was $364,904 and $582,310, respectively, as compared to $204,734 and
$408,206, respectively, for the three and six months ended December 31, 2004. In
general, loss from operations increased for the three and six months ended
December 31, 2005 as compared to the three months ended December 31, 2004 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 six months ended December 31, 2005
was $30,675 and $225,332, respectively, as compared to $33,186 and $138,949,
respectively, for the three and six months ended December 31, 2004. The decrease
of $2,511 for the three months ended December 31, 2005 as compared to the three
months ended December 31, 2004 is substantially the result of Mr. Evans
converting $257,754 of his 5% interest bearing Amended Evans Loan during the
three months ended December 31, 2005, thereby reducing the outstanding principal
balance on the Amended Evans Loan and the corresponding interest expense
incurred by the Company of approximately $4,300. Additionally, interest expense
related to the 5% interest bearing Debentures decreased by approximately $2,000
for the three months ended December 31, 2005 as compared to the three months
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ended December 31, 2004 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 December 31, 2005, approximately $20,000
of unamortized discount was recognized as interest expense upon conversion by
one investor as compared to unamortized discount of approximately $15,000 that
was recognized as interest expense upon conversion by one investor during the
three months ended December 31, 2004.
The increase of $86,383 for the six months ended December 31, 2005 as
compared to the six months ended December 31, 2004 is substantially the impact
of investors exercising their conversion right in accordance with the terms of
the 2003 Offering. Five investors exercised their conversion right during both
the six months ended December 31, 2005 and 2004. However, the unamortized
discount recognized as interest expense upon conversion was approximately
$190,000 during the six months ended December 31, 2005 as compared to
approximately $100,000 during the six months ended December 31, 2004.
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 $12,412,781 through December 31, 2005 and had negative working capital of
$1,389,298 as of December 31, 2005. 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 December
31, 2005, the Company has accrued $862,150 related to the deferred payment of
salaries and professional fees of which $682,000 is included under deferred
wages and $180,150 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.
17
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 $64,162 and $101,977 for the three and six months ended
December 31, 2004, respectively. The fair value of the warrants issued during
the three and six months ended December 31, 2004, 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
$23,838 and $56,023 during the three and six months ended December 31, 2004,
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 six months ended December 31, 2005, one 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
$19,993 and $189,954 at the conversion date was recognized as interest expense
during the three and six months ended December 31, 2005, respectively.
During the three and six months ended December 31, 2004, four 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 $15,000 and $100,000 at the conversion date was recognized as
interest expense during the three and six months ended December 31, 2004,
respectively.
As of December 31, 2005, accrued interest on the Debentures was $2,383.
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 $20,026 and $190,011 for the three and six
months ended December 31, 2005, 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 $15,011 and $100,014 for the three and six months ended
December 31, 2004, respectively. As of December 31, 2005 the carrying value of
the long-term portion of the Debentures was $73, net of unamortized debt
discount of $75,427.
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 six months ended December 31, 2005, the Company raised
$755,500 under the terms of the 2005 Offering. Accordingly, the Company issued
1,511,000 shares of common stock and warrants to purchase up to 1,511,000 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
18
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 six months ended December 31, 2005, the Company incurred $19,700 and
$71,350, respectively, of fees to be paid in cash to the brokerage firm and
issued warrants to purchase 39,400 and 142,700, respectively, shares of common
stock. During the three and six months ended December 31, 2005, the Company
recorded $39,006 and $107,184, 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 December 31, 2005 was
estimated using the Black-Scholes option pricing model with the following
weighted average assumptions: expected volatility of 376.16%, risk-free interest
rate of 4.14%, expected lives of five years, and a 0% dividend yield. The fair
value of the warrants issued to the brokerage firm during the six months ended
December 31, 2005 was estimated using the Black-Scholes option pricing model
with the following weighted average assumptions: expected volatility ranging
from 353.30% to 376.15%, risk-free interest rates ranging from 4.14% to 4.35%,
expected lives of five years, and a 0% dividend yield.
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 December 31, 2005, the Company had outstanding loans payable to
certain officers, directors and stockholders with principal amounts, in the
aggregate, equal to $479,990. The terms of the various notes are described above
under "Note 6: Notes Payable - Stockholders."
As of December 31, 2005, the Company has future minimum lease payments
of approximately $6,078 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 (as discussed in
the "General" section) 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.
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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.
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.
20
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.
During the three months ended December 31, 2005, an investor exercised
their conversion right, pursuant to the terms of the 2003 Offering, and
converted $40,000 of principal pursuant to the terms of the 2003 Offering.
Accordingly, the Company issued 80,000 shares of common stock and warrants to
purchase up to 80,000 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, 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 December 31, 2005, the Company raised
$207,000 and issued 414,000 shares of common stock and warrants to purchase up
to 414,000 shares of stock in accordance with the terms of the 2005 Offering.
During the three months ended December 31, 2005, Mr. Evans exercised his
conversion right, pursuant to the terms of the Amended Evans Loan, and converted
$577,000 of principal and accrued interest pursuant to the terms of the 2005
Offering. Accordingly, the Company issued 1,154,000 shares of common stock and
warrants to purchase up to 1,154,000 shares of common stock in accordance with
the terms of the 2005 Offering.
Stock Options
On December 12, 2005, the Board approved the issuance of options
exercisable for 435,000 shares of common stock pursuant to the 1999 Stock Option
Plan to certain directors, officers, an employee and three consultants of the
Company. The options will be granted by the Company on December 12, 2005.
Directors, officers, and an employee will be granted options exercisable for
350,000 shares of common stock and will have a ten-year term. Options
exercisable for the remaining 85,000 shares of common stock will be granted to
three of the Company's consultants and will have a five-year term. The exercise
price of the options granted to insiders owning or controlling more than ten
percent of the Company's common stock will be $1.21, which is ten percent over
the closing bid price of the Company's common stock as quoted on the Over the
Counter Bulletin Board on the grant date, December 12, 2005. The exercise price
of the stock options granted to non-insiders will be $1.12. These securities
were issued in reliance on exemptions from registration provided by Section 4(2)
of the Securities Act.
21
Warrants
During the three months ended December 31, 2005, the Company issued a
warrant to a brokerage firm to purchase 39,400 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.
As of December 31, 2005, the outstanding principal balance of the
Amended Evans Loan (see "Note 6. Notes Payable - Stockholders" in the "Notes to
Financial Statements") was equal to $422,490. The outstanding principal balance
of the Amended Evans Loan was due and payable on December 31, 2003. The Company
has not made the interest payments which were due and payable to Mr. Evans on
June 30 and December 31 of every year. As of December 31, 2005, the Company's
total arrearage under the Amended Evans Loan with respect to accrued interest
payments was equal to $83,453. Mr. Evans has not made any demand for payment, or
exercised any of his remedies, under the Amended Evans Loan. Subsequent to
December 31, 2005, Mr. Evans loaned the Company an additional $5,979 pursuant to
the terms of the Amended Evans Loan. Additionally, on January 10, 2006, Mr.
Evans provided a notice of conversion to the Company to convert his entire
outstanding principal balance of $428,469 and accrued interest of $84,031 on the
Amended Evans Loan pursuant to the terms of the 2005 offering. Accordingly, Mr.
Evans received 1,025,000 shares of common stock and warrants to purchase
1,025,000 shares of common stock at an exercise price of $0.75 per share.
Item 4. Submission of Matters to a Vote of Shareholders.
The Annual Meeting of Stockholders (the "Annual Meeting") of the Company
was held on December 12, 2005.
At the Annual Meeting, 5,505,161 shares were present in person or by
proxy. The following is a summary and tabulation of the matters that were voted
upon at the Annual Meeting:
Proposal I.
The election of a board of directors to serve a term of one year or
until their respective successors are elected and qualified.
Votes For Votes Withheld
--------- --------------
Henry E. Gemino 5,487,771 17,390
Murphy Evans 5,487,771 17,390
Charles Christenson 5,502,961 2,200
William A. Krivsky 5,502,961 2,200
Item 5. Other Information.
None.
22
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:
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 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: February 14, 2006 /s/ Henry E. Gemino
-------------------
Henry E. Gemino
Chief Executive Officer and
Chief Financial Officer
24