In December 2004, the FASB issued Staff Position no. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FAS 109-2”). The American Jobs Creation Act of 2004 allows for a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer if certain criteria are met. The provisions of FAS 109-2 were effective immediately upon issuance. The adoption of FAS 109-2 did not have a significant impact on our financial statements.
IFT’s financial statements are presented on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. IFT has incurred significant losses since inception and has previously had limited funds with which to operate. Management is in the process of executing a strategy based upon developing pollution emission control technologies that also offer enhanced engine performance with respect to greater fuel economy. IFT has several technologies in the commercialization phase and in development, and may seek to add other technologies through acquisitions. IFT has received necessary regulatory and commercial acceptance for its products currently in the commercialization phase. During the first quarter of 2002, IFT began selling its products directly to the commercial marketplace. IFT expects to begin licensing its products and increasing its direct sales to the marketplace, with IFT eventually generating a level of revenues sufficient to meet IFT’s working capital requirements. However, it is possible that this may take a few years or may never occur. While management cannot make any assurance as to the accuracy of our projections of future capital needs, it is anticipated that a total of approximately $2 million over the 2005 fiscal year will be necessary in order to enable IFT to meet its current capital needs. IFT will continue to seek funding, on a monthly basis, through private placements of equity securities with existing shareholders/investors of IFT. However, there is the possibility that these private placements may end at some point in the future. If IFT is unable to secure this additional funding, IFT may need to significantly curtail operations.
During 2004, IFT entered into four distribution agreements to market and sell its products in the United States, Europe, and Asia.
In December 2004, IFT sold restricted shares, in a private placement, to a director netting $650,000 in cash.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of IFT to continue as a going concern.
On May 25, 2001 IFT issued 12,500,001 common shares to the shareholders of Interfacial to acquire all of Interfacial’s outstanding common stock. Interfacial is a company formed in May 2000 which has since its inception focused its efforts to develop proprietary fuels and fuel additive formulations that will improve fuel economy, enhance lubricity and lower harmful engine emissions, while decreasing reliance on petroleum-based fuels. IFT acquired Interfacial because it believed their technology could be more expeditiously and cost effectively brought to market than its previously acquired PEERFUEL™ technology. The purchase price of approximately $6,750,001 was determined based on the market price
INTERNATIONAL FUEL TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
of IFT’s common stock on the date the acquisition was announced. Stock certificates for an additional 8,500,002 common shares were placed in an escrow account subject to a performance escrow agreement that provided for the release of the stock certificates to the Interfacial shareholders based on the achievement of certain revenue levels by IFT. In January 2002, IFT and the former shareholders of Interfacial agreed to reduce the additional shares subject to the performance escrow by 500,000 shares. In May 2003, IFT cancelled the remaining 8,000,002 shares in the escrow account as a result of IFT not achieving the revenue levels described in the performance agreement.
The acquisition has been accounted for using the purchase method of accounting, and the assets have been recorded at fair value. Results of operations have been included as of the effective date of the transaction. The purchase price of $6,750,001 was allocated as follows: $2,400,001 to purchased technology, $1,900,000 to in-process research and development, and $2,450,000 to goodwill. IFT is using an estimated life of six years for the purchased technology. At the date of acquisition, Interfacial’s efforts focused on fine-tuning its additive technology for aqueous blends and tailoring it to existing applications, in order to optimize the emission-reducing characteristics while preserving engine efficiency, and there existed uncertainties regarding the successful development of the technology. The amount allocated to in-process research and development was calculated in a valuation using the discounted cash flow method based on a useful life of six years, and the entire value of $1,900,000 was charged to research and development expense during 2001. As of December 31, 2001, IFT had completed development of this technology and was shifting its focus to commercialization. Amortization of purchased technology amounted to $400,000, $400,000 and $400,000 for the years ended December 31, 2004, 2003, and 2002, respectively. Amortization expense for the next three years will be as follows: 2005 - $400,000; 2006 - $400,000; 2007 - $166,668.
IFT adopted an annual goodwill impairment test date as of the beginning of the fourth quarter of 2002 and updated its test at the beginning of the fourth quarter of 2004. Following this approach, the business was evaluated using the quoted market price of the common stock, which indicated that the fair value of the business exceeded its carrying value. As a result, no impairment of goodwill was recorded. Goodwill is currently being deducted over 15 years for tax purposes.
Note 4. Notes Payable and Convertible Debentures
During 2002, IFT received advances totaling $280,000 from shareholders. IFT repaid the $280,000 by issuing 1,555,555 shares of common stock in 2002. In connection with the issuance of the shares, IFT recognized $77,777 in interest expense due to the fair value of the stock on the date of extinguishment exceeding the carrying value by this amount.
During the year ended December 31, 2002, IFT issued 1,410,633 shares of common stock upon the conversion of $475,000 worth of convertible debentures owned by Equity Opportunities Fund, Ltd. (“IIG”). An additional $112,760 had been recorded as a discount on the convertible debentures and added to additional paid-in capital, relating to the beneficial conversion feature in 2002. The beneficial conversion feature was calculated as the excess value of the shares to be converted over the amount of the proceeds allocated to the convertible debentures.
As of December 31, 2004 and 2003, IFT had no outstanding notes payable or convertible debentures.
F - 12
INTERNATIONAL FUEL TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
Note 5. Extinguishment of Liabilities
Included in accrued compensation at December 31, 2004 and 2003, is $239,469 and $194,785, respectively, of compensation relating to employment agreements for which services have been rendered. During 2004 and 2003, an officer of IFT agreed to relieve IFT from its obligation of $35,000 and $70,000, respectively, of salary owed to him for service in previous years. The write-off of the $35,000 and $70,000 liabilities were accounted for as a contribution of capital.
In December 2003, as a result of a litigation settlement, IFT was released from its obligation regarding notes payable in the amount of $162,500 accrued interest relating to the notes of $27,500 and 2003 interest expense of $8,900. The write-off of the notes and interest was recognized as other income.
Note 6. Stockholders’ Equity
Effective October 27, 1999, IFT merged with and into Blencathia Acquisition Corporation (“Blencathia”). Blencathia had 300,000 shares outstanding at the time of the merger, which it redeemed and canceled. In exchange for 300,000 shares of Blencathia’s common stock, IFT issued 300,000 shares of its restricted common stock. These shares are expected to be sold in an amount sufficient to provide the former shareholders of Blencathia with proceeds of $500,000, the negotiated cost of the acquisition.
On May 8, 2000 IFT issued 300,000 common shares that were contingently issued per the Blencathia merger agreement. The 300,000 shares of common stock are included in the statement of stockholders’ deficit for the year ended December 31, 2004, 2003 and 2002 but are not included in earnings per share and weighted average share calculations for those periods. They will be included when the shares are sold to provide payment to the shareholders of Blencathia. The shareholders of Blencathia have represented to the management of IFT that the 300,000 shares will be sold only with IFT’s approval. If the shares are sold and $500,000 is not generated additional shares may need to be issued to the shareholders of Blencathia. Based on the December 31, 2004 market price, $1.90, of IFT’s common stock, no additional shares would need to be issued to generate the $500,000 proceeds.
During 2002, IFT entered into consulting agreements providing for the issuance of shares through 2003. IFT recorded the value of the shares to be issued ratably based on the fair value of the stock over the terms of the consulting agreements. During 2002, IFT issued 5,075,000 shares of common stock and recorded $764,293 of consulting expense. During 2003, IFT issued 480,000 shares of common stock and recorded $248,059 of consulting expense. No additional stock is to be issued under these agreements. During 2004, IFT issued 350,000 shares of common stock under new agreements and recorded $134,000 of consulting expense.
During 2002, IFT issued 125,000 shares of stock to employees and Directors. Compensation expense of $150,000 was recognized in 2002, based on the trading price on the date of issuance.
In 2002, IFT secured $2.5 million in new capital from the sale of 13,888,889 shares of restricted common stock to R.C. Holding Company. IFT received $1,900,000 and $600,000 from the sale of these shares in 2003 and 2002, respectively.
F - 13
INTERNATIONAL FUEL TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
During 2002, IFT sold 850,000 shares of common stock to a consultant and received proceeds of $200,000. During 2003, IFT sold 2,457,142 shares of common stock to consultants (800,000) and Directors (1,657,142) and received proceeds of $319,980 and $280,000, respectively. During 2004, IFT sold 5,181,925 shares of common stock to a director and received proceeds of $2,100,000. The sale price of the stock was based on the trading price on the date of issuance.
Note 7. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of temporary differences that give rise to significant portions of the net deferred income tax asset are as follows:
December 31, | | 2004 | | 2003 | |
| |
| |
| |
Net operating loss carryforwards | | $ | 9,865,000 | | $ | 9,068,000 | |
Goodwill | | | 666,000 | | | 683,000 | |
Stock option expense | | | 901,000 | | | 172,000 | |
Accrued compensation | | | 40,000 | | | 21,000 | |
| |
|
| |
|
| |
| | | 11,472,000 | | | 9,944,000 | |
Less valuation allowance | | | (11,472,000 | ) | | (9,944,000 | ) |
| |
|
| |
|
| |
Deferred tax asset | | $ | — | | $ | — | |
| |
|
| |
|
| |
In accordance with generally accepted accounting principles, a valuation allowance must be established for a deferred tax asset if it is uncertain that a tax benefit may be realized from the asset in the future. IFT has established a valuation allowance to the extent of its deferred tax assets since it is more likely than not that the benefit cannot be realized in the future.
Net operating loss carryforwards available for IFT for Federal tax purposes are as follows:
Balance | | Expiration | |
| |
| |
$ | 344,473 | | | 2012 | |
| 1,090,666 | | | 2013 | |
| 12,971,893 | | | 2019 | |
| 4,213,207 | | | 2020 | |
| 2,878,026 | | | 2021 | |
| 2,729,826 | | | 2022 | |
| 2,441,976 | | | 2023 | |
| 2,345,857 | | | 2024 | |
|
| | | | |
$ | 29,015,924 | | | | |
|
| | | | |
The reconciliation of income tax computed at the United States federal statutory tax rate of 34% to the income tax benefit is as follows:
F - 14
INTERNATIONAL FUEL TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
Year ended December 31, | | 2004 | | 2003 | | 2002 | |
| |
| |
| |
| |
Tax benefit at federal statutory rate | | $ | (1,536,000 | ) | $ | (890,000 | ) | $ | (1,183,000 | ) |
Change in deferred tax valuation allowance | | | 1,528,000 | | | 817,000 | | | 1,010,000 | |
Other | | | 8,000 | | | 73,000 | | | 173,000 | |
| |
|
| |
|
| |
|
| |
Income tax benefit | | $ | — | | $ | — | | $ | — | |
| |
|
| |
|
| |
|
| |
Note 8. Lease Commitment
As of January 1, 2002, IFT leased office space under a five-year operating lease, expiring on December 31, 2006. Future minimum lease payments are $52,800 for the years 2005 and 2006. Rent expense was $47,976, $52,755, and $57,607, during the fiscal years ended December 31, 2004, 2003, and 2002, respectively.
Note 9. Legal Proceedings
IFT is subject to various lawsuits and claims with respect to matters arising out of the normal course of business. While the impact on future financial results is not subject to reasonable estimation because considerable uncertainty exists, management believes, after consulting with counsel, that the ultimate liabilities resulting from such lawsuits and claims will not materially affect the consolidated results, liquidity or financial positions of IFT.
Note 10. Quarterly Statements of Operation Information (Unaudited)
| | For the Three Month Period Ended | |
| |
| |
| | March 31, 2004 | | June 30, 2004 | | September 30, 2004 | | December 31, 2004 | |
| |
| |
| |
| |
| |
Revenues | | $ | 3,614 | | $ | 4,605 | | $ | 6,435 | | $ | 9,168 | |
Gross profit | | $ | 2,048 | | $ | 2,329 | | $ | 357 | | $ | 2,668 | |
Net loss | | $ | (602,540 | ) | $ | (589,362 | ) | $ | (580,443 | ) | $ | (2,746,591 | ) |
Basic and diluted net loss per share | | $ | (0.01 | ) | $ | (0.01 | ) | $ | (0.01 | ) | $ | (0.04 | ) |
Weighted average common shares outstanding | | | 72,720,699 | | | 73,924,060 | | | 75,094,192 | | | 77,904,945 | |
F - 15
INTERNATIONAL FUEL TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
| | For the Three Month Period Ended | |
| |
| |
| | March 31, 2003 | | June 30, 2003 | | September 30, 2003 | | December 31, 2003 | |
| |
| |
| |
| |
| |
Revenues | | $ | 1,295 | | $ | 571 | | $ | 373 | | $ | 6,782 | |
Gross profit | | $ | 511 | | $ | 249 | | $ | 43 | | $ | 2,973 | |
Net loss | | $ | (783,206 | ) | $ | (729,896 | ) | $ | (583,719 | ) | $ | (521,897 | ) |
Basic and diluted net loss per share | | $ | (0.01 | ) | $ | (0.01 | ) | $ | (0.01 | ) | $ | (0.01 | ) |
Weighted average common shares outstanding | | | 69,474,685 | | | 69,838,685 | | | 70,254,685 | | | 70,995,042 | |
Note 11. Options
On October 23, 2001, the Board of Directors adopted IFT’s Long-term Incentive Plan. The Board of Directors will be responsible for the administration of this Plan, and will grant awards under this Plan. Subject to the express provisions of the Plan, the Board of Directors shall have full authority and sole and absolute discretion to interpret and amend this Plan, to prescribe, amend and rescind rules and regulations relating to it, and to make all other determinations which it believes to be necessary or advisable in administering this Plan. The determinations of the Board of Directors on the matters referred to in this Section shall be conclusive. No member of the Board of Directors shall be liable for any act or omission in connection with the administration of this Plan unless it resulted from the member’s willful misconduct.
The maximum number of shares of common stock as to which awards may be granted under this Plan, subject to subsequent amendments, is 17,500,000 shares. The common stock which is issued on grant of awards may be authorized except for unissued shares or shares which have been issued and reacquired by IFT. The Board of Directors may increase the maximum number of shares of common stock as to which awards may be granted at such time as it deems advisable. Awards may be granted to employees or consultants of IFT in their individual capacity only.
During the twelve months ended December 31, 2002, IFT recorded $298,963 in compensation expense relating to shares that were to be issued to employees on various anniversary dates of their employment. These shares were never issued, and were replaced with grants of options under the Long-Term Incentive Plan to purchase an aggregate of 510,000 shares of common stock at exercise prices ranging from $0.14 to $0.25 per share, vesting immediately, and expiring in December 2009. These options are being accounted for using variable-based accounting in accordance with APB 25. As a result, IFT incurred compensation expense of $746,700 and $32,500 in 2004 and 2003, respectively, as a result of the stock price exceeding the exercise price established by repricing (which ranged from $0.26 to $0.48).
In 2002 and 2003, IFT granted an additional 4,850,000 and 1,500,000 stock options to employees. 3,000,000 of the options granted in 2002 vested immediately, and the remaining 2002 options and all the 2003 options vest over 12 or 24 months. The options have exercise prices ranging from $0.25 to $0.75 and expire in 2007 and 2008. In 2004, IFT granted an additional 3,950,000 stock options to employees.
F - 16
INTERNATIONAL FUEL TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
2,300,000 of the options granted in 2004 vested immediately, and the remaining 2004 options vest over 12 or 24 months. The options have exercise prices ranging from $0.14 to $2.00 and expire in 2009 and 2010. IFT applied the intrinsic value method under APB 25 and related interpretations in accounting for these options. Accordingly, $880,000 of compensation expense was recognized in 2004 as the market price of the stock exceeded the exercise price on the measurement date for 500,000 stock options. No compensation cost has been recognized for the options granted with a market price of the stock that did not exceed the exercise price on the measurement date.
The following tables summarize information about stock options during the three years ended December 31, 2004:
| | Shares | | Exercise Price
per Share | | Weighted
Average
Exercise Price | |
| |
| |
| |
| |
Outstanding at December 31, 2001 | | | — | | | — | | | — | |
Granted | | | 5,360,000 | | $ | 0.14-0.75 | | $ | 0.47 | |
| |
|
| |
|
| |
|
| |
Outstanding at December 31, 2002 | | | 5,360,000 | | | | | | | |
Granted | | | 1,500,000 | | $ | 0.5 | | $ | 0.5 | |
Exercised | | | — | | | — | | | — | |
Forfeited | | | (100,000 | ) | $ | 0.5 | | $ | 0.5 | |
| |
|
| |
|
| |
|
| |
Outstanding at December 31, 2003 | | | 6,760,000 | | $ | 0.14-0.75 | | $ | 0.48 | |
Granted (1) | | | 3,950,000 | | $ | 0.14-2.00 | | $ | 1.31 | |
Exercised | | | — | | | — | | | — | |
Forfeited | | | (250,000 | ) | $ | 0.5 | | $ | 0.5 | |
| |
|
| |
|
| |
|
| |
Outstanding at December 31, 2004 | | | 10,460,000 | | $ | 0.14-2.00 | | $ | 0.79 | |
| |
|
| |
|
| |
|
| |
Options exercisable at December 31, 2004 | | | 8,810,000 | | $ | 0.14-1.00 | | $ | 0.56 | |
| |
|
| |
|
| |
|
| |
Options exercisable at December 31, 2003 | | | 4,385,000 | | $ | 0.14-0.75 | | $ | 0.46 | |
| |
|
| |
|
| |
|
| |
Options exercisable at December 31, 2002 | | | 3,510,000 | | $ | 0.14-0.75 | | $ | 0.46 | |
| |
|
| |
|
| |
|
| |
|
(1) Includes 500,000 options granted at less than market price with a weighted average exercise price of $0.14 and 3,450,000 options granted at greater than market price with a weighted average exercise price of $1.48. |
F - 17
INTERNATIONAL FUEL TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
| | Options Outstanding | | Options Exercisable | |
|
| |
| |
Exercise Price | | Number
Outstanding at
December 31,
2004 | | Weighted
Average
Remaining
Contractual
Life (in years) | | Weighted
Average
Exercise
Price | | Number
Exercisable at
December 31,
2004 | | Weighted
Average
Exercise
Price | |
| |
| |
| |
| |
| |
| |
$0.14 - $0.25 | | | 2,010,000 | | | 4.99 | | $ | 0.21 | | | 2,010,000 | | $ | 0.21 | |
$0.50 - $0.75 | | | 5,000,000 | | | 5.00 | | | 0.55 | | | 5,000,000 | | | 0.55 | |
$1.00 - $2.00 | | | 3,450,000 | | | 5.48 | | | 1.48 | | | 1,800,000 | | | 1.00 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | 10,460,000 | | | 5.16 | | $ | 0.79 | | | 8,810,000 | | $ | 0.56 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
In 2002 and 2003, IFT granted 3,000,000 and 500,000 stock options to non-employees. 1,000,000 of the options granted in 2002 vested immediately and were recorded as consulting expense at that time. The remaining 2002 options and all the 2003 options vest over 12 or 24 months and the fair value of the options are being recorded as consulting expense ratably over the vesting period. In 2003, 1,500,000 options granted in 2002 that had not yet vested were forfeited. IFT cancelled these options and reversed previously recognized consulting expense relating to these options. In 2004, IFT granted 7,480,000 stock options to non-employees. 1,230,000 of the options granted in 2004 vested immediately and were recorded as consulting expense at that time. Some of the 2004 options will vest over 10 or 12 months and the fair value of the options are being recorded as consultant expense ratably over the vesting period. The majority of the 2004 options will vest based on the occurrence of certain events and therefore consulting expense will not be recorded until the triggering event occurs. Total consulting expense recognized in connection with these options was $174,167 in 2002, $779 in 2003, and $516,695 in 2004.
Options outstanding to non-employees at December 31, 2004, 2003 and 2002 are 9,480,000, 2,000,000 and 3,000,000, respectively. Options exercisable by non-employees at December 31, 2004, 2003 and 2002 are 3,380,000, 1,500,000 and 1,000,000, respectively. The weighted average exercisable prices by non-employees at December 31, 2004, 2003 and 2002, for options outstanding and exercisable was $0.74 and $0.65, $0.50 and $0.50, and $0.50 and $0.50, respectively.
Services performed by non-employees who were granted options include product/distribution consulting and legal. The fair value for these options ($0.37 for 2004, $0.07 for 2003 and $0.04 for 2002) was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rates of 3.40% for 2004, 1.66% for 2003 and 1.54% for 2002; volatility factor of 1.52 for 2004, 1.36 for 2003 and 1.28 for 2002; and a weighted average expected life of the option of 4.75 years for 2004, 2003 and 2002.
F - 18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INTERNATIONAL FUEL TECHNOLOGY, INC. |
(Registrant) |
| | | |
By: | /s/ JONATHAN R. BURST | | Date March 24, 2005 |
|
| | |
| Jonathan R. Burst | | |
| President and Chief Executive Officer | | |
| | | |
By: | /s/ MICHAEL F. OBERTOP | | Date March 24, 2005 |
|
| | |
| Michael F. Obertop | | |
| Chief Financial Officer | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on behalf of the registrant and in the capacities and on the dates indicated.
By: | /s/ JONATHAN R. BURST | | Date March 24, 2005 |
|
| | |
| Jonathan R. Burst | | |
| Chairman of the Board | | |
| | | |
By: | /s/ REX CARR | | Date March 24, 2005 |
|
| | |
| Rex Carr | | |
| Director | | |
| | | |
By: | /s/ GARY KIRK | | Date March 24, 2005 |
|
| | |
| Gary Kirk | | |
| Director | | |
| | | |
By | /s/ DAVID B. NORRIS | | Date March 24, 2005 |
|
| | |
| David B. Norris | | |
| Director | | |
| | | |
By: | /s/ HARRY DEMETRIOU | | Date March 24, 2005 |
|
| | |
| Harry Demetriou | | |
| Director | | |
| | | |
By: | /s/ TONY CROSS | | Date March 24, 2005 |
|
| | |
| Tony Cross | | |
| Director | | |
F - 19
