The Share Subscription Agreement for the 2010 Debentures contains an exchange feature. The exchange feature provides that if within twelve months from March 19, 2010 we enter into or closes another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the 2010 Debentures) on terms and conditions more favorable to another purchaser, the terms and conditions of the 2010 Debentures shall be adjusted to reflect the more favorable terms. On March 31, 2011, we re-evaluated the fair value of the exchange feature and determined that the probability of closing another financing was 100% and the conversion price of the 2010 Debentures would be reset. On March 31, 2011, an additional liability of $578,739 was recorded for the exchange feature in our consolidated financial statements with a $578,739 expense related to change in fair value of exchange feature liability recorded in the consolidated condensed statements of operations and comprehensive loss.
Change in fair value of exchange feature liability for the three month period ended March 31, 2011 amounted to $578,739 as compared to $0 for the three month period ended March 30, 2010.
We incurred $34,521 interest cost on notes payable to a related party under the Bridge Loans for the three month period ended March 31, 2011 as compared to $11,342 for the three month period ended March 31, 2010.
At March 31, 2011, we recorded interest accretion expense of $1,050,000 ($0 for March 31, 2010), financing charge on embedded derivative liability of $485,101 ($0 for March 31, 2010) and a gain on convertible derivative of $1,336,445 ($0 for March 31, 2010) related to the discount feature and the embedded derivative features in the $3,000,000 notes payable to related party.
expenses. These increases were offset by a decrease in facility costs of $24,696 as a larger portion of overheads applied to the cost of sales.
Research & Development (“R&D”). R&D expenses for the year ended December 31, 2010 decreased by $146,604, or 15.8 percent, to $783,944 from $930,548 for the year ended December 31, 2009, in each case net of grants. We incurred R&D expenses associated with the verification and expansion of engine family sizes of our Therma Cat (TM) Active Level III Plus Diesel Particulate Filter, as well as the verification of our locomotive and marine products and the certification of our Level II product. During the year ended December 31, 2010, we received grant money for our R&D activities amounting to $143,375 as compared to $168,753 for the year ended December 31, 2009.
Officers’ Compensation. Officers’ compensation and directors’ fees for the year ended December 31, 2010 increased by $281,610, or 41.9 percent, to $954,054 from $672,444 for the year ended December 31, 2009. The increase is mainly due to the addition of two outside directors in 2010, a wage increase for one of our officers retroactive to January 2010, stock based compensation expense for the April 2010 stock options and the effect of exchange rate differences on Canadian Dollar (“CAD”) contracts for our officers.
Consulting and Professional Fees. Consulting and professional fees for the year ended December 31, 2010 increased by $235,361 to $451,345 from $215,984 for the year ended December 31, 2009. The increase is mainly attributed to increased legal fees associated with the closing of the Demand Credit Agreement, legal fees related to the renewal of our Canadian subsidiary’s lease agreement, increased audit and other fees related to Sarbanes-Oxley 404, as well as general consulting fees.
Foreign Exchange Loss. Foreign exchange loss for the year ended December 31, 2010 amounted to $103,256. For the year ended December 31, 2009 foreign exchange gain amounted to $10,035. This is a result of the fluctuation in the exchange rate of the Canadian Dollar relative to the U.S. Dollar.
Depreciation and Amortization. Depreciation and amortization expense for the year ended December 31, 2010 decreased by $286,112, or 25.5 percent to $837,448 from $1,123,560 for the year ended December 31, 2009.
Loss From Operations. Loss from operations for the year ended December 31, 2010 decreased by $345,083, or 6.9 percent, to $4,673,760 from $5,018,843 for the year ended December 31, 2009. The decrease is mainly due to increased revenues in the current year offset by an increase in costs.
Interest Expense. Interest expense on long-term debt was $183,858 for the year ended December 31, 2010 as compared to $870,632 for the year ended December 31, 2009. Amortization of deferred costs amounted to $117,131 and long- term debt accretion amounted to $768,981 for the year ended December 31, 2010 as compared to $19,912 and $27,019 respectively for the year ended December 31, 2009. As of December 31, 2010, we has no debt outstanding related to the convertible debentures.
Financing Expenses. As discussed above, since we did not have sufficient authorized shares as of the date of conversion of the 2008 Debenture, 2009 Debentures and 2010 Debentures to fulfill the premium owed on such conversion, the premium was recorded as an advance share purchase agreement at fair market value $2,909,872 at March 31, 2010. Subsequently, as of October 14, 2010, we revalued the advance share purchase agreement at fair market value $1,662,753 with a $1,247,119 gain recorded in the consolidated statements of operations and comprehensive loss. Effective November 30, 2010, we issued an aggregate of 4,375,668 restricted shares of common stock to holders of the debentures in connection with the early conversion of the debentures and settled the obligation.
On December 31, 2010, we evaluated the fair value of the exchange feature of the 2010 Debentures based on the probability of closing another financing by March 18, 2011 and the fair value of the number of incremental shares to be issued at a lower estimated issue price. The probability of closing another financing by March 18, 2011 was estimated to be 100% on December 31, 2010. The fair value of our common stock was determined by the closing price on the valuation date. At December 31, 2010, an exchange feature liability of $1,680,000 was recorded for the 2010 Debentures with a $1,680,000 expense related to change in fair value of exchange feature liability.
Effective November 9, 2010 and December 8, 2010, we closed on our first tranche and second tranche of a unit offering in the amount of $300,000 per tranche for gross proceeds of $600,000 whereby we issued 1,500,000
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units (“the unit offering”). The Share Subscription Agreement for the units contains an exchange feature which provides that if within six months from effective date of closing, we enter into or close another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the securities) on terms and conditions more favorable to another purchaser, the terms and conditions of the unit offering shall be adjusted to reflect the more favorable terms. On November 9, 2010, December 8, 2010 and December 31, 2010, we evaluated the fair value of the exchange feature based on the probability of closing another financing within six months and the fair value of the number of incremental shares and warrants to be issued at a lower estimated issue price for units. The fair value of our common stock was determined by the closing price on the valuation date and the fair value of the warrants was determined using a binomial option valuation model. At December 31, 2010, an exchange feature liability of $453,861 was recorded for the unit offering, with $112,649 recorded as the fair value of exchange feature liability on the issuance dates of the unit offering (November 9, 2010 and December 8, 2010) and a $341,213 change in fair value of exchange feature liability.
Change in fair value of exchange feature liability for the year ended December 31, 2010 amounted to $2,021,213 as compared to $0 for the year ended December 31, 2009.
Interest on note payable to related party amounted to $11,342 for the year ended December 31, 2010 as compared to $0 for the year ended December 31, 2009. On March 31, 2010, we repaid $500,000 principal and $11,342 in interest from the proceeds of the March 19, 2010 convertible debentures.
Loss on disposal of property and equipment amounted to $8,828 for the year ended December 31, 2010 and $1,404 for the same period in the previous year.
Liquidity and Capital Resources
Cash Flows
During the three month period ended March 31, 2011, we used $227,567 of cash to sustain operating activities compared with $1,530,685 for the three month period ended March 31, 2010. As of March 31, 2011 and March 31, 2010, we had cash and cash equivalents of $956,337 and $949,021, respectively.
During the year ended December 31, 2010, we used $5,875,140 of cash to sustain operating activities compared with $4,353,576 for the year ended December 31, 2009. As of December 31, 2010 and December 31, 2009, we had cash and cash equivalents of $13,328 and $632,604, respectively.
Net cash used in operating activities for the three month period ended March 31, 2011, amounted to $227,576. This amount was attributable to the net loss of $3,134,632, plus non cash expenses such as depreciation, amortization, interest accretion expense, change in fair value of exchange feature liability and others of $1,182,293, and an increase in net operating assets and liabilities of $1,724,763. Net cash used in operating activities for the three month period ended March 31, 2010 amounted to $1,530,685. This amount was attributable to the net loss of $4,997,559, plus non cash expenses such as depreciation, amortization, interest and accretion on long term debt, inducement premium on conversion of debentures and others of $4,237,365, and a decrease in net operating assets and liabilities of $770,491.
Net cash used in operating activities for the year ended December 31, 2010 amounted to $5,875,140. This amount was attributable to the net loss of $9,447,641, plus non cash expenses such as depreciation, amortization, interest and accretion on long term debt, inducement premium on conversion of debentures, exchange feature expense and others of $6,370,409, and a decrease in net operating assets and liabilities of $2,797,908. Net cash used in operating activities for the year ended December 31, 2009 amounted to $4,353,576. This amount was attributable to the net loss of $5,936,952, plus non cash expenses such as depreciation, amortization, interest on long term debt and others of $2,199,407, and a decrease in net operating assets and liabilities of $616,031.
Net cash used in investing activities was $15,729 for the three month period ended March 31, 2011 as compared to $100,998 provided by investing activities for the three month period ended March 31, 2010.
Net cash used in investing activities was $414,188 for the year ended December 31, 2010 as compared to $171,176 for the year ended December 31, 2009. The capital expenditures during the year ended December 31, 2010 were primarily dedicated to production tooling.
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Net cash provided by financing activities totaled $1,174,725 for the three month period ended March 31, 2011, as compared to $1,775,822 for the three month period ended March 31, 2010. In the current period of 2011, $3,000,000 was provided through the issuance of the Bridge Loans, $1,823,319 was repaid under the Demand Credit Agreement and $1,956 was repaid under capital lease obligation. In the prior year period of 2010, $3,000,000 was provided through issuance of convertible debentures, $720,510 was repaid under our prior bank loan, $500,000 repaid promissory notes to a related party, and $3,668 repaid a capital lease obligation.
Net cash provided by financing activities totaled $5,570,429 for the year ended December 31, 2010, as compared to $3,086,915 provided by financing activities for the year ended December 31, 2009. In the current period $2,919,375 (net of debt issuance costs of $80,625) was provided through issuance of convertible debentures, $3,312,254 was borrowed under our senior credit facility and $723,431 was repaid to Royal Bank of Canada prior to closing the facility, $500,000 repayment of promissory note to a related party, $576,000 (net of $24,000 broker fees related to share subscription) was received through the issuance of common stock and $13,769 repaid under capital lease obligation.
Liquidity and Capital Requirements
The industry that we operate in is capital intensive and there is a timing issue bringing product to market which is considered normal for this industry, there is a timing difference between awards of funding and the final funding released by the regulatory agencies which also affect revenues. We continue to invest in research and development to improve our technologies and bring them to the point where our customers have a high confidence level allowing them to place larger orders The length of time a customer needs to build confidence in ESW’s technologies cannot be predetermined and as a result, ESW has sustained operating losses as a result of not generating sufficient sales to generate a profit from operations. In 2011 ESW plans to adjust it business to correct for these issues.
During the first quarter of 2011 and the years ended 2010 and 2009, we did not produce sufficient cash from operations to support our expenditures. Prior financings as discussed below under the Debt Structure along with continued borrowing on our Demand Credit Agreement supported our operations during the period. Our principal use of liquidity relates to our working capital needs and to finance any further capital expenditures or tooling needed for production and/or our testing facilities.
Effective March 31, 2010, our subsidiary, ESW Canada, entered into the Demand Credit Agreement to meet working capital requirements. The facility has a credit limit of CAD $1.5 million. Borrowings under the facility are limited to a percentage of accounts receivable plus a percentage of inventories (capped at CAD $1.0 million or 50% of the accounts receivable portion) less any prior ranking claims.
We anticipate certain capital expenditures in 2011 related to the general operation of our business as well as to upgrade the air testing facilities in Montgomeryville, Pennsylvania. We do not expect that total capital expenditures for 2011 will amount to more than $1,400,000.
In February 2011, we secured $3,000,000 in additional financing through the Bridge Loans. Proceeds of the Bridge Loans, along with available cash, was used to fund working capital, planned capital investments and other general corporate purposes. As at March 31, 2011, of the $3.0 million in financing secured, $1,823,319 was used to repay our credit facility. Effective April 27, 2011, we secured $1.0 million in additional financing through the Bridge Loans, which being used for working capital to secure and deliver the current sales opportunities.
We are engaging in this rights offering to raise capital. Through this rights offering, we plan to sell up to 66,666,667 shares of common stock, at a subscription price of $0.12 per share, for net proceeds of $7.8 million. This capital will be used to repay indebtedness and fund working capital requirements. See “Use of Proceeds.”
With our anticipated growth in revenue, profitability and cash flow should improve to reflect our operating leverage. Enhanced profitability and cash flow will also result from our initiatives to enhance our commercial policies, streamline our infrastructure and drive our operational efficiencies across our operations.
Competition is expected to intensify as the market for our products expands. Our ability to continue to gain significant market share will depend upon our ability to continue to develop strong relationships with distributors, customers and develop new products. Increased competition in the market place could result in lower average pricing which could adversely affect our market share and pricing for our products.
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We have 700,000 Class A special shares, authorized, issued and outstanding, recorded at $453,900 (based on the historical exchange rate at the time of issuance). The Class A special shares are issued by our wholly-owned subsidiary BBL Technologies, Inc. (“BBL”) without par value, and are redeemable on demand by the holder of the shares which is a private Ontario Corporation at $700,000 CAD (which translates to $721,980 U.S. Dollars and $703,801 U.S. Dollars at March 31, 2011 and December 31, 2010, respectively). As the redeemable Class A special shares were issued by our wholly owned subsidiary, BBL, the maximum value upon which we are liable is the net book value of BBL. As of March 31, 2011 and December 31, 2010, BBL had an accumulated deficit of $1,192,858 U.S. dollar ($1,845,375 CAD), and therefore, the holder would be unable to redeem the redeemable Class A special shares at their ascribed value.
Debt Structure
Effective March 19, 2010, we issued the 2010 Debentures, which were $3,000,000 of 9% convertible debentures to 5 accredited investors under Rule 506 of Regulation D. The 2010 Debentures were for a term of 3 years and were convertible into shares of our common stock at the option of the holder by dividing the principal amount of the 2010 Debentures to be converted by $0.50. The 2010 Debentures earned interest at a rate of 9% per annum payable in cash or in shares of our common stock at the option of the holder. If the holder elected to receive interest in shares of common stock, the number of shares of common stock to be issued for interest would be determined by dividing accrued interest by $0.50. The 2010 Debentures had a mandatory conversion feature that required the holders to convert in the event a majority of our pre-existing outstanding 9% convertible debentures converted. Subject to the holder’s right to convert and the mandatory conversion feature, we had the right to redeem the 2010 Debentures at a price equal to one hundred and ten percent (110%) multiplied by the then outstanding principal amount plus unpaid interest to the date of redemption. Upon maturity, the 2010 Debentures and interest were payable in cash or common stock at the option of the holder. We also had provided the holders of the 2010 Debentures registration rights. The 2010 Debentures contained customary price adjustment protections.
Effective March 25, 2010, the holders of the 2008 Debentures and 2009 Debentures agreed to convert all outstanding convertible debentures as per the terms of the respective debenture agreements. The early conversion of the 2008 Debentures and 2009 Debentures was a condition precedent to ESW Canada entering into the Demand Credit Agreement. The conversion of the 2008 Debentures and 2009 Debentures triggered the mandatory conversion feature on the 2010 Debentures. As part of the agreement to convert all existing convertible debentures, we paid a share-based premium as an inducement to convert all debentures. The premium was payable to all converting debenture holders and was subject to a positive fairness opinion, provided by a Fairness Committee consisting of independent directors of our board of directors and an increase in our share capital. The premium consisted of 4,375,665 shares of common stock. As we did not have sufficient authorized shares as of the date of conversion of the debentures to fulfill the premium, the premium was recorded as an advance share purchase agreement at a fair market value of $2,909,872 at March 31, 2010. The agreement was without interest, subordinated to the bank’s position and payable in a fixed number of shares of common stock (4,375,665 shares) upon increase in our authorized share capital. In summary, the fair value of the advanced share subscription was dependent on the market price of our common stock, as we did not have sufficient available authorized common shares to fulfill this obligation as on March 31, 2010. The advanced share subscription was revalued based on the market price of our common stock at the end of each reporting period until it was fulfilled by the issuance of authorized common shares. Gains and losses from the resulting revaluations were recognized on the consolidated condensed statement of operations and comprehensive loss.
The Share Subscription Agreement for the 2010 Debentures contains an exchange feature. The exchange feature provides that if within twelve months from March 19, 2010, we enter into or close another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the securities) on terms and conditions more favorable to another purchaser, the terms and conditions of the 2010 Debentures shall be adjusted to reflect the more favorable terms. On March 31, 2011, we re-evaluated the fair value of the exchange feature and determined that the probability of closing another financing was 100% and the conversion price of the 2010 Debentures would be reset. On March 31, 2011 an additional liability of $578,739 was recorded for the exchange feature in these consolidated condensed financial statements with a $578,739 expense related to change in fair value of exchange feature liability recorded in the consolidated statements of operations and comprehensive loss.
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Effective March 31, 2010, our subsidiary, ESW Canada, entered into the Demand Credit Agreement to meet working capital requirements. The facility has a credit limit of CAD $4 million. Borrowings under the facility are limited to a percentage of accounts receivable plus a percentage of inventories (capped at CAD $1 million or 50% of the accounts receivable portion) less any prior ranking claims. The credit facility is guaranteed by us and our subsidiaries, ESW Canada, ESW America, BBL, and ESW Technologies, through a general security agreement over all assets. The facility has been guaranteed to the bank under EDC’s Export Guarantee Program. Borrowings under the credit facility bear interest at 2.25% above the bank’s prime rate of interest. Obligations under the revolving credit agreement are collateralized by a first-priority lien on our assets and the assets of our subsidiaries, including, accounts receivable, inventory, equipment and other tangible and intangible property, including the capital stock of all direct subsidiaries.
The terms relating to the Demand Credit Agreement require that we maintain a tangible net worth of at least $4.0 million. The credit agreement contains, among other things, covenants, representations and warranties and events of default customary for a facility of this type for us and our subsidiaries. Such covenants include certain restrictions on the incurrence of additional indebtedness, liens, acquisitions and other investments, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other repurchases in respect of capital stock, voluntary prepayments of certain other indebtedness, capital expenditures and transactions with affiliates, subject to certain exceptions. Under certain conditions amounts outstanding under the credit agreements may be accelerated. Such events include failure to comply with covenants, breach of representations or warranties in any material respect, non-payment or acceleration of other material debt, entry of material judgments not covered by insurance, or a change of control of us.
Effective May 31, 2011, we entered into a sixth modification of the Demand Credit Agreement, whereby we received an extension on the term of the Demand Credit Agreement through June 30, 2011. In addition, the Demand Credit Agreement was amended to provide that the credit limit for the facility be reduced from CAD $4.0 million to CAD $1.5 million or, if less, the borrowing base established by the security margin. The sixth modification is subject to all covenants and the security margin under the Demand Credit Agreement remaining in order at all times. The lender also advised us that any reasonable request for an extension of the June 30, 2011 date will be considered in light of this rights offering. We paid a fee to the lender for the extension, which included reimbursement of reasonable legal and advisory fees.
From November 8, 2010 through February 14, 2011, our wholly owned subsidiary, ESW Canada, received waivers of certain financial covenants under the Demand Credit Agreement. Without the waivers, ESW Canada would not have been in compliance with certain covenants in the credit agreement. On February 17, 2011, we raised a $3.0 million pursuant to the Bridge Loans, following which we were in compliance with covenant obligations under the Demand Credit Agreement. On May 3, 2011, we raised an addition $1.0 million pursuant to the Bridge Loans, which were effective as of April 27, 2011.
As at March 31, 2011, $1,636,444 was owed under the Demand Credit Agreement ($0 for March 31, 2010).
Effective February 17, 2011 and April 27, 2011, we entered into the Bridge Loans. See “The Rights Offering — Background of the Rights Offering — The Bridge Loans.” As of March 31, 2011, $3,000,000 of principal and $34,521 of interest was owed under the Bridge Loans, compared to $0 of principle and $0 of interest as of March 31, 2010.
We are dependent upon the closing of this rights offering and the transactions contemplated by the Investment Agreement to meet our debt service obligations under the Demand Credit Agreement and the Bridge Loans. Our ability to service our indebtedness, other obligations and commitments in cash will depend on our future performance and our ability to raise capital, which will be affected by prevailing economic conditions, financial, business, regulatory and other factors. Certain of these factors are beyond our control. We may need additional financing after the completion of this rights offering to meet our financial projections and obligations. Significant assumptions underlie our projections, including, among other things, that we will be successful in implementing our business strategy, that some of our new products that have received verification from the appropriate regulatory authorities will obtain customer and market acceptance, and that there will be no material adverse developments in our business, liquidity or capital requirements.
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Contractual Obligations
Leases
Effective November 24, 2004, our wholly-owned subsidiary, ESW America, entered into a lease agreement for approximately 40,220 square feet of leasehold space at 2 Bethlehem Pike Industrial Center, Montgomery Township, Pennsylvania. The leasehold space houses our research and development facilities. The lease commenced on January 15, 2005 and expired January 31, 2010. Effective October 16, 2009, ESW America entered into a lease renewal agreement with Nappen & Associates for the leasehold property in Pennsylvania. There were no modifications to the original economic terms of the lease under the lease renewal agreement. Under the terms of the lease renewal, the lease term will now expire February 28, 2013. Effective March 31, 2011, ESW America entered into a lease amendment agreement with Nappen & Associates for the leasehold property at Pennsylvania, whereby ESWA has the sole option to extend the expiry of the lease agreement by an additional 3 years six months prior to February 28, 2013; there were no modifications to the original economic terms of the lease.
Effective December 20, 2004, our wholly-owned subsidiary, ESW Canada, entered into a lease agreement for approximately 50,000 square feet of leasehold space in Concord, Ontario, Canada. The leasehold space houses our executive offices and a high volume manufacturing plant. The possession of the leasehold space took place on May 24, 2005 and the term of the lease was extended to September 30, 2010. ESW Canada renewed its lease agreement at the current property for an additional five year term. The renewed lease period commenced on October 1, 2010 and ends on September 30, 2015.
The following is a summary of the minimum annual lease payments, for both leases as of March 31, 2011:
| 2011 | | | | $ | 351,021 | |
| 2012 | | | | | 468,029 | |
| 2013 | | | | | 319,813 | |
| 2014 | | | | | 297,476 | |
| 2015 | | | | | 223,107 | |
| | | | | $ | 1,659,447 | |
Capital Lease Obligation
We are committed to the following lease payments in connection with the acquisition of equipment under capital leases as of March 31, 2011:
| 2011 | | | | $ | 2,124 | |
| 2012 | | | | | 1,180 | |
| TOTAL | | | | | 3,304 | |
| Less imputed interest | | | | | (179 | ) |
| Total obligation under capital lease | | | | | 3,125 | |
| Less current portion | | | | | (1,806 | ) |
| TOTAL LONG-TERM PORTION | | | | $ | 1,319 | |
We incurred $80 and $515 of interest expense on capital lease obligation for the periods ended March 31, 2011 and 2010, respectively.
Restructuring Expenses and Severance Agreements
We accrued expenses related to severance agreements with our former Chief Executive Officer, Vice President of Operations and Director of Sales. As of March 31, 2011, $310,947 was included in accrued liabilities towards the balance of severance payments owing.
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Critical Accounting Policies and Estimates
General
Our discussion and analysis of the financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. (“US GAAP”).
A critical accounting policy is defined as one that is both material to the presentation of our financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. Specifically, critical accounting estimates generally require management to make assumptions about matters that are highly uncertain at the time of the estimate; and if different estimates or judgments were used, the use of these estimates or judgments would have a material effect on our financial condition or results of operations.
The estimates and judgments we make that affect the reported amount of assets, liabilities, revenues and expenses are based on historical experience and on various other factors, which ESW believes to be reasonable in the circumstances under which they are made. Actual results may differ from these estimates under different assumptions or conditions. We consider accounting policies related to revenue recognition, the valuation of inventories, research and development and accounting for the value of long-lived assets and intangible assets to be critical accounting policies.
Basis of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, ESW America, ESW Technologies, ESW Canada and BBL. All inter-company transactions and balances have been eliminated on consolidation. Amounts in the consolidated financial statements are expressed in U.S. dollars.
Estimates
The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reported period. Actual results could differ from those estimates. Significant estimates include amounts for impairment of property plant and equipment, intangible assets, share based compensation, inventory, redeemable class A special shares, convertible debentures, valuation of warrants, accrued liabilities and accounts receivable exposures.
Concentration of Credit Risk
Our cash balances are maintained in various banks in Canada and the U.S. Deposits held in banks in the U.S. are insured up to $250,000 per depositor for each bank by the Federal Deposit Insurance Corporation. Deposits held in banks in Canada are insured up to $100,000 Canadian dollar per depositor for each bank by The Canada Deposit Insurance Corporation a Federal Crown corporation. Actual balances at times may exceed these limits.
Accounts Receivable and Concentrations of Credit Risk: We perform on-going credit evaluations of our customers’ financial condition and generally do not require collateral from our customers. Three of our customers accounted for 21%, 19%, and 13%, respectively, of our revenue in the fiscal year 2010 and 48%, 21%, and 13%, respectively, of its accounts receivable as of December 31, 2010. Three of our customers accounted for 45%, 20%, and 9%, respectively, of our revenue in the fiscal year 2009 and 27%, 11%, and 25%, respectively, of our accounts receivable as of December 31, 2009.
As at December 31, 2010 and March 31, 2011, we believe that the allowance for uncollectible accounts sufficiently covers any credit risk related to past due accounts receivable balances.
Allowance for Doubtful Accounts
We extend unsecured credit to our customers in the ordinary course of business but mitigate the associated credit risk by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is estimated and recorded based on management’s assessment of the credit history with the customer and current
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relationships with them. On this basis management has determined that an allowance for doubtful accounts of $70,028 and $6,637 was appropriate as at December 31, 2010 and 2009, respectively.
Inventory
Inventory is stated at the lower of cost or market determined using the first-in first-out method. Inventory is periodically reviewed for use and obsolescence, and adjusted as necessary. Inventory consists of raw materials, work in progress and finished goods.
Property, Plant and Equipment Under Construction
We capitalize customized equipment built to be used in the future day to day operations at cost. Once complete and available for use, the cost for accounting purposes is transferred to property, plant and equipment, where normal depreciation rates apply.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, generally 5 to 7 years. Maintenance and repairs are charged to operations as incurred. Significant renewals and betterments are capitalized. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated discounted cash flow used in determining the fair value of the asset. We conducted a test for impairment as of December 31, 2010 and 2009, and found no impairment.
Internal-Use Software
We capitalize costs related to computer software obtained or developed for internal use. Software obtained for internal use is an enterprise-level business and finance software that we are customizing to meet specific operational needs. Costs incurred in the development phase are capitalized and amortized over the useful life of the internal use software, which is generally from three to five years. Capitalized internal-use software development costs for a project which is not yet complete is included as Internal-use Software under Development in the consolidated balance sheet. Capitalization of such costs ceases at the point at which the project is substantially complete and ready for its intended purpose. Costs capitalized during for the years ended December 31, 2010 and 2009 were $126,340 and $0, respectively.
Patents and Trademarks
Patents and trademarks consist primarily of the costs incurred to acquire them from an independent third party. Accounting Standards Codification (“ASC”) Topic 350 requires intangible assets with a finite life be tested for impairment whenever events or circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated discounted cash flow used in determining the fair value of the asset. We conducted a test for impairment as of December 31, 2010 and 2009 and found no impairment.
Patents and trademarks are being amortized on a straight-line basis over their estimated life of ten years. Amortization expense for the year ended December 31, 2010 and 2009 was $213,212 and $212,792 respectively.
Fair Value of Financial Instruments
ASC Topic 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.
Included in the ASC Topic 820 framework is a three level valuation inputs hierarchy with Level 1 being inputs and transactions that can be effectively fully observed by market participants spanning to Level 3 where estimates are unobservable by market participants outside of us and must be estimated using assumptions developed by us. We disclose the lowest level input significant to each category of asset or liability valued within the scope of ASC Topic 820 and the valuation method as exchange, income or use. We use inputs which are as observable as possible and the methods most applicable to the specific situation of each company or valued item.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, notes payable to related party, bank loan, redeemable Class A special shares and capital lease obligation approximate
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fair value because of the short-term nature of these items. Per ASC Topic 820 framework these are considered Level 2 inputs where estimates are unobservable by market participants outside of us and must be estimated using assumptions developed by us.
The advance share subscription was classified as a liability and periodically marked to market until October 14, 2010 (see Note 10 to the consolidated financial statements for the year ended December 31, 2010). The fair value of the advance share subscription obligation was determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock and might be adversely affected by a change in the price of our common stock. Per ASC Topic 820 framework this was considered a Level 1 input.
The exchange feature liability is classified as a liability and periodically marked to market. The fair value of the exchange feature liability is determined by the cash settlement value at the end of each period based on the closing price of our common stock and might be adversely affected by a change in the price of our common stock. Per FAS 157 framework these are considered a Level 1 input.
Interest rate risk is the risk that the value of a financial instrument might be adversely affected by a change in the interest rates. In seeking to minimize the risks from interest rate fluctuations, we manage exposure through our normal operating and financing activities.
Revenue Recognition
We derive revenue primarily from the sale of our catalytic products. In accordance with ASC Topic 605, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the amount is fixed or determinable, risk of ownership has passed to the customer and collection is reasonably assured.
We also derive revenue (less than 1.5% in 2010 and 3.0% in 2009 of total revenue) from providing air testing and environmental certification services. Revenues from these services are recognized upon performance.
Research and Development
We are engaged in research and development work. Research and development costs, are charged as operating expense as incurred. Any grant money received for research and development work is used to offset these expenditures. For the years ended December 31, 2010 and 2009, we expensed $783,944 and $930,548 net of grant revenues, respectively, towards research and development costs. The expense excluding grant revenues used to offset research and development costs for the years ended December 31, 2010 and 2009 amounted to $927,319 and $1,099,301. In 2010 and 2009, grant money amounted to $143,375 and $168,753, respectively.
Comprehensive Income
ASC Topic 830 establishes standards for reporting and display of comprehensive income and its components. As of December 31, 2010 and 2009, accumulated other comprehensive income is reported as a component of stockholders’ equity (deficit). Other comprehensive income includes only foreign currency translation adjustments.
Product Warranties
We provide for estimated warranty costs at the time of sale and accrues for specific items at the time their existence is known and the amounts are determinable. We estimate warranty costs using standard quantitative measures based on industry warranty claim experience and evaluation of specific customer warranty issues. We currently record warranty costs as 2% of revenue. As of December 31, 2010 and 2009, $102,793 and $40,290, respectively, was accrued against warranty provision and included in accrued liabilities. For the years ended December 31, 2010 and 2009, the total warranty, service, service travel and installation costs included in cost of sales was $224,766 and $38,209, respectively.
Segmented Reporting
ASC Topic 280 changed the way public companies report information about segments of their business in their quarterly reports issued to shareholders. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues and its major customers.
We also derive revenue (less than 1.5% in 2010 and 3.0% in 2009 of total revenue) from providing air testing and environmental certification services. For the years ended December 31, 2010 and 2009, all revenues were
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generated from the U.S. As of December 31, 2010 and 2009, $1,182,263 and $1,662,243, respectively, of property, plant and equipment is located at the air testing facility in Pennsylvania and all remaining long lived assets are located in Concord, Ontario.
Recently Adopted Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU” or “Update”) No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 improves disclosures originally required under SFAS No. 157. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2009, and for interim periods within those years. The adoption of the guidance did not have a material effect on our consolidated condensed financial position, results of operations, cash flows or related disclosures.
In December 2009, the FASB issued ASU 2009-16, Transfers and Servicing (Topic 860) — Accounting for Transfers of Financial Assets (“ASU 2009-16”). ASU 2009-16 amends the accounting for transfers of financials assets and will require more information about transfers of financial assets, including securitizations, and where entities have continuing exposure to the risks related to transferred financial assets. ASU 2009-16 is effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, with early adoption not permitted. The adoption of the guidance did not have a material effect on our consolidated condensed financial position, results of operations, cash flows or related disclosures.
In October 2009, the FASB issued ASU 2009-15, Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing (“ASU 2009-15”). ASU 2009-15 amends the accounting and reporting guidance for debt (and certain preferred stock) with specific conversion features or other options. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009. The adoption of the guidance did not have a material effect on our consolidated condensed financial position, results of operations, cash flows or related disclosures.
In August 2010, the FASB issued ASU No. 2010-22, Accounting for Various Topics — Technical Corrections to SEC Paragraphs this update amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends or rescinds portions of certain SAB topics. The adoption of this ASU had no effect on our consolidated condensed financial statements.
In August 2010, the FASB issued ASU No. 2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This updates various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies. The adoption of this ASU had no effect on our consolidated condensed financial statements.
In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition — Milestone Method. The objective of this Update is to provide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. The amendments in this Update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The adoption of this ASU had no effect on our consolidated condensed financial statements.
In April 2010, the FASB issued ASU No. 2010-013, Compensation — Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades a consensus of the FASB Emerging Issues Task Force. ASU 2010-13 addresses the classification of an employee share-based award with an exercise price denominated in the currency of a market in which the underlying equity security trades. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The adoption of this ASU had no effect on our consolidated condensed financial statements.
In October 2009, the FASB issued ASU No. 2009-13, Multiple Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”) (codified within ASC Topic 605). ASU 2009-
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13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The adoption of this ASU had no effect on our consolidated condensed financial statements.
Foreign Currency Transactions
The results of operations and the financial position of our operations in Canada is principally measured in Canadian currency and translated into U.S. dollars. The future effects of foreign currency fluctuations between U.S. dollars and Canadian dollars will be somewhat mitigated by the fact that certain expenses will be generally incurred in the same currency in which revenues will be generated. The future reported income of our Canadian subsidiary would be higher or lower depending on a weakening or strengthening of the U.S. dollar against the Canadian dollar. During the first quarter of 2011, we experienced a net loss on foreign exchange due the fluctuation of the U.S. dollar against the Canadian dollar.
A portion of our assets are based in our foreign operations and are translated into U.S. dollars at foreign currency exchange rates in effect as of the end of each period. Accordingly, our consolidated investment will fluctuate depending upon the weakening or strengthening of the Canadian dollar against the U.S. dollar.
Adjustments resulting from our foreign subsidiaries’ financial statements are included as a component of other comprehensive income within stockholders equity/(deficit) because the functional currency of subsidiaries is not the U.S. dollar.
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BUSINESS
General
We were formed in 1987 in the State of Florida as BBC Stock Market, Inc. (“BBC”), a development stage enterprise. We subsequently changed our name to Environmental Solutions Worldwide, Inc.
We are engaged through our wholly owned subsidiaries in the design, development, manufacturing and sale of environmental technologies and emission testing service. We are currently focused on the international medium duty and heavy duty diesel engine market for on-road and off-road vehicles as well as the utility engine, mining, marine, locomotive and military industries. We also offer engine and after treatment emissions verification testing and certification services.
The “ESW Group” trade name is being used to identify our potential participation in business opportunities outside our traditional focus of engine emissions controls.
We operate through three wholly owned subsidiaries:
| • | | ESW America Inc. (a Delaware corporation) is our technical, research and development division. ESW America houses our engine emissions testing laboratory and certification services known under the trade name “Air Testing Services™” (“ATS”) recognized by the Environmental Protection Agency (EPA), California Air Resources Board (“CARB”) and Mine Safety and Health Administration (“MSHA”) as capable of performing engine emissions verification test protocols. ESW America’s capabilities include certification and verification of internal combustion and compression engines ranging from 5 to 600 horsepower as well as vehicle chassis testing capabilities up to 1000 horsepower. ESW America is a fully compliant ISO 9001:2008 certified manufacturing and laboratory testing facility. |
| • | | ESW Canada Inc. (an Ontario corporation) serves as a fabrication and substrate manufacturing facility, as well as houses ESW Group’s sales division, managing all sales and marketing as well as the research and development activities for our catalytic product lines. ESW Canada is a fully compliant ISO 9001:2008 certified manufacturing facility. |
| • | | ESW Technologies Inc. (a Delaware corporation) holds our intellectual property and/or rights to the same. |
We are a developer of diesel emissions technology solutions, advancing emissions reduction technology by commercializing leading edge proprietary catalytic emission conversion, control and support products and technologies. Our key technologies and products are detailed below and are believed to be responsive to more stringent global emissions regulations being implemented. Among the key products are our Therma Cat™, Xtrm Cat™ and Clean Cat™ diesel emissions control technologies. We also manufacture a line of military technologies including the Stlth Cat™ and Scat-IR-Shield™ exhaust shielding technology currently employed on US Marine Light Armored Vehicles.
We are currently focused on the retrofit opportunities available in North America. We have successfully expanded coverage of the North American market by growing our distributor network from 18 distributors in 2009 to 36 by year end 2010. Our current distributor base allows us to position our technologies in key markets spanning from California to New York. We continue to focus on growing our “share of wallet” within our existing distributor base, as well as expanding our distributor network across North America, and we will opportunistically expand into markets outside of North America if deemed to be financially accretive in the short term.
Industry Trends
Emissions regulations for mobile diesel engines in the major markets of North America, Europe and Asia have continued to tighten and are now 40% to 90% lower than previous regulations. Regulations in effect in the U.S., Europe and in Asia are expected to reduce the emissions level for new mobile diesel engines from 85% to 99% of the levels mandated in the mid-1980s. While much of the regulatory pressure and resulting action from engine manufacturers has focused on reducing emissions from new engines, there is increasing focus and concern over pollution from existing diesel engines, many of which have 20- to 30-year life cycles. The EPA has estimated that in the U.S. alone there are approximately 11 million diesel powered vehicles which need to be retrofitted over the
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next ten years. Our future performance and growth at the present time is directly related to this trend within the global market.
In the U.S., the EPA, CARB and MSHA continue to place great emphasis on compliance with emission reduction standards. The identification of diesel particulate matter (“PM”) as a toxic air contaminant in 1998 led the CARB to adopt the Risk Reduction Plan to Reduce Particulate Matter Emissions from Diesel-fueled Engines and Vehicles (Plan) in September 2000.
The cost of meeting emission regulations, retrofit and replacement projects in the U.S. is estimated to be approximately $7.0 billion dollars as published in the National Clean Diesel Campaign Fact Sheet (Source EPA’s National Clean Diesel Campaign Fact Sheet). CARB estimates retrofits and engine replacements for approximately 420,000 trucks and buses registered in California as well as those transiting California roadways from other states and countries. As of today, sixteen U.S. states have committed to voluntarily adopt California’s stricter regulations to control greenhouse gas emissions.
Over the last five years, the EPA has brought forward a number of very successful innovative programs all designed to reduce emissions from diesel fleets. In conjunction with state and local governments, public interest groups and industry partners, the EPA has established a goal of reducing emissions from the over 11 million diesel engines in the existing fleets by 2014. The EPA offers numerous programs in order to provide technical and financial assistance to stakeholders interested in reducing their fleets’ emissions effectively and efficiently.
The Diesel Emissions Reduction Program (known as “DERA”) was created under the Energy Policy Act of 2005. This gave the EPA new grant and loan authority for promoting diesel emission reductions and authorized appropriations to the EPA of up to $200 million per year for fiscal years 2007 through 2011. In addition, $300 million was appropriated under the American Reinvestment and Recovery Act of 2009 and $120 million was appropriated for 2009-2010. In January 2011, the U.S. government successfully reauthorized the DERA for five more years. This will continue the legislation’s important environmental and economic benefits for the U.S. Passage of the DERA reauthorization will play a major role in the U.S.’s effort to expand clean air initiatives. In its first five years, DERA has proven to be one of the nation’s most successful clean air programs. In addition, DERA has provided an average of $20 worth of environmental and health benefits for every $1 spent.
The EPA and CARB programs are accelerating the activities toward creation of active markets for diesel emissions reduction technologies and products in the U.S. These markets include retrofit applications in on- and off-road segments, as well as for stationary power generation and marine and rail applications. Thus, the market for diesel emissions reduction technologies and products is still emerging. We expect growing demand for diesel emissions reduction technologies and products for the diesel engine market, owners of existing fleets of diesel-powered vehicles, and expanding requirements from the off-road, marine and railroad sectors. It is an essential requirement of the U.S. retrofit market that emissions control products and systems are verified under the EPA and/or CARB protocols to qualify for credits within the EPA and/or CARB programs. Funding for these emissions control products and systems is generally limited to those products and technologies that have already been verified. ESW has CARB Level III + product verifications which provide an advantage in attracting customers with access to governmental funding for retrofit programs.
Business Strategy
Our focus is to be a leading player in the environmental emissions market by providing leading-edge catalyst technology as well as best-in-class engine and vehicle emissions testing services. Our strategy is centered on identifying and deploying resources against our “sweet-spot” products, where we have identified our core competencies and differentiation in the marketplace. Our core geography focus is North America, and we will opportunistically explore business development opportunities in other markets if accretive in the short term. By focusing financial, human and intellectual capital on our core competencies and markets, we are targeting profitable growth in the short term and value creation for our shareholders over the long term.
We believe that we can improve and maintain profitability and grow our business by pursuing the following strategy:
| • | | focus on delivering controlled and profitable growth to our shareholders; |
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| • | | center our sales strategy around identified “sweet-spots” that will allow manufacturing efficiency gains and optimized resource allocation; |
| • | | educate the end customers about the technology and ensure realistic delivery timeline expectations; |
| • | | enhance scheduling and customer service functions and importance; |
| • | | locate recurring revenue opportunities and focus sales efforts on such opportunities; |
| • | | work with vendors to optimize our material buys and lead times; and |
| • | | constantly review operations, processes and products under a “continuous improvement/performance-based culture.” |
Principal Products and Their Markets
Our woven stainless steel wire mesh catalytic converter substrate forms the basis of our product lines. This key component can be produced in almost any size and shape. The wire mesh substrate creates a turbulent environment, which increases catalytic activity, and when manufactured for diesel applications, is designed to serve as a partial filter of PM, an important factor in diesel emission control. Our manufacturing process and chemical wash coat formula is proprietary.
XTRM CAT™ is an innovative proprietary diesel oxidation catalyst designed for Electro Motive Diesel (EMD) turbocharged and roots blown engine systems. The outstanding durability and flexible characteristics enable the Xtrm Cat™ to perform within the extreme operating conditions of locomotive and marine two stroke diesel engine applications. The XTRM CAT™ is in the process of being verified / certified with the US EPA or CARB. Xtrm Cat™ provides significant reductions of PM, hydro carbons (“HC”), and carbon monoxide (“CO”), which may allow EMD engines to be rebuilt to the stringent EPA standards of today and to meet the evolving standards of the future.
THERMA CAT™ Active Diesel Particulate Filter is an advanced Level III+ technology that provides the flexibility and pre-retrofit usability that makes the Therma Cat™ a seamless retrofit device for its end users. Other competing retrofit technologies either limit the vehicles’ use or require driver interaction and limit the vehicles’ availability during regular or multi-shift operations. These competing solutions increase costs in manpower and vehicle management that add to the retrofit devices initial purchase price. The Therma Cat™ is designed to address these issues with the introduction of an exothermic based (flameless technology) that utilizes the vehicle’s existing fuel supply to supplement and raise the exhaust heat so that the Diesel Particulate Filter can regenerate and continue normal operations. The system operates in the background, transparent to the vehicle operator and does not impact the vehicle’s normal operations. We took comprehensive steps to ensure the safe operation of the Therma Cat™ that included meeting Federal Motor Vehicle Safety Standards 301S for fuel system integrity for School Buses through school bus crash tests that ensures the integrity of the fuel system incorporated in the Therma Cat™ system. We also completed a 1,000 hour vibration test that simulated a typical 100,000 mile life cycle on rural roads. Our Therma Cat™ Active Level III+ catalyst system has obtained CARB verification for a variety of on- and off-road engine applications.
CLEAN CAT XP™ is proven to be effective in achieving significant reductions in particulate matter emissions, while simultaneously reducing CO and HC. The unit is designed to be installed as a muffler replacement after the turbocharger. The unit has broad engine coverage on four-stroke diesel engines for on-road applications with engine horsepower ranges of 150-600 hp and meet EPA Level II emissions requirements. The Clean Cat XP™ is designed to be maintenance free, does not require ash cleaning and is designed to be taken apart in event of engine malfunction. We are in the process of certifying/verifying this product.
STLTH CAT™ unit construction incorporates our proprietary catalyzed wire mesh substrate integrated into an advanced sound abatement system. The units were specifically engineered to decrease military vehicles and equipment’s overall tactical signature by reducing the diesel engines black smoke (soot), eye and throat irritating noxious diesel engine emissions, temperature and sound. The Stlth Cat™ is currently employed on US Military vehicles.
SCAT-IR-SHIELD™ is an innovative technology and operates in combination with our proprietary Stlth Cat™. The complete system is engineered to reduce the overall heat/infrared, sound and exhaust signature of tactical military vehicles and equipment.
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AIR TESTING SERVICES™ (“ATS”) is ESW America’s Emissions and Durability Testing Facility. ATS performs engine emissions verification test protocols according to established EPA, CARB and MSHA standards, while providing vehicle and engine manufacturers with a wide range engine and chassis dynamometer-based durability testing. ATS has capabilities for providing testing protocols with a broad range of fuels, including diesel, gasoline, and alternative fuels. ATS Engine Dynamometer-based Durability Testing protocols can also help develop custom accelerated aging test schedules for emissions control technologies, or support customer-designed tests for component stress. A full range of services is offered including emissions testing, compilation and submission of applications, final issuance of the certifications, production line, and audit testing. ATS offers customers complete testing and validation services that includes complete project management and verification management.
Our objective is the development and commercialization of technologies to reduce the overall emissions from diesel applications. Central to the emissions reduction market is the certification, verification and registration process established by regulatory bodies in the U.S. The industry is substantially driven by higher emissions reductions targets set by Federal and state-level regulations, which led us to focus on the development of the Therma Cat™ Level III Active Diesel Particulate Filter for on/off-road, medium and heavy duty diesel engines and the Xtrm Cat™ Diesel Oxidation Catalyst for marine and rail applications. We achieved the Therma Cat™ Level III Active Diesel Particulate Filter development through verifications from CARB with product development and testing conducted at ESW’s Air Testing Services division.
Our target markets include the following seven areas regulated in North America by EPA, CARB and other state and local standards:
| • | | on-road vehicle sector generally comprised of on-road trucks and school buses employed with private and municipal fleets; |
| • | | off-road engine/vehicle sector defined as construction equipment, tractors, power generators, irrigation pumps, stationary power and others; |
| • | | marine sector comprising of solutions for workboat applications such as tows, ferries, dredges, tugs, and yachts, to generator sets on blue water vessels; |
| • | | rail sector comprising of solutions for line haul and switching, as well as passenger rail locomotive and head end power systems; |
| • | | mining industry, including all equipment and vehicles operating in and around a mine; |
| • | | military sector, including catalyst products and support technologies; and |
| • | | engine and vehicle emissions testing services. |
Distribution
We distribute our catalyst technologies through:
| • | | a comprehensive network of established independent distributors that actively service the retrofit market; |
| • | | strategic partnerships that provide a unique competitive advantage into specific markets; and |
| • | | direct sales leveraging our sales personnel, local trade magazines and trade shows to complement distribution of our products into key markets. |
Within the ATS business, we are currently focused on a direct sales program targeting Original Equipment Manufacturers (“OEMs”) and other companies demanding engine and vehicle emissions testing services.
Competition
We sell into a competitive market focused on providing retrofit solutions for diesel powered engines, with the number of competitors varying by market segment. We compete primarily on the basis of technology, performance, price, quality, reliability, distribution, customer service, and support. Our competitors include companies that have deeper financial, technological, manufacturing and personnel resources. Other than other Level III+, marine and
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rail products that are available in the marketplace, we face competition from substitute products that offer lower emissions reduction benefits but are also more competitively priced and are deemed by the ultimate users as acceptable alternatives to our products and services.
Our direct competitors in the North American on-road, off-road, and mining markets include Engine Control Systems, Donaldson, DCL International, Huss and Cleaire.
Our marine and rail products compete in the engine rebuild sector with low oil consumption kits provided by manufacturers such as EMD Marine and other DOC technology providers such as Miratech.
ESW America faces competition from established emissions and durability testing facilities such as South West Research Institute and TRC Inc. and smaller facilities such as Olson-Eco Logic and California Environmental Engineering.
We believe that we can address the competitive landscape within the catalyst emissions market by providing:
| • | | Unique Substrate Technology — Our proprietary wire mesh substrate is very flexible in design, size, performance and overall product configuration. The high mechanical and thermally durable wire mesh technology is suitable for Diesel Oxidation Catalyst applications. The technology is cost effective and can be applied to almost any application. Traditional ceramic or metal based flow-through type technologies are typically less efficient, larger in size, and are only available in pre-configured sizes and designs. |
| • | | Leading edge products that are designed to have operational and technical advantages over the competition and are priced aggressively in the market. The Therma Cat™ is an example of a product that offers technical and operational advantages over competing products. |
| • | | Solution driven services — We do not only offer an emission control technology, but also provide a variety of tailored engineering solutions, extensive on-site and remote installation training programs, as well as project management services. |
| • | | Air Testing Services™ — ESW America’s CARB and EPA recognized facility provides us with the unique ability to develop and verify new catalyst technologies developed by us. ESW America allows us to quickly react to changing regulatory requirements, as well as offer the trusted emissions results to us and external clients that comply with strict CARB and EPA testing standards. |
ESW America differentiates itself from the competition in the air and durability testing market by continually updating its testing facilities and equipment in response to changing regulatory mandates and vehicle technology. ATS also provides a broad set of capabilities for advanced research, engineering and testing for various aftermarket products and new technologies. In addition, ESW America is one of a small number of CARB and EPA recognized testing facilities located on the east coast of the U.S., which provides a logistical advantage for clients focused on this geographical coverage.
Raw Materials
The primary raw materials used to manufacture our catalyst products include, among others, stainless steel, stainless steel wire, stainless steel tubing, precious metals such as platinum and palladium, particulate filters and other electronic and mechanical components. In 2010, we built up inventories of raw materials that are subject to long lead times.
Overall, raw steel, steel mesh, particulate filters and precious metal coated components accounted for the most significant component of our raw materials costs in 2010. We do spot-buys of steel products from suppliers to meet customer demand. We are exposed to fluctuating raw material prices, and we are particularly exposed to certain precious metal such as platinum which has had a run-up in prices in 2010. We seek to offset raw material price fluctuations on our result of operations by passing through certain price increases, negotiating volume discounts from raw material suppliers; purchasing high-value inventory components based on committed orders; scrapping and selling steel cut-offs at the highest possible price; and implementing continuous cost reduction programs. We do not currently pursue a financial hedging strategy for any of our raw materials; however, this approach could be reviewed in the future subject to precious metals pricing volatility. Our results of operations could be adversely
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affected if steel and precious metal prices increase substantially, unless we are successful in passing along these price increases to customers or otherwise offset these in material and/or operating costs.
Other raw materials or components purchased by us include electronic components, tools, fasteners, other steel and components for the Level III plus Therma Cat™ product, as well as a variety of custom alloy materials and chemicals, all of which are available from numerous suppliers. For Air Testing Services™, key raw materials include fuels, rollers and other consumables.
Customers
Our customers consist of established distributors focused in the emissions space. We recorded sales from 30 distributors in 2010 as compared to 26 customers in fiscal year 2009. Three distributor/customers accounted for 21%, 19%, and 13% of revenues in 2010. In 2009, one customer accounted for 45% and two other customers accounted for 20% and 9% of our revenue.
We will continue to establish long-term relationships with new customers and foster greater opportunities with existing distributors. The loss of, or major reduction in business from, one or more of the major distributors could have a material adverse effect on our liquidity, financial position, or results of operations.
Patent and Trademarks
We develop new technologies or further the development of existing technologies through internal research and development. Where necessary, we will seek access to third-party patents and/or licenses to develop new products and services aimed at the emissions and air testing markets.
Through our wholly owned subsidiary, ESW Technologies, we hold both Canadian and U.S. patents and pending applications covering the catalytic converter and related technology. Our issued and pending patents are important to us and we will pursue our legal rights to the fullest extent of the law to ensure non-infringement of our established patents. However, there can be no assurance that these patents, combined with pending patent applications or existing or future trade secret protections that we pursue, will survive legal challenge or provide meaningful levels of protection.
Additionally, we possess certain registered, pending and common law trademarks. We consider the goodwill associated with the trademarks to be an important part of developing product identity.
Product Certification
Our customers have acquired, where necessary, engine certifications and catalyst verifications using our products from such authorities as the EPA, CARB, MSHA and ETV Canada for gasoline and diesel products. We were the first catalytic substrate manufacturer and catalyst coating company in North America to verify a metallic wire mesh substrate based catalytic converter system as a gasoline retrofit replacement devices. We were the first catalytic substrate manufacturer and catalyst coating company in the world to verify a metallic wire mesh substrate based catalytic converter system as a passive stand alone Level II diesel retrofit replacement device. This verification status was removed by CARB effective January 2009 in light of EPA’s 2009 regulated nitrogen dioxide (“NO2”) limits.
CARB has established three primary technology levels for diesel catalyst verifications:
| • | | LEVEL I: PM reduction greater than 25% |
| • | | LEVEL II: PM reduction greater than 50% |
| • | | LEVEL III: PM reduction greater than 85% |
Effective January 1, 2009, the EPA has established a NO2 limit for diesel retrofit technologies verified under the EPA’s National Clean Diesel Campaign (“NCDC”) Retrofit Technology Verification Program. The EPA implemented a NO2 increase limit that is harmonized with the requirements for retrofit technologies by CARB. This requirement limits the increase in NO2 emissions associated with retrofit technologies to levels no greater than 20% above baseline engine levels.
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We have completed an extensive research and development program to upgrade our existing Level II diesel retrofit replacement device to meet the aforementioned new regulations. We are pursuing the verification of a Level II device through EPA or CARB. We have also completed the development for Level I technologies; however, at the present time we have decided not to pursue the verification of this technology.
In 2009, our Therma Cat™ Active Level III Plus catalyst system was verified by CARB for a variety of on-road and off-road engine applications (PM reduction greater than 85%). The Therma Cat™ filter system is a combined technology comprised of a chemically coated wire mesh substrate and Diesel Particulate Filter (DPF) combined with an electronically controlled external fuel injection component. The Therma Cat™ regeneration process is an electronically controlled exothermic reaction and occurs automatically during normal vehicle operation, transparent to the operator.
In October 2008, our Xtrm Cat™ product designed for Marine, 2-stroke, Tier 0 and Tier 1, turbocharged EMD 645 and 710 models was listed as an emerging technology on the EPA’s Emerging Technology List. In October 2009, the Emerging Technology listing was extended for an additional year. In October 2010, this listing expired. The Xtrm Cat™ product is ready for certification/verification, and we intend to complete this process in 2011.
Our products are generally sold according to appropriate government application regulations; however, we do not necessarily need government approval to sell our products into unregulated markets.
Warranty Matters
We may face an inherent business risk of exposure to product liability and warranty claims in the event that our products fail to perform as expected. We cannot assure you that we will not experience any material warranty or product liability losses in the future or that we will not incur significant costs to defend such claims. In addition, if any of the products are or are alleged to be defective, we may be required to participate in a recall involving such products. Each of our customers has its own policy regarding product recalls and other product liability actions relating to its suppliers. CARB verified products require us to provide specific warranties and warranty reporting on products depending upon engine applications. A successful claim brought against us or a requirement to participate in a product recall may have a material adverse effect on our business.
Our Therma Cat™ Active Level III Plus on-road catalyst system which has been verified as a Level III technology is typically required to meet CARB limited warranty standard of 5 years or 100,000 miles or 5 years or 150,000 miles, or 2 years unlimited miles depending on engine application.
Our Therma Cat™ Active Level III Plus off-road catalyst system which has been verified as a Level III technology is typically required to meet CARB limited warranty standard of 5 years or 4,200 hours.
To date, we have not had any major product warranty recalls.
Manufacture and Testing Services
We have made capital investments in manufacturing capability to support our products. Our substrate manufacturing plant located in Concord, Ontario, Canada enables us to control the complete fabrication and manufacturing process of catalyzed substrates and catalytic converter systems. Catalyzed substrates are the integral part of all catalytic converter systems sold worldwide. This facility has the capability to design, develop and manufacture complete catalytic converter systems based on specific customer requirements.
We have made significant capital investments in our Tech Center based in Montgomeryville, Pennsylvania, where our emission testing laboratories and testing capabilities are located. The 40,200 square foot facility houses a state-of-the-art emissions testing lab that is recognized as capable of performing engine emissions verification test protocols by the EPA, CARB and MSHA. ATS incorporates eight dedicated engine and vehicle dynamometer test cells.
ATS’s capabilities include:
| • | | engine dynamometer capacity from 5hp to 600hp, including both transient and steady state testing; |
| • | | chassis dynamometer testing, including light duty (up to 10,000lbs) and medium/heavy duty (up to 50,000lbs); |
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| • | | full flow Constant Volume Sampling emission measurement system capability across all test cells; |
| • | | all emission systems have dual Nitrogen Oxide Chemiluminescence detector and non-methane hydrocarbon measurement capability; |
| • | | engine dynamometer test cells comply with 40 Code of Federal Regulations (CFR) Part 60, 86, 89, 90, 92, 1042, 1048 and CARB testing protocols; and |
| • | | Test Cells are currently in transition to 40 CFR Part 1065. |
Our manufacturing and testing facilities are subject to continuous investment to ensure best-in-class capabilities to meet the challenges of a dynamic marketplace, as well as the need for greater efficiencies, to improve quality systems, and to meet the demands placed by changing regulations.
Research and Development
Research and development costs amounted to $ 783,944 in 2010 and $930,548 in 2009. We aggressively pursue testing as well as research and development for new products to serve potential customers and meet new regulations that are regularly being imposed on the industry. Through proprietary methods for improving our catalyzed substrates, there are prospects for the development of innovative applications outside of our current verified product line. We continue to spend further resources on new research and development projects.
Environmental Matters
We are presently engaged in a business that does not generate significant hazardous waste. Our facilities may have tanks for storage of diesel fuel and other petroleum products that are subject to laws regulating such storage tanks. Federal, state, and local provisions relating to the protection of the environment have not had, and are not expected to have, a material adverse effect on our liquidity, financial position, and results of operations. However, like all manufacturers, if a release of hazardous substances occurs, we may be held liable for the contamination, and the amount of such liability could be material. While we devote resources designed to maintaining compliance with these requirements, there can be no assurance that we operate at all times in complete compliance with all such requirements.
Employees
We and our subsidiaries presently employ 53 full-time employees. We do not have any collective bargaining agreements and consider our relationship with our employees to be good.
Properties
We do not own real property. Through our subsidiary, ESW Canada, we lease our executive, sales and marketing offices as well as our production center which totals approximately 50,000 square feet located at 335 Connie Crescent, Concord, Ontario, Canada. The lease expires September 30, 2015. Additionally, our wholly owned subsidiary, ESW America, leases approximately 40,220 square feet at 200 Progress Drive, Montgomery Township, Pennsylvania. The leasehold space houses our research and development facilities. The lease expires February 28, 2013.
Legal Proceedings
From time to time, we may be involved in a variety of claims, suits, investigations and proceedings arising from the ordinary course of our business, breach of contract claims, labor and employment claims, tax and other matters. Although claims, suits, investigations and proceedings are inherently uncertain and their results cannot be predicted with certainty, we believe that the resolution of current pending matters will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flow. Regardless of the outcome, litigation can have an adverse impact on us because of legal costs, diversion of management resources and other factors. In addition, it is possible that an unfavorable resolution of one or more such proceedings could in the future materially and adversely affect our financial position, results of operations or cash flows in a particular period.
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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
In 2010, there were no changes or disagreements.
Effective May 15, 2009, we dismissed the firm of Deloitte & Touche LLP (“Deloitte”) who was previously engaged as our principal auditor. Deloitte’s audit report on our consolidated financial statements for the fiscal year ended December 31, 2008 and December 31, 2007, did not contain any adverse opinion or disclaimer of opinion, and was not qualified or modified as to audit scope or accounting principles, except that the aforementioned report for the year ended December 31, 2008 included was modified for an uncertainty relating to our ability to continue as a going concern. The decision to dismiss Deloitte was approved by our audit committee and board of directors.
Effective May 15, 2009, we, upon approval of our audit committee and board of directors, elected to retain the firm of MSCM LLP (“MSCM”) as our principal independent accountants. During the two most recent fiscal years prior to May 15, 2009 and through May 15, 2009, we did not consult with MSCM regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on our financial statements, and neither a written report nor oral advice was provided that was an important factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a disagreement, as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to Item 304 of Regulation S-K.
MANAGEMENT
Certain information concerning our directors and executive officers is set forth in the following table and in the paragraphs following. Information regarding each such director’s and executive officer’s ownership of our voting securities appears under “Securities Ownership of Certain Beneficial Owners and Management” below.
FISCAL YEAR 2010
Name
| | | | Position
| | Date Elected/
Appointed
| | Footnote
|
|---|
| Elbert O. Hand | | | | Chairman | | January 2010 | | (1) |
| David J. Johnson | | | | Director, President and Chief Executive Officer | | September 2000 | | (2) |
| Nitin Amersey | | | | Director | | January 2003 | | | | |
| Michael F. Albanese | | | | Director | | February 2006 | | (3) |
| John D. Dunlap III | | | | Director | | February 2007 | | | | |
| Bengt G. Odner | | | | Director | | September 2000 | | (4) |
| Joey Schwartz | | | | Director | | June 2005 | | (5) |
| Peter Bloch | | | | Director | | November 2010 | | (6) |
| Mark Yung | | | | Director | | December 17, 2010 | | | | |
| Stefan Boekamp | | | | Vice President Of Operations | | February 2008 | | (7) |
| Praveen Nair | | | | Chief Accounting Officer | | February 2008 | | | | |
| (1) | | Mr. Elbert O. Hand voluntarily resigned from our board of directors on February 7, 2011. |
| (2) | | Mr. David J. Johnson resigned as our President and Chief Executive Officer as well as all of our subsidiaries wherein he served as an executive officer on March 9, 2011. Additionally, Mr. Johnson resigned from our board of directors as well from the board of directors of each of our wholly owned subsidiaries wherein he served. Mr. Johnson resigned without any disputes or disagreements with us or any of our subsidiaries. |
| (3) | | Mr. Michael F. Albanese was not nominated and did not stand for re-election as a director effective October 14, 2010. Mr. Albanese had no disputes or disagreements with us. |
| (4) | | Mr. Bengt G. Odner resigned from our board of directors on December 17, 2010. |
| (5) | | Mr. Joey Schwartz was not nominated and did not stand for re-election as a director effective October 14, 2010. Mr. Schwartz had no disputes or disagreements with us. |
| (6) | | Mr. Peter Bloch voluntarily resigned from our board of directors on March 4, 2011. Mr. Bloch had no disputes or disagreements with us. |
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| (7) | | Mr. Stefan Boekamp resigned on mutually agreeable terms from his position as Vice President of Operations on March 11, 2011. Mr. Boekamp resigned without any disputes or disagreements with us or any of our subsidiaries. |
Name
| | | | Current Executive Officers and
Board Position
| | Date Elected/
Appointed
|
|---|
| Mark Yung | | | | Executive Chairman | | February 7, 2011 |
| Nitin Amersey | | | | Director | | January 2003 |
| John D. Dunlap III | | | | Director | | February 2007 |
| John J Suydam | | | | Director | | January 25, 2011 |
| John J Hannan | | | | Director | | January 25, 2011 |
| Benjamin Black | | | | Director | | January 25, 2011 |
| Joshua Black | | | | Director | | January 25, 2011 |
| Zohar Loshitzer | | | | Director | | January 25, 2011 |
| Frank Haas | | | | Chief Technology Officer and Chief Regulatory Officer | | March 9, 2011 |
| Praveen Nair | | | | Chief Financial Officer | | March 9, 2011 |
| Virendra Kumar | | | | Vice President of Operations | | March 9, 2011 |
Set forth below is information relating to the business experience of each of the directors and executive officers of the Company.
ELBERT O. HAND, age 70, has extensive experience in corporate management. Mr. Hand became President of Hartmarx Corporation in 1985 and Chairman and Chief Executive Officer from 1992 through 2004 and thereafter retired as Chairman and remained as a director though 2009. Mr. Hand has also served on the Main Board of Austin Reed PLC, London from 1993 to 2002 and currently serves on the Board of Arthur J. Gallagher Inc. and has been a director from 2002 through the present. Mr. Hand also serves on the advisory board of Terlato Wines International and is a board member of the Savannah Music Festival, Savannah Georgia and Chicago’s Music of the Baroque Chorus and Orchestra of which he was Chairman from 1995 to 2004. Mr. Hand attended The Kellog School of Management’s Executive Development Program at Northwestern University and received a bachelor’s degree from Hamilton College, Clinton, New York State. Effective January 25, 2010, ESW’s Board of Directors elected Elbert O. Hand to serve as a member of the Board of Directors and appointed Mr. Hand to serve as Chairman. Mr. Hand voluntarily resigned from ESW’s Board on February 7, 2011.
DAVID J. JOHNSON, age 49, has 28 years of experience in the automotive industry in various aspects of advanced engineering, systems development, manufacturing of components, and as an entrepreneur. Mr. Johnson served as the Company’s Chief Operating Officer from August 2000 through November 2001 and was elected to the Board of Directors in September 2000. In addition to serving as a director of the Company, Mr. Johnson has served as Senior Vice President of Sales and Marketing from November 2001 until May 2004 and served as acting Chief Financial Officer from December 2004 through May 2005. Mr. Johnson was appointed as the Interim Chief Executive Officer and President on May 1, 2004 and was subsequently appointed President and Chief Executive Officer in June 2005. Mr. Johnson attended Tollgate Tech. Secondary, Mohawk College, Devry Institute of Technologies and is an active member of the Society of Automotive Engineers (SAE). Effective March 8, 2011, the Company and David J. Johnson, entered into an Employment Separation and General Release Agreement (the “Agreement”), whereby Mr. Johnson resigned as President and Chief Executive Officer of the Company as well as all of its subsidiaries wherein he served as an executive officer. Additionally, Mr. Johnson resigned from the Company’s Board of Directors as well from the Board of Directors of each of the Company’s wholly owned subsidiaries wherein he served. Mr. Johnson resigned without any disputes or disagreements with the Company or any of its subsidiaries.
NITIN M. AMERSEY, age 59, has over 36 years of experience in international trade, marketing and corporate management. Mr. Amersey was elected as a director of ESW and has served as a member of the board since January 2003. Mr. Amersey was appointed Interim Chairman of the Board in May 2004 and subsequently was appointed Chairman of the Board in December 2004 and served as Chairman on ESW’s board through to January 2010. In addition to his service as a board member of ESW, Mr. Amersey has been Chairman of Scothalls Limited, a private trading firm since 1978. Mr. Amersey has also served as President of Circletex Corp., a financial consulting management firm since 2001, has been the Managing Member in Amersey Investments, LLC, a financial consulting
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management firm since 2006, and has served as chairman of Midas Touch Global Media Corp from 2005 to the present. He is also Chairman of Hudson Engineering Industries Pvt. Ltd. and of Trueskill Technologies Pvt. Ltd., private companies domiciled in India. He is a director and Chief Financial Officer of the Trim Holding Group, director and Chief Executive Officer of New World Brands, Inc., and director and Chief Executive Officer of Azaz Capital Corp., formerly ABC Acquisition Corp. Mr. Amersey served as director and Chief Executive Officer of ABC Acquisition Corp. 1502 from June 2010 to February 2011. From 2003 to 2006 Mr. Amersey was Chairman of RMD Entertainment Group and also served during the same period as chairman of Wide E-Convergence Technology America Corp. Mr. Amersey is also the owner of Langford Business Services LLC. Mr. Amersey has a Masters of Business Administration Degree from the University of Rochester, Rochester, New York, and a Bachelor of Science in Business from Miami University, Oxford, Ohio. He graduated from Miami University as a member of Phi Beta Kappa and Phi Kappa Phi. He is the sole member manager of Amersey Investments LLC. Mr. Amersey also holds a Certificate of Director Education from the NACD Corporate Director’s Institute. Mr. Amersey continues to serve on ESW’s board.
MICHAEL F. ALBANESE, age 57, has over 34 years of financial experience including roles as Chief Financial Officer and Chief Operating Officer. Mr. Albanese was president of Cost Reduction Solutions, a CPA consulting firm providing services to both private and public companies as well as to the banking industry. Mr. Albanese received a Bachelor’s degree in Accounting and is a licensed CPA practicing in New Jersey. He is a member of the AICPA and NJSCPA, The Garden State Credit Association and is a registered accountant with the SEC’s Public Company Accounting Oversight Board (PCAOB). Mr. Albanese was not nominated and did not stand for re-election as a director effective October 14, 2010. Mr. Albanese had no disputes or disagreements with the Company.
JOHN DUNLAP, III, 52, served as Chairman of the Board of Directors of the California Air Resources Board from 1994 to 1999. In this post, Mr. Dunlap promoted advanced technological solutions to achieve air quality and public health protection gains. During his tenure as Chairman, Mr. Dunlap oversaw the development and implementation of the most far-reaching air quality regulations in the world aimed at fuels, engines and over 200 consumer products. Prior to Mr. Dunlap’s tenure at CARB, he served as the Chief Deputy Director of the California Department of Toxic’s Substances Control where his responsibilities included crafting the state’s technology advancement program, serving as the lead administration official in securing congressional and U.S. Department of Defence/Executive Branch support and funding for military base closure environmental clean-up and in creating a network of ombudsman staff to assist the regulated businesses in demystifying the regulatory process. In addition, Mr. Dunlap spent more than a decade at the South Coast Air Quality Management District in a host of regulatory, public affairs and advisory positions where he distinguished himself as the principal liaison with the business and regulatory community. Mr. Dunlap is currently the owner of a California-based advocacy and consulting firm called the Dunlap Group. He has served on the Board of Director’s of ESW since 2007. Mr. Dunlap has a BA degree in Political Science and Business from the University of Redlands (California) and a Master’s degree in Public Policy from Claremont Graduate University (California). Mr. Dunlap continues to serve on ESW’s board.
BENGT G. ODNER, age 58, has served as a director since September 2000. He served as the Company’s Chairman from September 2000 through October 2002. Mr. Odner has also served as our Chief Executive Officer from August 1999 through September 2000 and as Interim Chief Executive Officer from February 2002 to July 2002. Mr. Odner was a director of Crystal Fund Ltd., a Bermuda mutual fund, and was a director of Crystal Fund Managers, Ltd. from 1996 until January 2003. From 1990 through 1995, Mr. Odner was the Chairman of Altus Nord AB, a property holding company specializing in Scandinavian properties and a wholly owned subsidiary of Credit Lyonais Bank Paris. Mr. Odner holds a masters degree in Business Administration from Babson College. Mr. Odner resigned from ESW’s Board on December 17, 2010.
JOEY SCHWARTZ, age 49, has over 26 years of experience in financial management, business strategy development and marketing. During various periods from February 2001 to September 2004, Mr. Schwartz served in various consulting positions involving organizational development, corporate compliance, legal affairs and finance for ESW and its wholly owned subsidiary ESW Canada Inc. In May 2005 he was appointed as Chief Financial Officer (CFO) and served as CFO through February 2008. He served as a consultant to the Company on special projects and provided advice on compliance, due diligence, regulatory and business matters from February 2008 through to December 2008. Prior to his association with the Company, Mr. Schwartz consulted for several companies in different industries including Identicam Systems Canada Ltd., which was acquired under the
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GE Infrastructure security group of companies. He was President of Empereau Manufacturing, for over 18 years, a manufacturing company supplying products to the commercial specification and construction industry as well as government procurement. He is currently president of JMC Emerald Corp. a consulting company. Mr. Schwartz graduated on the dean’s honour roll from York University where he received a Bachelor of Arts Degree in Economics and Mathematics. Mr. Schwartz was not nominated and did not stand for re-election as a Director effective October 14, 2010. Mr. Schwartz had no disputes or disagreements with the Company.
PETER BLOCH, age 52, is the co-founder and partner of Guarden Capital, a private company which invests in clean technology companies and assists their management with strategy and planning. From 2008 to 2009, Mr. Bloch served as Chief Financial Officer of Just Energy a gas and electricity marketing income trust which is listed on the TSX. From 2005 to 2008, Mr. Bloch was also a co-founder and served as a Partner of Tribute Pharmaceuticals, a specialty pharmaceutical company engaged in the acquisition, licensing and management of mature prescription pharmaceutical products in the United States and Canada. From 2000 to 2005, he served as Chief Financial Officer, Vice President Finance and Administration of Gennum Corporation, an international semiconductor company listed on the Toronto Stock Exchange. Mr. Bloch holds a Bachelors of Commerce degree with Honours from the University of Cape Town, South Africa and is a Chartered Accountant in South Africa and Canada. Mr. Bloch voluntarily resigned from ESW’s Board on March 4, 2011. Mr. Bloch had no disputes or disagreements with the Company.
MARK YUNG, age 37, is a Senior Investment Executive at Orchard Capital, an investment firm located in Los Angeles, California. Mr. Yung currently acts as Executive Chairman of ESW and as a board member of Polymer Plainfield. Prior to joining Orchard, Mr. Yung was a Senior Vice President in the Corporate Strategy and Merger and Acquisitions groups of Citigroup and ABN AMRO. Prior to his corporate strategy roles, Mr. Yung was an investment professional at JPMorgan Partners (“JPMP”). At JPMP, Mr. Yung focused on venture capital, growth equity and buyout transactions in Latin America and acted as board member for various emerging companies in the region. Mr. Yung holds a B.A. from Cornell University and a M.B.A. from INSEAD. Effective February 10, 2011, Mr. Mark Yung was elected to serve as Executive Chairman of the Company’s Board of Directors. Mr. Yung has been serving as an elected member of the Board of Directors of the Company since December 17, 2010. Mr. Mark Yung is also employed by Orchard Capital Corporation, which is controlled by Mr. Richard Ressler. Affiliated entities of Orchard Capital Corporation as well as Mr. Richard Ressler are shareholders of the Company.
STEFAN BOEKAMP, age 62, joined the Company in July 2005 as the Plant Manager of the Company’s wholly owned subsidiary, ESW Canada Inc. In February 2008 he was appointed as the Company’s Vice President of Operations. Prior to joining the Company, Mr. Boekamp ran several machine building companies in Europe engaged in tooling and specialized equipment design and building between 1971 and 1983. From 1983 to 1992 he served as a General Manager and Vice President of Operations for Magna International. He was the President and Chief Executive Officer of Evermore Automation, an industrial magnet and automated equipment manufacturer between 1992 and 2005. Mr. Boekamp has a Masters Degree in Tool and Die Making, equivalent to a Professional Engineer Degree and a Masters in Business Administration from Handwerskammer Ostwetfalen-Lippe Zu Bielefeld, Bielefeld, Germany. Mr. Boekamp resigned on mutually agreeable terms from his position as Vice President of Operations of the Company on March 11, 2011. Mr. Boekamp resigned without any disputes or disagreements with the Company or any of its subsidiaries.
PRAVEEN NAIR, age 35, was appointed Chief Accounting Officer in February 2008. He joined the Company in May 2005 and served in the position of Assistant to the Chief Financial Officer supporting the Company’s Chief Financial Officer in day-to-day operations. In May 2006 he was promoted to Controller for the Company’s wholly owned subsidiaries, ESW America Inc. and ESW Canada Inc. Prior to joining the Company, Mr. Nair was with e-Serve International Ltd, a Citigroup company from December 2000 through January 2005 where he served as a Deputy Manager in the Business Development and Migrations Unit and subsequently as Manager and Senior Manager. He was responsible for feasibility studies and regionalizing operations from countries in Europe, North America and Africa into processing centers in Mumbai and Chennai in India. Mr. Nair has a Bachelors Degree in Commerce with specialization in Accounting and a Masters Degree in Finance from Faculty of Management Studies, College of Materials Management, Jabalpur, India. Effective March 9, 2011 Mr. Nair was promoted to the position of Chief Financial Officer of the Company.
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New Board and Executive Officer Appointments as at March 31, 2011:
ZOHAR LOSHITZER, age 53, Chief Executive Officer of Presbia an ophthalmic-device firm. Mr. Loshitzer possesses a varied background guiding commercialization of emerging technologies in fields including aerospace, telecommunications and medical devices. Mr. Loshitzer has held leadership positions in several portfolio companies affiliated to Orchard Capital, including Presbia. Previously, Mr. Loshitzer served as the President, CEO and founder of Universal Telecom Services (UTS), which provides high-quality, competitively priced voice and data telecommunications solutions to emerging markets. Mr. Loshitzer oversaw the company’s operations and its critical relationships with key foreign entities, mainly in the Indochina region. He is one of the founders of J2 Global Communications (NASDAQ: JCOM), and a co-founder and former managing director of Life Alert Emergency Response, Inc., currently serves as a managing director of Orchard Telecom, Inc., and has served as a board member to MAI Systems Corporation, an AMEX-listed company and j2 Global communications (NASDAQ: JCOM) from 1998–2001 . Earlier in his career, Mr. Loshitzer worked in the aerospace industry at the R&D lab of Precision Instruments, a division of IAI (Israel Aircraft Industries). Mr. Loshitzer focuses on helping grow companies from start-ups to global enterprises. Mr. Loshitzer holds a degree in Electrical & Electronic Engineering from Ort Syngalowski College in Israel.
JOSHUA BLACK, age 24, is employed by the Leveraged Finance Group within the Investment Banking Division at Goldman, Sachs & Co. From 2008 to 2010, he was employed in the Financial Institutions Group within the Investment Banking Division also at Goldman, Sachs & Co. He graduated cum laude and with departmental distinction from Princeton University in 2008 with a major in Religion.
JOHN J SUYDAM, age 51, Mr. Suydam joined Apollo Investment Corporation in 2006 and serves as the Chief Legal and Administrative Officer at the firm. From 2002 through 2006, Mr. Suydam was a partner at O’Melveny & Myers, where he served as head of Mergers & Acquisitions and co-head of the Corporate Department. Prior to that, Mr. Suydam served as Chairman of the law firm O’Sullivan, LLP which specialized in representing private equity investors. Mr. Suydam serves on the Board of the Big Apple Circus and is a member of Mount Sinai Hospital Department of Medicine Advisory Board . Mr. Suydam received his JD from New York University in 1985 and graduated magna cum laude with a BA in history from the State University of New York at Albany.
JOHN J HANNAN, age 58, is Chairman of the Board of Directors of Apollo Investment Corporation, a public investment company. He served as Chief Executive Officer of Apollo Investment Corporation from 2006 to 2008. Mr. Hannan, a senior partner of Apollo Management, L.P., co-founded Apollo Management, L.P. in 1990. He received a BBA from Adelphi University and an MBA from the Harvard Business School.
BENJAMIN BLACK, age 26, is a 2013 joint degree candidate for a Juris Doctor/Master of Business Administration from Harvard University. From 2007 to 2009, he was employed in the Technology, Media & Telecoms Group within the Investment Banking Division at Goldman, Sachs & Co. He graduated cum laude from the University of Pennsylvania in 2007 with a major in History.
FRANK HAAS, age 47, was appointed the Company’s Chief Technology Officer and Chief Regulatory Officer. Mr. Haas has been the Vice President of Special Projects for the Company since 2007. He joined the Company in 2001 and served in several capacities, such as technical Sales Engineer and Director of Sales. Prior to joining the Company Mr. Haas was employed by Nett Technologies and Husky Injection Moulding, where he served in the roles of technical Sales and Project Engineer. Mr. Haas holds a Bachelors degree in Mechanical Engineering with specialization in Production Engineering from the University of Applied Sciences in Cologne, Germany.
VIRENDRA KUMAR, age 36, was appointed Vice President of Operations of the Company. Mr. Kumar has been General Manager of ESW America, Inc. (“ESWA”) since 2010 and is responsible for the overall operations related to Air Testing Services. Prior to joining ESWA in 2009, Mr. Kumar was employed by Cummins Inc. as an Emission Operations Leader from 2004 through 2009, prior to that by Escort JCB as a design and production engineer, and by the Indian Institute of Technology Delhi as a project manager. Mr. Kumar holds a Masters degree in Mechanical Engineering from the Indian Institute of Technology Delhi and a Bachelors degree in Mechanical Engineering from the University of Rajasthan. Mr. Kumar was also a PhD candidate at University of California, Riverside.
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EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth the compensation for each of the last two fiscal years earned by the Chief Executive Officer and each of the most highly compensated executive officers (the “Named Executives”).
SUMMARY COMPENSATION TABLE
Name/
Principal Position
| | | | Year
| �� | Salary
| | Bonus
| | Stock
Awards
| | Option
Awards
(6)
| | Non-Equity
Incentive
Plan
Compensation
| | Non-Qualified
Deferred
Compensation
Earnings
| | All Other
Compensation
| | Total
|
|---|
| David J. Johnson (1) | | | | 2010 | | $ | 360,000 | | | | — | | | | — | | | $ | 62,127 | | | | — | | | | — | | | $ | 34,732 | | | $ | 456,859 | |
Director, Chief Executive
Officer And President
| | | | 2009 | | $ | 240,000 | | | | — | | | | — | | | | | | | | — | | | | — | | | $ | 34,998 | | | $ | 274,998 | |
| |
| Stefan Boekamp (2) | | | | 2010 | | $ | 111,662 | | | | — | | | | — | | | | | | | | — | | | | — | | | $ | 8,840 | | | $ | 120,502 | |
Vice President Of
Operations
| | | | 2009 | | $ | 100,709 | | | | — | | | | — | | | | | | | | — | | | | — | | | $ | 10,421 | | | $ | 111,130 | |
| |
| Praveen Nair (3) | | | | 2010 | | $ | 116,516 | | | | — | | | | — | | | | | | | | — | | | | — | | | $ | 7,636 | | | $ | 124,152 | |
Chief Accounting Officer
| | | | 2009 | | $ | 105,088 | | | | — | | | | — | | | | | | | | — | | | | — | | | $ | 8,282 | | | $ | 113,370 | |
| |
EFFECTIVE MARCH 9, 2011
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Frank Haas (4) | | | | 2010 | | $ | 87,387 | | | | — | | | | — | | | | | | | | — | | | | — | | | $ | 5,073 | | | $ | 92,460 | |
Chief Technology Officer
& Chief Regulatory Officer
| | | | 2009 | | $ | 78,809 | | | | — | | | | — | | | | | | | | — | | | | — | | | $ | 4,998 | | | $ | 83,807 | |
| |
| Virendra Kumar (5) | | | | 2010 | | $ | 112,000 | | | | | | | | | | | | | | | | | | | | | | | $ | 6,900 | | | $ | 118,900 | |
Vice President Of
Operations
| | | | 2009 | | $ | 112,000 | | | | | | | | | | | | | | | | | | | | | | | $ | 6,900 | | | $ | 118,900 | |
| (1) | | Mr. David J. Johnson was paid at the annual rate of $360,000. In 2010, Mr. Johnson received $360,000 as salary, $18,358 pay in lieu of vacation, a car allowance of $12,000 per annum and standard medical and dental benefits provided by the Company totaling $4,374. Mr. Johnson also received 600,000 stock options. The options vest over a period of three years with an exercise price of $0.65 (fair market value of the Company’s common stock as of the date of grant) with expiry five years from the date of award. In 2009 Mr. Johnson received $240,000 as salary and fees, $18,000 pay in lieu of vacation, a car allowance of $12,000 per annum and standard medical and dental benefits provided by the Company totaling $4,998. Effective March 9, 2011, the Company and David J. Johnson, entered into an Employment Separation and General Release Agreement (the “Agreement”), whereby Mr. Johnson resigned as President and Chief Executive Officer of the Company as well as all of its subsidiaries wherein he served as an executive officer. Mr. Johnson will receive severance payments based upon his regular salary of $360,000 per annum as prorated. The severance payments will be made on a quarterly basis for the remainder of the calendar year. Mr. Johnson will also continue to receive customary medical benefits and a car allowance of 1,000 a month for the remainder of the calendar year. |
| (2) | | Mr. Stefan Boekamp was paid at the annual rate of CAD $115,000 (which translates to $111,662 in U.S. dollars for the year ended December 31, 2010). In 2010 Mr. Boekamp received $111,662 as salary, $4,466 pay in lieu of vacation, and standard medical and dental benefits provided by the Company totaling $4,374. In 2009 Mr. Boekamp received $100,709 as salary, $5,423 pay in lieu of vacation, and standard medical and dental benefits provided by the Company totaling $4,998. Effective March 11, 2011, Mr. Boekamp, resigned on mutually agreeable terms from his position as Vice President of Operations of the Company. |
| (3) | | Mr. Praveen Nair was paid at the annual rate of CAD$120,000 (which translates to USD $116,516 for the year ended December 31, 2010). In 2010 Mr. Nair received $116,516 as salary, $3,262 pay in lieu of vacation, and standard medical and dental benefits provided by the Company totaling $4,374.In 2009 Mr. Nair received $105,088 as salary, $3,284 pay in lieu of vacation, and standard medical and dental benefits provided by the Company totaling $4,998. Effective March 9, 2011, Mr. Praveen Nair the Company’s Chief Accounting Officer |
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| | was promoted to the position of Chief Financial Officer of the Company. Mr. Nair will receive an annual salary of CAD $150,000. |
| (4) | | Effective March 9, 2011, Mr. Frank Haas was appointed the Company’s Chief Technology Officer and Chief Regulatory Officer. Mr. Haas will receive an annual salary of CAD $160,000 and will receive an incentive compensation for each of the first two achieved verification/certifications of certain of the Company’s products within the first year of his appointment. In 2010 Frank Hass was paid at the rate of CAD $90,000 (which translates to USD $87,387 for the year ended December 31, 2010). In 2010 Mr. Haas received $87,387 as salary, $699 pay in lieu of vacation, and standard medical and dental benefits provided by the Company totaling $4,374. In 2009 Mr. Haas received $87,387 as salary, $0 pay in lieu of vacation, and standard medical and dental benefits provided by the Company totaling $4,998. |
| (5) | | Effective March 9, 2011, Mr. Virendra Kumar was appointed the Company’s Vice President of Operations. Mr. Kumar will receive an annual salary of $150,000. In 2010 Virendra Kumar was paid at the rate of $112,000 annually. In 2010 Mr. Kumar received $112,000 as salary and standard medical and dental benefits provided by the Company totalling $6,900. In 2009 Mr. Kumar received the following compensation, $112,000 as salary and standard medical and dental benefits provided by the Company totalling $6,000. |
| (6) | | Represents the cost of the compensation expense recorded by the Company for option grants in 2010. |
Employment Agreements
In February 2007, we entered into an employment agreement with Mr. David J. Johnson as President and Chief Executive Officer. The agreement provided, among other things, for an annual salary of $240,000, as well as an award of 600,000 options exercisable for a term of five years at an exercise price of $0.71 per share (fair market value of our stock as of the date of grant). The agreement also provided that, other than in connection with Mr. Johnson’s employment being terminated other than for death, disability, conviction of a felony or non-performance of duties, he will be paid the balance of his contract. The employment agreement provided for participation in benefit plans we offer to our employees, and a car allowance of $1,000 per month. Effective May 13, 2010, our board of directors approved the recommendation of the Compensation Committee whereby the base salary for Mr. Johnson was increased to $360,000 per annum. The increase in Mr. Johnson’s salary was retroactive to January 1, 2010. On April 15, 2010, the Board of Directors granted an aggregate award of 600,000 stock options to Mr. Johnson. The options vest over a period of three years with exercise prices of $0.65 (fair market value of the Company’s common stock as of the date of grant) with expiry of five years from the date of award.
Effective March 9, 2011, we and David J. Johnson, entered into an Employment Separation and General Release Agreement (the “Agreement”), whereby Mr. Johnson resigned as President and Chief Executive Officer. Mr. Johnson will receive a severance payments based upon his regular salary of $360,000 per annum as prorated. The severance payments will be made on a quarterly basis for the remainder of the calendar year. Mr. Johnson will also continue to receive customary medical benefits and a car allowance of 1,000 a month for the remainder of the calendar year.
Outstanding Equity Awards at Fiscal Year End
The following table shows certain information regarding the outstanding equity awards held by the Named Executives at the end of 2010.
No stock options were granted in 2009.
Name
| | | | Number of Securities
Underlying
Unexercised Options (#)
| | Option
Exercise
Price
| | Date of
Grant
| | Option
Expiry
Date
|
|---|
| David J. Johnson | | | | | 600,000
700,000
150,000 | | | | $ 0.65
$ 0.71
$ 0.27 | | | | 04/15/2010
02/16/2007
06/08/2003 | | | | 02/16/2012
02/16/2012
08/06/2013 | |
| Stefan Boekamp | | | | | 50,000 | | | | $ 0.71 | | | | 02/07/2008 | | | | 02/06/2011 | |
| Praveen Nair | | | | | 50,000 | | | | $ 0.71 | | | | 02/07/2008 | | | | 02/06/2011 | |
| Frank Haas | | | | | 50,000 | | | | $ 1.00 | | | | 02/07/2008 | | | | 02/06/2011 | |
| Virendra Kumar | | | | | — | | | | — | | | | — | | | | — | |
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Stock Option Plan
On June 23, 2005, the Company, with shareholder approval, amended its 2002 Stock Option Plan to increase the underlying shares of common stock available under the plan to 5,000,000 shares. The 2002 Stock Option Plan is the successor plan to the 2000 Nonqualified Stock Option Plan. All stock options outstanding under the 2000 Nonqualified Stock Option Plan remain in effect according to their terms and conditions (including vesting requirements). Under the Company’s 2002 Stock Option Plan, the compensation committee may grant equity incentive awards to directors, officers, employees and service providers of the Company, in the form of incentive stock options, non-qualified stock options, and other performance-related or non-restricted stock awards. The selection of participants in the 2002 Stock Option Plan, the determination of the award vehicles to be utilized and the number of stock options or shares subject to an award are determined by the Company compensation committee, in its sole discretion, within the approved allocation of shares. The committee shall determine any service requirements and/or performance requirements pertaining to any stock awards under the 2002 Stock Option Plan. The 2002 Stock Option Plan permits the Company to provide its employees with incentive compensation opportunities which are motivational and which afford the most favourable tax and accounting treatments to the Company. The exercise price of any option granted under the 2002 Stock Option Plan shall not be less than the fair market value of the common stock of the Company on the date of grant.
In October 2010, the 2002 Stock Option Plan was replaced by the 2010 Stock Incentive Plan (the “Stock Incentive Plan”). While previously granted options under the Company’s 2002 Stock Option Plan will remain in effect in accordance with the terms of the individual options, the 2010 Stock Incentive Plan will replace the Company’s 2002 Plan for future grants. The Stock Incentive Plan authorizes the granting of awards to employees (including officers) of the Company and certain related companies in the form of any combination of (1) options to purchase shares of common stock, (2) stock appreciation rights (“SARs”), (3) shares of restricted common stock (“restricted stock”), (4) shares of deferred common stock (“deferred stock”), (5) bonus stock, and (6) tax-offset payments with respect to any of such awards. The Stock Incentive Plan also authorizes the granting of awards to directors who are not employees or officers of the Company (“Outside Directors”) to purchase shares of common stock and related limited SARs and tax-offset payments. The Stock Incentive Plan is administered by a committee of the Company’s Board of Directors, which consists of at least two Outside Directors. The Committee has authority to interpret the Stock Incentive Plan, adopt administrative regulations, and determine and amend the terms of awards to employees. The Board of Directors has similar authority with respect to Outside Directors (although the Stock Incentive Plan may also provide for certain automatic grants to Outside Directors). The aggregate number of shares of common stock which may be issued under the Stock Incentive Plan is 5,000,000. Such shares may consist of authorized but unissued shares or treasury shares. The exercise of a SAR for cash or for the settlement of any other award in cash will not count against this share limit. Shares subject to lapsed, forfeited or cancelled awards, including options cancelled upon the exercise of tandem SARs for cash, will not count against this limit and can be re-granted under the Stock Incentive Plan. If the exercise price of an option is paid in common stock or if shares are withheld from payment of an award to satisfy tax obligations with respect to the award, such shares also will not count against the above limit. Under the 2002 Stock Option Plan, SARs, restricted stock, deferred stock, or bonus stock can be granted with a limitation of no more than 1,500,000 shares or derivatives granted in the aggregate in any fiscal year. No employee or Outside Director may be granted tax-offset payments with respect to more than the number of shares of common stock covered by awards held by such employee. The Stock Incentive Plan does not limit awards which may be made under other plans of the Company.
The following table sets forth as at December 31, 2010 securities authorized for issuance under equity compensation plans.
68
EQUITY COMPENSATION PLAN INFORMATION
| | | | (A) | | (B) | | (C) |
|---|
Plan Category
| | | | Number of Securities to be
Issued Upon Exercise of
Outstanding Options
| | Weighted-average
exercise price of
outstanding options
| | Number of securities remaining
available for future issuance under
equity compensation plans (excluding
securities in column A)
|
|---|
2002 Stock Option Plan
(Shareholder Approved.
Authorized — 5,000,000 shares) | | | | | 3,600,000 | | | $ | 0.68 | | | | 0 | |
| |
2010 Stock Option Plan
(Shareholder Approved.
Authorized — 5,000,000 shares) | | | | | — | | | | — | | | | 5,000,000 | |
As reflected in the aggregate numbers above, no options were awarded under the Company’s 2002 stock plan in fiscal 2009.
On April 15, 2010, the Board of Directors granted an aggregate award of 900,000 stock options to one executive officer and director and one director. The options vest over a period of three years with an exercise price of $0.65 (fair market value of the Company’s common stock as of the date of grant) with expiry of five years from the date of award.
Compensation of Non-Management Directors
Name of Outside Director
| | | | Year
| | Fees Earned
or Paid in
Cash
| | Options Awards (1)
$
| | Total
|
|---|
| Elbert O. Hand (2) | | | | | 2010 | | | $ | 18,000 | | | $ | 31,063 | | | $ | 49,063 | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
| Nitin M. Amersey | | | | | 2010 | | | $ | 19,000 | | | $ | — | | | $ | 19,000 | |
| | | | | | 2009 | | | $ | 49,500 | | | $ | — | | | $ | 49,500 | |
| Michael F. Albanese | | | | | 2010 | | | $ | 21,000 | | | $ | — | | | $ | 21,000 | |
| | | | | | 2009 | | | $ | 38,500 | | | $ | — | | | $ | 38,500 | |
| John D. Dunlap III | | | | | 2010 | | | $ | 15,000 | | | $ | — | | | $ | 15,000 | |
| | | | | | 2009 | | | $ | 27,500 | | | $ | — | | | $ | 27,500 | |
| Bengt G. Odner | | | | | 2010 | | | $ | 15,000 | | | $ | — | | | $ | 15,000 | |
| | | | | | 2009 | | | $ | 27,500 | | | $ | — | | | $ | 27,500 | |
| Joey Schwartz | | | | | 2010 | | | $ | 15,000 | | | $ | — | | | $ | 15,000 | |
| | | | | | 2009 | | | $ | 27,500 | | | $ | — | | | $ | 27,500 | |
| Peter Bloch (3) | | | | | 2010 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
| Mark Yung (4) | | | | | 2010 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
| Zohar Loshitzer (5) | | | | | 2010 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
| Benjamin Black (6) | | | | | 2010 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
| Joshua Black (7) | | | | | 2010 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
| John J Hannan (8) | | | | | 2010 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
| John Suydam (9) | | | | | 2010 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | 2009 | | | $ | — | | | $ | — | | | $ | — | |
69
During the fiscal year 2010 and 2009, outside directors were compensated at the rate of $2,500 a month. The Chairman of the Board of Directors received an additional $2,000 per month and the Chair of the Audit Committee received an additional $1,000 per month.
| (1) | | Represents the cost of the compensation expense recorded by the Company in accordance with FAS123R (ASC 718-10-10). In 2009 no stock option awards were issued to Outside Directors. |
| (2) | | Effective January 25, 2010, ESW’s Board of Directors unanimously elected Elbert O. Hand to serve as a member of the Board of Directors and appointed Mr. Hand as Interim Chairman. Mr. Hand did not receive any compensation from the Company in 2009. |
| (3) | | Effective November 1, 2010, ESW’s Board of Directors unanimously elected Peter Bloch to serve as a member of the Board of Directors. Mr. Bloch did not receive any compensation from the Company in 2010 and 2009. |
| (4) | | Effective December 17, 2010, Mark Yung was appointed to serve as a member of the Board of Directors by written action and vote of majority shareholders of ESW. Mr. Yung did not receive any compensation from the Company in 2010 and 2009. |
| (5) | | Effective January 25, 2011, Zohar Loshitzer was appointed to serve as a member of the Board of Directors by written action and vote of majority shareholders of ESW. Mr. Loshitzer did not receive any compensation from the Company in 2010 and 2009. |
| (6) | | Effective January 25, 2011, Benjamin Black was appointed to serve as a member of the Board of Directors by written action and vote of majority shareholders of ESW. Mr. Benjamin Black did not receive any compensation from the Company in 2010 and 2009. |
| (7) | | Effective January 25, 2011, Joshua Black was appointed to serve as a member of the Board of Directors by written action and vote of majority shareholders of ESW. Mr. Joshua Black did not receive any compensation from the Company in 2010 and 2009. |
| (8) | | Effective January 25, 2011, John J. Hannan was appointed to serve as a member of the Board of Directors by written action and vote of majority shareholders of ESW. Mr. Hannan did not receive any compensation from the Company in 2010 and 2009. |
| (9) | | Effective January 25, 2011, John Suydam was appointed to serve as a member of the Board of Directors by written action and vote of majority shareholders of ESW. Mr. Suydam did not receive any compensation from the Company in 2010 and 2009. |
The following table shows certain information regarding the outstanding equity awards held by the outside directors at the end of 2010.
On April 15, 2010, the Board of Directors granted an aggregate award of 300,000 stock options Mr. Elbert O. Hand. The options vest over a period of three years with exercise prices of $0.65 (fair market value of the Company’s common stock as of the date of grant) with expiry five years from the date of award.
No stock awards or stock options were granted to the outside directors in 2009.
Name
| | | | Number of
Options (#)
Outstanding
| | Option
Exercise Price
($)
| | Option
Expiration
Date
|
|---|
| Nitin M. Amersey | | | | | 50,000 | | | $ | 0.27 | | | | 08/06/2013 | |
| | | | | | 300,000 | | | $ | 0.71 | | | | 02/16/2012 | |
| Michael F. Albanese | | | | | 450,000 | | | $ | 0.71 | | | | 02/16/2012 | |
| John D. Dunlap III | | | | | 300,000 | | | $ | 0.71 | | | | 02/16/2012 | |
| Bengt G. Odner | | | | | 50,000 | | | $ | 0.27 | | | | 08/06/2013 | |
| | | | | | 300,000 | | | $ | 0.71 | | | | 02/16/2012 | |
70
Name
| | | | Number of
Options (#)
Outstanding
| | Option
Exercise Price
($)
| | Option
Expiration
Date
|
|---|
| Joey Schwartz (1) | | | | | 100,000 | | | $ | 0.71 | | | | 02/16/2012 | |
| | | | | | 100,000 | | | $ | 1.00 | | | | 02/08/2013 | |
| Elbert O. Hand | | | | | 300,000 | | | $ | 0.65 | | | | 04/15/2015 | |
| (1) | | Mr. Joey Schwartz’s status changed to an outside director in December 2008. As an outside director, Mr. Schwartz has not received any stock option awards. The option awards show in the table above reflect Mr. Schwartz’s prior awards as an executive officer of ESW which are still effective until their expiration date. |
Compensation Committee Interlocks and Insider Participation
During fiscal 2010, none of our executive officers served on the board of directors or compensation committee of any other entity any of whose executive officers served on our board of directors or Compensation Committee.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During the year ended December 31, 2010, transactions with related parties included $6,134,024 related to conversion of convertible debentures including interest of $634,024 thereon into common stock; $1,032,849 related to inducement on early conversion of convertible debentures; the repayment of $511,342 principal and interest on promissory note and $144,967 for various services in addition to salaries and reimbursement of business expenses. During the year ended December 31, 2009, we paid shareholders and their affiliates $238,750 for various services, principal and interest on promissory notes and fees rendered in addition to salaries and reimbursement of business expenses. All transactions are recorded at the exchange amounts. Any one transaction or combination attributed to one individual or entity exceeding $120,000 on an annual basis are as follows:
Note Payable to Related Party
On December 29, 2009, we issued a $500,000 unsecured subordinated promissory note, with interest accruing at the annual rate of 9%, to Begnt G. Odner, a shareholder who was also one of our directors. In accordance with the terms of the note, upon our completing a financing for the gross sum of $2.0 million dollars or more, or in the event we did not complete a financing by March 31, 2010, the note would have been payable upon demand of the holder. Effective March 31, 2010, we repaid $500,000 principal and $11,342 in interest from the proceeds of the March 19, 2010 convertible debentures issuance.
Convertible Debenture Issued to Related Party
On August 28, 2009, we issued the 2009 Debentures whereby we issued $1.6 million of 9% convertible debentures to six accredited investors. Begnt G. Odner, a shareholder who was also one of our directors, participated in the 2009 Debentures offering with a principal investment of $500,000, which consisted of an exchange of a $300,000 unsecured 9% subordinated demand short term loan previously provided to us on August 11, 2009 and an additional $200,000 investment.
Effective March 25, 2010, the holders of the 2008 Debentures and the 2009 Debenture agreed to convert all outstanding convertible debentures as per the terms of the respective debenture agreements. The early conversion of the debentures was a condition precedent to ESW Canada entering into the Demand Credit Agreement. A total of $5,500,000 in principal and $634,024 of accrued interest due to related parties was converted into 23,489,494 shares of restricted common stock. As part of the agreement to convert all existing convertible debentures, we were committed to pay a premium as an inducement to convert all debentures. The premium was payable to all converting debenture holders and was subject to a positive fairness opinion, approval by a Fairness Committee consisting of independent directors of our board of directors and an increase in our share capital. The premium consisted of 4,375,668 shares of common stock. As we did not have sufficient authorized shares as of the date of conversion of the debentures to fulfill the premium, the premium was recorded as an advance share purchase agreement at a fair market value of $2,909,872 as at March 31, 2010. The agreement was without interest, subordinated to the
71
bank’s position and payable in a fixed number of shares of common stock upon increase in our authorized share capital.
Up to October 14, 2010, we did not have sufficient authorized and unissued shares to fulfill the advance share subscription. Under these conditions, FASB ASC Subtopic 815-40, Contracts in Entity’s Own Equity, precludes equity classification of this obligation. As such, the advance share subscription was classified as a liability and periodically marked to market. The fair value of the obligation was determined to be $1,662,753 and $2,909,872 at October 14, 2010 and March 31, 2010, respectively. The fair value of the obligation was determined by the cash settlement value at the end of each period based on the closing price of our common stock. The decrease in fair value of this liability of $1,247,119 was recorded as a mark to market adjustment on advance share subscription in the consolidated statement of operations and comprehensive loss. Of the total amount $784,965 (fair market value of 2,065,697 shares of common stock) was attributed to related parties.
Effective November 30, 2010, we issued an aggregate of 4,375,668 restricted shares of common stock to thirteen prior debenture holders in connection with the early conversion of their debentures. Of these shares of common stock, an aggregate of 2,065,697 shares were issued to Begnt Odner, who was director at the time of the issuance, and Leon D. Black, Black Family 1997 Trust, Leon D. Black Trust UAD 11/30/92 FBO Victoria Black, Leon D. Black Trust UAD 11/30/92 FBO Benjamin Black, Leon D. Black Trust UAD 11/30/92 FBO Joshua Black, and Leon D. Black Trust UAD 11/30/92 FBO Alexander Black, each of whom were shareholders of the Company.
As of December 31, 2010, principal and interest on total convertible debentures due to related parties was $0. As of December 31, 2009, the principal amount of convertible debentures, net of accretion, due to Begnt Odner, who was director at the time of the issuance, and Leon D. Black, Black Family 1997 Trust, Leon D. Black Trust UAD 11/30/92 FBO Victoria Black, Leon D. Black Trust UAD 11/30/92 FBO Benjamin Black, Leon D. Black Trust UAD 11/30/92 FBO Joshua Black, and Leon D. Black Trust UAD 11/30/92 FBO Alexander Black, each of whom were shareholders of the Company, amounted to $5,428,443 with a corresponding accrued interest of $540,128, and debt discount of $71,557.
Contracts and Agreements
Mr. Nitin Amersey, who is a director of the Company, is listed as a control person with the Securities and Exchange Commission of Bay City Transfer Agency & Registrar Inc., our transfer agent and subscription agent for this rights offering. Mr. Amersey has no ownership equity in Bay City Transfer Agency & Registrar Inc. nor is he an officer or a director thereof. For the years ended December 31, 2010 and 2009, we paid Bay City Transfer Agency & Registrar Inc. $7,363 and $1,683, respectively.
For the year ended December 31, 2010, Mr. Nitin Amersey received $25,500 for consulting services to the Company. In 2009, Mr. Amersey did not provide any services to us.
Mr. Peter Bloch, who was a director of the Company, provided consulting services to the Company. For the year ended December 31, 2010, we paid Mr. Bloch $112,104 for consulting services. In 2009 Mr. Bloch did not provide any services to the Company.
Services Agreement
On April 19, 2011, our board of directors ratified a Services Agreement (the “Agreement”) between us and Orchard Capital Corporation (“Orchard”) which was approved by our compensation committee. Under the Agreement, which is effective retroactively to January 30, 2011, Orchard will provide services that may be mutually agreed to by and between Orchard and us, including those duties customarily performed by the Chairman of the Board and an executive officer of the Company as well as providing advice and consultation on general corporate matters and other projects as may be assigned by our board of directors as needed. Orchard has agreed to appoint Mark Yung, who is also employed by Orchard, as our Executive Chairman to act on Orchard’s behalf and provide the services to us under the Agreement. Orchard reserves the right to replace Mr. Yung as the provider of services under the Agreement at its sole option. The Agreement may be terminated by either party upon thirty (30) days written notice unless otherwise provided for under the Agreement. Compensation under the agreement is the sum of $300,000 per annum plus reimbursement for out-of-pocket expenses incurred by Orchard. The agreement
72
includes other standard terms including indemnification and limitation on liability provisions. Orchard is controlled by Richard Ressler; affiliated entities of Orchard as well as Richard Ressler own shares of the Company.
The Investment Agreement
Effective May 10, 2011, we entered in to the Investment Agreement with the Bridge Lenders. See “The Rights Offering — The Investment Agreement.”
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS,
MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth, to the best knowledge of the Company, as of June 6, 2011, certain information with respect to (1) beneficial owners of more than five percent (5%) of the outstanding Common Stock of the Company, (2) beneficial ownership of shares of the Company’s Common Stock by each director and named executive, (3) beneficial ownership of shares of Common Stock of the Company by all directors and officers as a group.
Unless otherwise noted, all shares are beneficially owned and the sole voting and investment power is held by the persons/entities indicated.
Calculations are based upon the aggregate of all shares of Common Stock issued and outstanding as of June 6, 2011 in addition to shares issuable upon exercise of options currently exercisable or becoming exercisable within 60 days and which are held by the individuals named on the table.
Name and Address of
Beneficial Owner
| | | | Total Beneficial
Ownership
| | (1)
| | Percent of
Class
|
|---|
Mark Yung, Executive Chairman
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 0 | | | | | | | | 0.00 | % |
| |
Elbert O. Hand, Former Chairman
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 500,000 | | | | (2 | ) | | | 0.39 | % |
| |
Nitin M. Amersey, Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 350,000 | | | | (3 | ) | | | 0.27 | % |
| |
David J. Johnson
Former Chief Executive Officer,
President and Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 1,700,000 | | | | (4 | ) | | | 1.30 | % |
| |
Bengt G. Odner, Former Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 25,462,900 | | | | (5 | ) | | | 19.61 | % |
| |
Sedam Ltd
15 Rue Du Cendrier, 6TH Floor
Geneva V8 1211 | | | | | 25,462,900 | | | | (5 | ) | | | 19.61 | % |
| |
Joey Schwartz, Former Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 210,000 | | | | (6 | ) | | | 0.16 | % |
| |
Michael F. Albanese, Former Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 450,000 | | | | (7 | ) | | | 0.35 | % |
| |
John D. Dunlap, III, Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 300,000 | | | | (8 | ) | | | 0.23 | % |
73
Name and Address of
Beneficial Owner
| | | | Total Beneficial
Ownership
| | (1)
| | Percent of
Class
|
|---|
Stefan Boekamp,
Former Vice President of Operations
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 0 | | | | | | | | 0.00 | % |
| |
Praveen Nair, Chief Financial Officer
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 900 | | | | (9 | ) | | | 0.00 | % |
| |
Zohar Loshitzer, Director
c/o 335 Connie Crescent
Concord, ON L4K 5R20 | | | | | 0 | | | | | | | | 0.00 | % |
| |
Benjamin Black, Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 0 | | | | (10 | ) | | | 0.00 | % |
| |
Joshua Black, Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 0 | | | | (11 | ) | | | 0.00 | % |
| |
John J Suydam, Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 0 | | | | | | | | 0.00 | % |
| |
John J Hannan, Director
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 1,088,095 | | | | (12 | ) | | | 0.83 | % |
| |
Frank Haas, Chief Technology Officer
and Chief Regulatory Officer
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 246,050 | | | | (13 | ) | | | 0.19 | % |
| |
Virendra Kumar,
Vice President of Operations
c/o 335 Connie Crescent
Concord, ON L4K 5R2 | | | | | 0 | | | | | | | | 0.00 | % |
| |
John J. Hannan as Trustee
of the Black Family 1997 Trust
c/o 9 West 57TH Street, Suite 4300
New York NY 10019 | | | | | 15,624,615 | | | | (14 | ) | | | 12.07 | % |
| |
Leon D. Black
c/o 9 West 57TH Street, Suite 4300
New York NY 10019 | | | | | 6,724,211 | | | | (15 | ) | | | 5.19 | % |
| |
John J. Hannan as Trustee
of the Leon D. Black Trust UAD
11/30/92 FBO Alexander Black
c/o 9 West 57TH Street, Suite 4300
New York NY 10019 | | | | | 5,085,379 | | | | (16 | ) | | | 3.93 | % |
| |
John J. Hannan as Trustee
of the Leon D. Black Trust UAD
11/30/92 FBO Benjamin Black
c/o 9 West 57TH Street, Suite 4300
New York NY 10019 | | | | | 5,085,379 | | | | (17 | ) | | | 3.93 | % |
| |
John J. Hannan as Trustee
of the Leon D. Black Trust UAD
11/30/92 FBO Joshua Black
c/o 9 West 57TH Street, Suite 4300
New York NY 10019 | | | | | 5,085,379 | | | | (18 | ) | | | 3.93 | % |
74
Name and Address of
Beneficial Owner
| | | | Total Beneficial
Ownership
| | (1)
| | Percent of
Class
|
|---|
John J. Hannan as Trustee
of the Leon D. Black Trust UAD
11/30/92 FBO Victoria Black
c/o 9 West 57TH Street, Suite 4300
New York NY 10019 | | | | | 5,085,379 | | | | (19 | ) | | | 3.93 | % |
| |
Richard R. Ressler
C/O CIM GROUP
6922 Hollywood Boulevard
Los Angeles CA 90028 | | | | | 1,088,095 | | | | (20 | ) | | | 0.84 | % |
| |
Orchard Investments, LLC
C/O CIM GROUP
6922 Hollywood Boulevard
Los Angeles CA 90028 | | | | | 2,178,842 | | | | (21 | ) | | | 1.68 | % |
| |
All current directors and executive
officers as a group (Eleven persons) | | | | | 37,951,176 | | | | | | | | 29.17 | % |
| (1) | | On the basis of 129,463,767 shares of common stock outstanding, plus, in the case of any person deemed to own shares of common stock as a result of owning options or rights to purchase common stock exercisable within 60 days of June 6, 2011. |
| (2) | | Includes 200,000 shares of common stock. Includes options to purchase 300,000 shares of common stock at $0.65 per share, expiring April 15, 2015. |
| (3) | | Includes options to purchase 50,000 shares of common stock at $0.27 per share expiring August 6, 2013, and options to purchase 300,000 shares of common stock at $0.71 per share expiring February 16, 2012. |
| (4) | | Includes options to purchase 150,000 shares of common stock at $0.27 per share expiring August 6, 2013, options to purchase 700,000 shares of common stock at $0.71 per share expiring February 16, 2012, options to purchase 600,000 shares of common stock at $0.65 per share expiring April 15, 2015 and options to purchase 250,000 shares of common stock at $0.12 per share expiring September 09, 2012. |
| (5) | | Mr. Bengt George Odner is a past director of ESW. The aggregate amount of common stock beneficially owned by Mr. Bengt Odner, a former director of ESW, is represented by 1,275,780 shares of common stock and 350,000 shares of common stock underlying stock options that may be exercised. In addition to the direct ownership listed herein, Mr. Odner has indirect beneficial ownership by way of Sedam Limited. Sedam Limited, a corporation organized under the laws of Cyprus, is controlled by a trust, of which Mr. Bengt Odner is the sole beneficiary. Sedam Limited includes 23,837,120 shares. |
| (6) | | Includes 10,000 shares of common stock and options to purchase 100,000 shares of common stock at $0.71 per share expiring February 16, 2012, and options to purchase 100,000 shares of common stock at $1.00 per share expiring February 8, 2013. |
| (7) | | Includes 450,000 options to purchase 450,000 shares of common stock at $0.71 per share expiring February 16, 2012. |
| (8) | | Includes 300,000 options to purchase 300,000 shares of common stock at $0.71 per share expiring February 16, 2012. |
| (9) | | Includes 900 shares of common stock. |
| (10) | | Mr. Benjamin Black is a beneficiary of the Leon D. Black Trust UAD 11/30/92 FBO Benjamin Black (the “Benjamin Trust”) and the Black Family 1997 Trust (the “1997 Trust”). John J. Hannan is the trustee of the Benjamin Trust and the 1997 Trust and has the sole voting, investment and dispositive power with respect to the shares held by the Benjamin Trust and the 1997 Trust. Mr. Benjamin Black disclaims any beneficial ownership of the shares of common stock of the Company held by the Benjamin Trust and the 1997 Trust. |
| (11) | | Mr. Joshua Black is a beneficiary of the Leon D. Black Trust UAD 11/30/92 FBO Joshua Black (the “Joshua Trust”) and the 1997 Trust. John J. Hannan is the trustee of the Joshua Trust and the 1997 Trust and has the sole voting, investment and dispositive power with respect to the shares held by the Joshua Trust and the 1997 |
75
| | Trust. Mr. Joshua Black disclaims any beneficial ownership of the shares of common stock of the Company held by the Joshua Trust and the 1997 Trust. |
| (12) | | Includes 1,088,095 shares of common stock directly owned by John J. Hannan. As the trustee of each of the 1997 Trust, the Leon D. Black Trust UAD 11/30/92 FBO Alexander Black (the “Alexander Trust”), the Leon D. Black Trust UAD 11/30/92 FBO Victoria Black (the “Victoria Trust”), the Benjamin Trust and the Joshua Trust, Mr. Hannan is the beneficial owner of an additional 35,966,131 shares of common stock. |
| (13) | | Includes 246,050 shares of common stock. |
| (14) | | Includes 15,624,615 shares of common stock directly beneficially owned by the 1997 Trust. John J. Hannan is the trustee of the 1997 Trust and has the sole voting, investment and dispositive power with respect to the common stock shares of the Company held by the 1997 Trust. |
| (15) | | Includes 6,724,211 shares of common stock directly owned by Mr. Leon Black. |
| (16) | | Includes 5,085,379 shares of common stock directly beneficially owned by the Alexander Trust. John J. Hannan is the trustee of the Alexander Trust and has the sole voting, investment and dispositive power with respect to the common stock shares of the Company held by the Alexander Trust. |
| (17) | | Includes 5,085,379 shares of common stock directly beneficially owned by the Benjamin Trust. John J. Hannan is the trustee of the Benjamin Trust and has the sole voting, investment and dispositive power with respect to the common stock shares of the Company held by the Benjamin Trust. |
| (18) | | Includes 5,085,379 shares of common stock directly beneficially owned by the Joshua Trust. John J. Hannan is the trustee of the Joshua Trust and has the sole voting, investment and dispositive power with respect to the common stock shares of the Company held by the Joshua Trust. |
| (19) | | Includes 5,085,379 shares of common stock directly beneficially owned by the Victoria Trust. John J. Hannan is the trustee of the Victoria Trust and has the sole voting, investment and dispositive power with respect to the common stock shares of the Company held by the Victoria Trust. |
| (20) | | Includes 1,088,095 shares of common stock directly owned by Richard S. Ressler. Richard Ressler is the President of Orchard Capital Corporation, the Manager of Orchard Investments LLC. |
| (21) | | Includes 2,178,842 shares of common stock directly owned by Orchard Investments, LLC (“Orchard”). |
DESCRIPTION OF COMMON STOCK
Common Stock
We have 250,000,000 shares of common stock $0.001 par value authorized. Each holder of common stock is entitled to one vote for each share held of record on all matters submitted to a vote of the stockholders. The holders of common stock are not entitled to cumulative voting rights with respect to the election of directors, and, as a consequence, minority stockholders will not be able to elect directors on the basis of their votes alone. Holders of common stock are entitled to receive ratably such dividends as may be declared by the board of directors out of funds legally available therefore.
In the event of a liquidation, dissolution or winding up of the company, holders of our common stock would be entitled to share ratably in all assets remaining after payment of liabilities and the satisfaction of any liquidation preference of any then outstanding series of preferred stock. Holders of common stock have no preemptive rights and no right to convert their common stock into any other securities. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and nonassessable.
As of the record date, there were 129,463,767 shares of common stock outstanding held of record by approximately 264 stockholders.
CERTAIN MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES
The following discussion is a summary of certain material U.S. Federal income tax consequences of the rights offering to holders of our common stock. This discussion assumes that the holders of our common stock hold such common stock as a capital asset for U.S. Federal income tax purposes. This discussion is based on the Internal Revenue Code of 1986, as amended, Treasury Regulations promulgated thereunder, Internal Revenue Service
76
rulings and pronouncements and judicial decisions in effect on the date hereof, all of which are subject to change (possibly with retroactive effect) and to differing interpretations. The following summary does not purport to be a complete analysis of all of the potential U.S. Federal income tax considerations, applies only to holders that are United States persons and does not address all aspects of U.S. Federal income taxation that may be relevant to holders in light of their particular circumstances or to holders who may be subject to special tax treatment under the Internal Revenue Code, including, without limitation, holders who are dealers in securities or foreign currency, insurance companies, tax-exempt organizations, banks, financial institutions, broker-dealers, holders who hold our common stock as part of a hedge, straddle, conversion or other risk reduction transaction, or who acquired our common stock pursuant to the exercise of compensatory stock options or otherwise as compensation.
This summary is of a general nature only and is not intended to constitute a complete analysis of all tax consequences relating to the receipt, exercise, disposition and expiration of the subscription rights and the ownership and disposition of our common shares. It is not intended to constitute, and should not be construed to constitute, legal or tax advice to any particular holder. Holders should consult their own tax advisors as to the tax consequences in their particular circumstances.
We intend to treat the distribution of subscription rights pursuant to the rights offering as a non-taxable transaction for U.S. Federal income tax purposes and the remaining portion of this summary describes the U.S. Federal income tax consequences of such treatment. However, there can be no assurance that the Internal Revenue Service will take a similar view or would agree with the tax consequences described below. We have not sought, and will not seek, an opinion of counsel or a ruling from the Internal Revenue Service regarding the U.S. Federal income tax consequences of the rights offering or the related share issuance. The following summary does not address the tax consequences of the rights offering or the related share issuance under foreign, state, or local tax laws.Accordingly, each holder of our common stock should consult its tax advisor with respect to the particular tax consequences of the rights offering and the related share issuance to such holder.
The U.S. Federal income tax consequences to a holder of our common stock of the receipt and exercise of subscription rights under the rights offering will be as follows:
| • | | A holder will not recognize taxable income for U.S. Federal income tax purposes in connection with the receipt of subscription rights in the rights offering. |
| • | | A holder’s tax basis in its subscription rights will depend on the relative fair market value of the subscription rights received by such holder and the common stock owned by such holder at the time the subscription rights are distributed. If either (i) the fair market value of the subscription rights on the date such subscription rights are distributed is equal to at least 15% of the fair market value on such date of the common stock with respect to which the subscription rights are received or (ii) the holder elects, in a statement attached to its U.S. Federal income tax return for the taxable year in which the subscription rights are received, to allocate part of its tax basis in such common stock to the subscription rights, then upon exercise of the subscription rights, the holder’s tax basis in the common stock will be allocated between the common stock and the subscription rights in proportion to their respective fair market values on the date the subscription rights are distributed. If the subscription rights received by a holder have a fair market value that is less than 15% of the fair market value of the common stock owned by such holder at the time the subscription rights are distributed, the holder’s tax basis in its subscription rights will be zero unless the holder elects to allocate its adjusted tax basis in the common stock owned by such holder in the manner described in the previous sentence. A holder’s tax basis in the common stock will be reduced to the extent any such tax basis is allocated to the subscription rights. |
| • | | A holder which allows the subscription rights received in the rights offering to expire will not recognize any gain or loss, and no portion of the tax basis in the common stock owned by such holder with respect to which such subscription rights were distributed will be allocated to the unexercised subscription rights. |
| • | | A holder will not recognize any gain or loss upon the exercise of the subscription rights received in the rights offering. The tax basis in the common stock acquired through exercise of the subscription rights will equal the sum of the subscription price for the common stock and the holder’s tax basis, if any, in the rights as described above. The holding period for the common stock acquired through exercise of the subscription |
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| | rights will begin on the date the subscription rights are exercised. A gain or loss recognized upon a sale of such common stock will be a capital gain or loss if the common stock is held as a capital asset at the time of sale. Such capital gain or loss will be long-term capital gain or loss if the holding period for the common stock exceeds one year at the time of sale. |
| • | | If you exercise the subscription rights received in this rights offering after disposing of the shares of the common stock with respect to which the subscription rights were received, then certain aspects of the tax treatment of the exercise of the subscription rights are unclear, including (1) the allocation of tax basis between the common stock previously sold and the subscription rights, (2) the effect of such allocation on the amount and timing of gain or loss recognized with respect to the common stock previously sold, and (3) the effect of such allocation on the tax basis of common stock acquired through exercise of the subscription rights. A holder that exercises subscription rights received in this rights offering after disposing of the common stock with respect to which the subscription rights were received should consult its tax advisor. |
LEGAL MATTERS
The validity of the rights and shares of common stock offered by this prospectus have been passed upon for us by Chepenik Trushin LLP, Miami, Florida.
EXPERTS
The financial statements and management’s assessment of the effectiveness of internal control over financial reporting (which is included in Management’s Report on Internal Control over Financial Reporting) incorporated in this prospectus by reference to the Annual Report on Form 10-K for the year ended December 31, 2010, have been so incorporated in reliance on the report of MSCM LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We file reports, proxy statements and other information with the SEC. Information filed with the SEC can be inspected and copied at the public reference facilities maintained by the SEC at Headquarters Office, 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You may also obtain copies of this information by mail from the Public Reference Section of the SEC, Headquarters Office, 100 F Street, N.E., Room 1580, Washington, D.C. 20549, at prescribed rates. Further information on the operation of the SEC’s public reference room in Washington, D.C. can be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website that contains reports, proxy statements and other information about issuers, such as us, who file electronically with the SEC. The address of that website is http://www.sec.gov.
We filed a registration statement on Form S-1 to register with the SEC the securities offered by this prospectus. This prospectus is a part of that registration statement. As allowed by the rules of the SEC, this prospectus does not contain all of the information you can find in our registration statement or the exhibits to the registration statement.
Our common stock is traded on the OTCQB under the symbol “ESWW” and the Frankfurt Stock Exchange under the symbol “EOW”.
Our website is located at www.cleanerfuture.com. The information on our website, however, is not, and should not be deemed to be, a part of this prospectus.
DISCLOSURE OF COMMISSION POSITION
ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers or persons controlling us pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. In addition, indemnification may be limited by state securities laws.
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INDEX TO FINANCIAL STATEMENTS
Environmental Solutions Worldwide, Inc.
Annual Consolidated Financial Statements:
| | | | | | |
| Report of MSCM LLP, Independent Registered Public Accounting Firm | | | | | F-2 | |
| Consolidated Balance Sheets as of December 31, 2010 and 2009 | | | | | F-3 | |
| Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2010 and 2009 | | | | | F-4 | |
| Consolidated Statements of Changes in Stockholders’ Equity (Deficit) and Comprehensive Income for the years ended December 31, 2010 and 2009 | | | | | F-5 | |
| Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009 | | | | | F-6 | |
| Notes to Consolidated Financial Statements | | | | | F-7 | |
| |
Interim Unaudited Consolidated Financial Statements:
| | | | | | |
| Consolidated Condensed Balance Sheets as of March 31, 2011 and December 31, 2010 | | | | | F-28 | |
| Consolidated Condensed Statements of Operations and Comprehensive Loss for the three months ended March 31, 2011 and 2010 | | | | | F-29 | |
| Consolidated Condensed Statement of Changes in Stockholders’ Equity (Deficit) and Comprehensive Income for the three months ended March 31, 2011 | | | | | F-30 | |
| Consolidated Condensed Statements of Cash Flows for the three months ended March 31, 2011 and 2010 | | | | | F-31 | |
| Notes to Consolidated Condensed Financial Statements | | | | | F-32 | |
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Environmental Solutions Worldwide, Inc.
We have audited the accompanying consolidated balance sheets of Environmental Solutions Worldwide, Inc. (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity (deficit) and comprehensive income and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company’s experience of negative cash flows from operations and its dependency upon future financing raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ MSCM LLP
Toronto, Canada
March 31, 2011
701 Evans Avenue, 8th Floor,
Toronto, Ontario,
M9C 1A3, Canada
T (416) 626-6000
F (416) 626-8650
MSCM.CA
F-2
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED BALANCE SHEETS
| | | | December 31,
2010
| | December 31,
2009
|
|---|
ASSETS
| | | | | | | | | | |
Current Assets
| | | | | | | | | | |
| Cash and cash equivalents (Note 4) | | | | $ | 13,328 | | | $ | 632,604 | |
| Accounts receivable, net of allowance for doubtful accounts of $70,028 (2009 — $6,637) (Note 2) | | | | | 2,279,149 | | | | 1,118,929 | |
| Inventory (Note 5) | | | | | 4,414,518 | | | | 1,508,414 | |
| Prepaid expenses and sundry assets | | | | | 261,176 | | | | 213,484 | |
| Total current assets | | | | | 6,968,171 | | | | 3,473,431 | |
| Property, plant and equipment under construction (Note 6) | | | | | 185,542 | | | | 138,800 | |
| Property, plant and equipment, net of accumulated depreciation of $5,765,164 (2009 — $4,663,281) (Note 6) | | | | | 1,931,373 | | | | 2,687,105 | |
| Internal use software under development (Note 2) | | | | | 126,340 | | | | — | |
| Patents and trademarks, net of accumulated amortization of $2,115,091 (2009 — $1,901,501) (Note 2) | | | | | 16,145 | | | | 229,347 | |
| | | | | $ | 9,227,571 | | | $ | 6,528,683 | |
| |
LIABILITIES AND STOCKHOLDERS’ EQUITY / (DEFICIT)
| | | | | | | | | | |
Current Liabilities
| | | | | | | | | | |
| Bank loans (Note 8) | | | | $ | 3,424,889 | | | $ | 713,037 | |
| Accounts payable | | | | | 2,495,070 | | | | 1,126,680 | |
| Accrued liabilities | | | | | 512,964 | | | | 1,311,518 | |
| Exchange feature liability (Note 10 and 12) | | | | | 2,133,862 | | | | — | |
| Notes payable to related party (Note 7) | | | | | — | | | | 500,000 | |
| Customer deposits | | | | | 29,322 | | | | 9,857 | |
| Redeemable class A special shares (Note 9) | | | | | 453,900 | | | | 453,900 | |
| Current portion of capital lease obligation (Note 15) | | | | | 3,552 | | | | 8,857 | |
| Total current liabilities | | | | | 9,053,559 | | | | 4,123,849 | |
Long-term Liabilities
| | | | | | | | | | |
| Convertible debentures, net of deferred costs of $0 (2009 — $36,506) and debt discount of $0 (2009 — $228,981) (Note 10) | | | | | — | | | | 10,334,513 | |
| Capital lease obligation (Note 15) | | | | | 1,490 | | | | 10,861 | |
| Total long-term liabilities | | | | | 1,490 | | | | 10,345,374 | |
| Total liabilities | | | | | 9,055,049 | | | | 14,469,223 | |
Commitments and Contingencies (Note 15)
| | | | | | | | | | |
Stockholders’ Equity / (Deficit) (Notes 12 and 13)
| | | | | | | | | | |
| Common stock, $0.001 par value, 250,000,000 (2009 — 125,000,000) shares authorized; 129,463,767 shares issued and outstanding (2009 — 73,823,851) | | | | | 129,463 | | | | 73,822 | |
| Additional paid-in capital | | | | | 43,567,531 | | | | 26,083,635 | |
| Accumulated other comprehensive income | | | | | 446,549 | | | | 425,383 | |
| Accumulated deficit | | | | | (43,971,021 | ) | | | (34,523,380 | ) |
| Total stockholders’ equity / (deficit) | | | | | 172,522 | | | | (7,940,540 | ) |
| | | | | $ | 9,227,571 | | | $ | 6,528,683 | |
The accompanying notes are an integral part of these consolidated financial statements.
F-3
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31,
| | | | 2010
| | 2009
|
|---|
Revenue
| | | | | | | | | | |
| Net sales | | | | $ | 10,437,145 | | | $ | 3,075,398 | |
| Cost of sales | | | | | 7,261,496 | | | | 1,812,100 | |
| Gross profit | | | | | 3,175,649 | | | | 1,263,298 | |
Operating expenses
| | | | | | | | | | |
| Marketing, office and general costs | | | | | 4,719,362 | | | | 3,329,570 | |
| Research and development costs | | | | | 783,944 | | | | 930,548 | |
| Officers’ compensation and directors’ fees | | | | | 954,054 | | | | 672,444 | |
| Consulting and professional fees | | | | | 451,345 | | | | 215,984 | |
| Foreign exchange loss | | | | | 103,256 | | | | 10,035 | |
| Depreciation and amortization | | | | | 837,448 | | | | 1,123,560 | |
| | | | | | 7,849,409 | | | | 6,282,141 | |
| Loss from operations | | | | | (4,673,760 | ) | | | (5,018,843 | ) |
| |
| Interest on long-term debt | | | | | (183,858 | ) | | | (870,632 | ) |
| Amortization of deferred costs | | | | | (117,131 | ) | | | (19,912 | ) |
| Long-term debt accretion | | | | | (768,981 | ) | | | (27,019 | ) |
| Inducement premium | | | | | (2,909,872 | ) | | | — | |
| Mark to market adjustment on advance share subscription | | | | | 1,247,119 | | | | — | |
| Change in fair value of exchange feature liability | | | | | (2,021,213 | ) | | | — | |
| Interest on notes payable to related party | | | | | (11,342 | ) | | | — | |
| Loss on disposal of property and equipment | | | | | (8,828 | ) | | | (1,404 | ) |
| Interest income | | | | | 225 | | | | 858 | |
Net loss
| | | | | | | | | | |
| Foreign currency translation of Canadian subsidiaries | | | | | (9,447,641 | ) | | | (5,936,952 | ) |
| Other comprehensive income: | | | | | 21,166 | | | | 173,857 | |
| Net comprehensive loss | | | | $ | (9,426,475 | ) | | $ | (5,763,095 | ) |
| Net loss per share (basic and diluted) (Note 16) | | | | $ | (0.08 | ) | | $ | (0.08 | ) |
Weighted average number of shares outstanding
(basic and diluted) (Note 16) | | | | | 112,793,477 | | | | 73,416,317 | |
The accompanying notes are an integral part of these consolidated financial statements.
F-4
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(DEFICIT) AND COMPREHENSIVE INCOME FOR THE YEARS ENDED
DECEMBER 31, 2010 AND 2009
| | | | Common Stock
| |
|---|
| | | | Shares
| | Amount
| | Additional
Paid-in
Capital
| | Accumulated
Other
Comprehensive
Income
| | Accumulated
Deficit
| | Total
|
|---|
| Balance, January 1, 2009 | | | | | 72,973,851 | | | $ | 72,972 | | | $ | 25,403,485 | | | $ | 251,526 | | | $ | (28,586,428 | ) | | $ | (2,858,445 | ) |
| Net loss | | | | | — | | | | — | | | | — | | | | — | | | | (5,936,952 | ) | | | (5,936,952 | ) |
| Common stock issued from exercise of options | | | | | 850,000 | | | | 850 | | | | 424,150 | | | | — | | | | — | | | | 425,000 | |
| Intrinsic value of beneficial conversion feature of convertible debentures | | | | | — | | | | — | | | | 256,000 | | | | — | | | | — | | | | 256,000 | |
| Foreign currency translation of Canadian subsidiaries | | | | | — | | | | — | | | | — | | | | 173,857 | | | | — | | | | 173,857 | |
| Balance, January 1, 2010 | | | | | 73,823,851 | | | | 73,822 | | | | 26,083,635 | | | | 425,383 | | | | (34,523,380 | ) | | | (7,940,540 | ) |
| Net loss | | | | | — | | | | — | | | | — | | | | — | | | | (9,447,641 | ) | | | (9,447,641 | ) |
| Stock-based compensation | | | | | — | | | | — | | | | 93,189 | | | | — | | | | — | | | | 93,189 | |
| Common stock issued from share subscription | | | | | 1,500,000 | | | | 1,500 | | | | 598,500 | | | | — | | | | — | | | | 600,000 | |
| Broker fees related to share subscription | | | | | — | | | | — | | | �� | (24,000 | ) | | | — | | | | — | | | | (24,000 | ) |
| Fair value of exchange feature liability | | | | | — | | | | — | | | | (112,649 | ) | | | — | | | | — | | | | (112,649 | ) |
| Inducement on conversion of debentures with related party | | | | | 4,375,668 | | | | 4,376 | | | | 1,658,377 | | | | — | | | | — | | | | 1,662,753 | |
| Common stock issued on conversion of debentures | | | | | 49,764,248 | | | | 49,765 | | | | 14,730,479 | | | | — | | | | — | | | | 14,780,244 | |
| Intrinsic value of beneficial conversion feature of convertible debentures | | | | | — | | | | — | | | | 540,000 | | | | — | | | | — | | | | 540,000 | |
| Foreign currency translation of Canadian subsidiaries | | | | | — | | | | — | | | | — | | | | 21,166 | | | | — | | | | 21,166 | |
| Balance, December 31, 2010 | | | | | 129,463,767 | | | $ | 129,463 | | | $ | 43,567,531 | | | $ | 446,549 | | | $ | (43,971,021 | ) | | $ | 172,522 | |
The accompanying notes are an integral part of these consolidated financial statements.
F-5
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2010
| | | | 2010
| | 2009
|
|---|
| Net loss | | | | $ | (9,447,641 | ) | | $ | (5,936,952 | ) |
Adjustments to reconcile net loss to net cash used in operating activities:
| | | | | | | | | | |
| Inducement premium | | | | | 2,909,872 | | | | — | |
| Change in fair value of exchange feature liability | | | | | 2,021,213 | | | | — | |
| Mark to market adjustment on advance share subscription | | | | | (1,247,119 | ) | | | — | |
| Depreciation of property, plant and equipment | | | | | 1,045,096 | | | | 1,061,439 | |
| Long-term debt accretion | | | | | 768,981 | | | | 27,019 | |
| Amortization of patents and trademarks | | | | | 213,212 | | | | 212,792 | |
| Write-down of inventory | | | | | 195,293 | | | | — | |
| Interest on long-term debt | | | | | 183,858 | | | | 870,632 | |
| Amortization of deferred costs | | | | | 117,131 | | | | 19,912 | |
| Stock-based compensation | | | | | 93,189 | | | | — | |
| Provision for doubtful accounts | | | | | 60,855 | | | | 6,209 | |
| Loss on disposal of property, plant and equipment | | | | | 8,828 | | | | 1,404 | |
| | | | | | 6,370,409 | | | | 2,199,407 | |
Increase (decrease) in cash flows from operating activities resulting from changes in:
| | | | | | | | | | |
| Accounts receivable | | | | | (1,195,868 | ) | | | (954,177 | ) |
| Inventory | | | | | (3,066,562 | ) | | | (591,108 | ) |
| Prepaid expenses and sundry assets | | | | | (14,163 | ) | | | 151,036 | |
| Accounts payable and accrued liabilities | | | | | 1,459,220 | | | | 780,901 | |
| Customer deposits | | | | | 19,465 | | | | (2,683 | ) |
| | | | | | (2,797,908 | ) | | | (616,031 | ) |
| Net cash used in operating activities | | | | | (5,875,140 | ) | | | (4,353,576 | ) |
Investing activities:
| | | | | | | | | | |
| Proceeds from sale of property and equipment | | | | | 703 | | | | 951 | |
| Acquisition of property, plant and equipment | | | | | (254,581 | ) | | | (225,134 | ) |
| Addition to internal use software under development | | | | | (121,133 | ) | | | — | |
| Addition to property, plant and equipment under construction | | | | | (39,177 | ) | | | 54,115 | |
| Increase in patents and trademarks | | | | | — | | | | (1,108 | ) |
| Net cash used in investing activities | | | | | (414,188 | ) | | | (171,176 | ) |
Financing activities:
| | | | | | | | | | |
| Proceeds from convertible debentures placement | | | | | 3,000,000 | | | | 1,300,000 | |
| Debt issuance cost | | | | | (80,625 | ) | | | — | |
| Proceeds from bank loans | | | | | 3,312,254 | | | | 846,140 | |
| Repayment of bank loan | | | | | (723,431 | ) | | | (272,224 | ) |
| Repayment of notes payable to related party | | | | | (500,000 | ) | | | 800,000 | |
| Proceeds from issuance of common stock | | | | | 600,000 | | | | 425,000 | |
| Broker fees related to share subscription | | | | | (24,000 | ) | | | — | |
| Repayment of capital lease obligation | | | | | (13,769 | ) | | | (12,001 | ) |
| Net cash provided by financing activities | | | | | 5,570,429 | | | | 3,086,915 | |
| Net decrease in cash and equivalents | | | | | (718,899 | ) | | | (1,437,837 | ) |
| Foreign exchange loss (gain) on foreign operations | | | | | 99,623 | | | | (177,182 | ) |
| Cash and cash equivalents, beginning of year | | | | | 632,604 | | | | 2,247,623 | |
| Cash and cash equivalents, end of year | | | | $ | 13,328 | | | $ | 632,604 | |
Supplemental disclosures:
| | | | | | | | | | |
| Cash interest paid | | | | $ | 13,157 | | | $ | 858 | |
| Cash paid (received) as income taxes | | | | $ | — | | | $ | (10,838 | ) |
| Other non-cash conversion of debentures and related interest | | | | $ | 14,780,243 | | | $ | — | |
The accompanying notes are an integral part of these consolidated financial statements.
F-6
NOTE 1 — NATURE OF BUSINESS AND BASIS OF PRESENTATION
Environmental Solutions Worldwide, Inc. (the “Company” or “ESW”) through its wholly owned subsidiaries is engaged in the design, development, manufacturing and sales of environmental technologies and testing services with its primary focus on the international on-road and off-road diesel retrofit market. ESW currently manufactures and markets a line of catalytic emission control and enabling technologies for a number of applications.
The audited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”), which contemplates continuation of the Company as a going concern.
The Company has sustained recurring operating losses. As of December 31, 2010, the Company had an accumulated deficit of $43,971,021 and cash and cash equivalents of $13,328 and was in violation of certain financial covenants with its secured lender for which a waiver was obtained (see Note 8). There is no assurance that the Company will be successful in achieving sufficient cash flow from operations in the near future and there can be no assurance that it will either achieve or maintain profitability in the future. As a result, there is substantial doubt regarding the Company’s ability to continue as a going concern. The Company will require additional financing to fund its continuing operations. The Company is seeking additional funds by way of equity and debt financing. The Company’s ability to continue as a going concern is dependent on obtaining additional financing and achieving and maintaining a profitable level of operations. The outcome of these matters cannot be predicted at this time.
Effective November 9, 2010 and December 8, 2010 the Company completed two tranches of a unit offering, each unit was offered at a price of $0.40 and is comprised of one share of the Company’s common stock and one, warrant exercisable within two years, for one share of common stock, the exercise price will be $0.55; if a warrant is exercised between the first and second years from issuance, the exercise price will be $0.65. The Company raised gross proceeds of $600,000 and issued 1,500,000 shares of the Company’s common stock and 1,500,000 warrants to purchase 1,500,000 shares of the Company’s common stock. (See Note 12 for further details).
On February 17, 2011, the Company raised a further $3 million through the issuance of unsecured subordinated promissory notes (together “the Notes”) to current shareholders and deemed affiliates of certain members of the board of directors of the Company. Proceeds of the Notes and earlier financing will be used to fund working capital, planned capital investments and other general corporate purposes. With the proceeds of the Notes, the Company and its subsidiaries are in compliance with covenant obligations under the Demand Credit Agreement with the Canadian Imperial Bank of Commerce (“CIBC”) dated March 10, 2010 for which the Company and its subsidiaries had previously obtained waivers of covenant obligations through to February 15, 2011.
The Company has also proposed plans for a rights offering of the Company’s common stock, at a price of $0.12 per share pursuant to which the Company plans to offer rights to existing shareholders on the offering date to purchase approximately $6.5 million in shares of Common Stock, the offering is expected to raise at least an incremental $3.5 million of cash for the Company and will also permit all Subordinated Lenders to exchange their Notes (and the other Notes paid in-kind for the payment of interest under the Notes) for shares of Common Stock under the offering. The offering is expected to be completed by June 17, 2011.
These consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern for a reasonable period of time. All adjustments considered necessary for fair presentation and of a normal recurring nature have been included in these consolidated financial statements.
NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, ESW America Inc. (“ESWA”), ESW Technologies Inc. (“ESWT”), ESW Canada Inc. (“ESWC”) and BBL Technologies Inc. (“BBL”). All inter-company transactions and balances have been eliminated on consolidation. Amounts in the consolidated financial statements are expressed in US dollars.
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ESTIMATES
The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reported period. Actual results could differ from those estimates. Significant estimates include amounts for impairment of property plant and equipment, intangible assets, share based compensation, inventory, redeemable class A special shares, convertible debentures, valuation of warrants, accrued liabilities and accounts receivable exposures.
CONCENTRATIONS OF CREDIT RISK
The Company’s cash balances are maintained in various banks in Canada and the United States. Deposits held in banks in the United States are insured up to $250,000 per depositor for each bank by the Federal Deposit Insurance Corporation. Deposits held in banks in Canada are insured up to $100,000 Canadian per depositor for each bank by The Canada Deposit Insurance Corporation a federal Crown corporation. Actual balances at times may exceed these limits.
Accounts Receivable and Concentrations of Credit Risk: The Company performs on-going credit evaluations of its customers’ financial condition and generally does not require collateral from its customers. Three of its customers accounted for 21%, 19%, and 13%, respectively, of the Company’s revenue in the fiscal year 2010 and 48%, 21%, and 13%, respectively, of its accounts receivable as of December 31, 2010. Three of its customers accounted for 45%, 20%, and 9%, respectively, of the Company’s revenue in the fiscal year 2009 and 27%, 11%, and 25%, respectively, of its accounts receivable as of December 31, 2009.
As at December 31, 2010, the Company believes that the allowance for uncollectible accounts sufficiently covers any credit risk related to past due accounts receivable balances.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated credit risk by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is estimated and recorded based on management’s assessment of the credit history with the customer and current relationships with them. On this basis management has determined that an allowance for doubtful accounts of $70,028 and $6,637 was appropriate as at December 31, 2010 and 2009, respectively.
INVENTORY
Inventory is stated at the lower of cost or market determined using the first-in first-out method. Inventory is periodically reviewed for use and obsolescence, and adjusted as necessary. Inventory consists of raw materials, work in progress and finished goods.
PROPERTY, PLANT AND EQUIPMENT UNDER CONSTRUCTION
The Company capitalizes customized equipment built to be used in the future day to day operations at cost. Once complete and available for use, the cost for accounting purposes is transferred to property, plant and equipment, where normal depreciation rates apply.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, generally 5 to 7 years. Maintenance and repairs are charged to operations as incurred. Significant renewals and betterments are capitalized. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated discounted cash flow used in determining the fair value of the asset. ESW conducted a test for impairment as of December 31, 2010 and 2009, and found no impairment.
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INTERNAL-USE SOFTWARE
ESW capitalizes costs related to computer software obtained or developed for internal use. Software obtained for internal use is an enterprise-level business and finance software that ESW is customizing to meet specific operational needs. Costs incurred in the development phase are capitalized and amortized over the useful life of the internal use software, which is generally from three to five years. Capitalized internal-use software development costs for a project which is not yet complete is included as Internal-use Software under Development in the consolidated balance sheet. Capitalization of such costs ceases at the point at which the project is substantially complete and ready for its intended purpose. Costs capitalized during for the years ended December 31, 2010 and 2009 were $126,340 and $0, respectively.
PATENTS AND TRADEMARKS
Patents and trademarks consist primarily of the costs incurred to acquire them from an independent third party. Accounting Standards Codification (“ASC”) Topic 350 requires intangible assets with a finite life be tested for impairment whenever events or circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated discounted cash flow used in determining the fair value of the asset. ESW conducted a test for impairment as of December 31, 2010 and 2009 and found no impairment.
Patents and trademarks are being amortized on a straight-line basis over their estimated life of ten years. Amortization expense for the year ended December 31, 2010 and 2009 was $213,212 and $212,792 respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC Topic 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.
Included in the ASC Topic 820 framework is a three level valuation inputs hierarchy with Level 1 being inputs and transactions that can be effectively fully observed by market participants spanning to Level 3 where estimates are unobservable by market participants outside of the Company and must be estimated using assumptions developed by the Company. The Company discloses the lowest level input significant to each category of asset or liability valued within the scope of ASC Topic 820 and the valuation method as exchange, income or use. The Company uses inputs which are as observable as possible and the methods most applicable to the specific situation of each company or valued item.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, notes payable to related party, bank loan, redeemable Class A special shares and capital lease obligation approximate fair value because of the short-term nature of these items. Per ASC Topic 820 framework these are considered Level 2 inputs where estimates are unobservable by market participants outside of the Company and must be estimated using assumptions developed by the Company.
The advance share subscription was classified as a liability and periodically marked to market until October 14, 2010 (see Note 10). The fair value of the advance share subscription obligation was determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock and might be adversely affected by a change in the price of the Company’s common stock. Per ASC Topic 820 framework this was considered a Level 1 input.
The exchange feature liability is classified as a liability and periodically marked to market. The fair value of the exchange feature liability is determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock and might be adversely affected by a change in the price of the Company’s common stock. Per FAS 157 framework these are considered a Level 1 input.
Interest rate risk is the risk that the value of a financial instrument might be adversely affected by a change in the interest rates. In seeking to minimize the risks from interest rate fluctuations, the Company manages exposure through its normal operating and financing activities.
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REVENUE RECOGNITION
The Company derives revenue primarily from the sale of its catalytic products. In accordance with ASC Topic 605, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the amount is fixed or determinable, risk of ownership has passed to the customer and collection is reasonably assured.
The Company also derives revenue (less than 1.5% in 2010 and 3.0% in 2009 of total revenue) from providing air testing and environmental certification services. Revenues from these services are recognized upon performance.
LOSS PER COMMON SHARE
Loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding during the year. Common stock equivalents are excluded from the computation of diluted loss per share when their effect is anti-dilutive.
Therefore diluted loss per share has not been calculated for 2010 and 2009 (see Note 16).
INCOME TAXES
Income taxes are computed in accordance with the provisions of ASC Topic 740, which requires, among other things, a liability approach to calculating deferred income taxes. SFAS 109 requires a company to recognize deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in a company’s financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The guidance requires the Company to make certain estimates and judgments about the application of tax law, the expected resolution of uncertain tax positions and other matters. In the event that uncertain tax positions are resolved for amounts different than the Company’s estimates, or the related statutes of limitations expire without the assessment of additional income taxes, the Company will be required to adjust the amounts of the related assets and liabilities in the period in which such events occur.
Such adjustments may have a material impact on ESW’s income tax provision and results of operations. Note 11 to the consolidated financial statements describes the guidance and the effects on results of operations and financial position arising from its adoption.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company follows ASC Topic 360, which requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the assets’ carrying amounts may not be recoverable. In performing the review for recoverability, if future undiscounted cash flows (excluding interest charges) from the use and ultimate disposition of the assets are less than their carrying values, an impairment loss represented by the difference between its fair value and carrying value, is recognized. Management reviewed the related assets for impairment in the fourth quarter and found no impairment.
RESEARCH AND DEVELOPMENT
The Company is engaged in research and development work. Research and development costs, are charged as operating expense of the Company as incurred. Any grant money received for research and development work is used to offset these expenditures. For the years ended December 31, 2010 and 2009, the Company expensed $783,944 and $930,548 net of grant revenues, respectively, towards research and development costs. The expense excluding grant revenues used to offset research and development costs for the years ended December 31, 2010 and 2009 amounted to $927,319 and $1,099,301. In 2010 and 2009, grant money amounted to $143,375 and $168,753, respectively.
FOREIGN CURRENCY TRANSLATION
The consolidated financial statements have been translated into U.S. dollars in accordance with ASC Topic 830. All monetary items have been translated using the exchange rates in effect at the balance sheet date. All
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non-monetary items have been translated using the historical exchange rates at the time of transactions. Income statement amounts have been translated using the average exchange rate for the year. Translation adjustments that arise from translating the financial statements of the Company’s foreign subsidiaries from local currency to U.S. dollars are recorded in other comprehensive income component of stockholders’ equity (deficit).
COMPREHENSIVE INCOME
ASC Topic 830 establishes standards for reporting and display of comprehensive income and its components. As of December 31, 2010 and 2009, accumulated other comprehensive income is reported as a component of stockholders’ equity (deficit). Other comprehensive income includes only foreign currency translation adjustments.
PRODUCT WARRANTIES
The Company provides for estimated warranty costs at the time of sale and accrues for specific items at the time their existence is known and the amounts are determinable. The Company estimates warranty costs using standard quantitative measures based on industry warranty claim experience and evaluation of specific customer warranty issues. The Company currently records warranty costs as 2% of revenue. As of December 31, 2010 and 2009, $102,793 and $40,290, respectively, was accrued against warranty provision and included in accrued liabilities. For the years ended December 31, 2010 and 2009, the total warranty, service, service travel and installation costs included in cost of sales was $224,766 and $38,209, respectively.
SEGMENTED REPORTING
ASC Topic 280 changed the way public companies report information about segments of their business in their quarterly reports issued to shareholders. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues and its major customers.
The Company also derives revenue (less than 1.5% in 2010 and 3.0% in 2009 of total revenue) from providing air testing and environmental certification services. For the years ended December 31, 2010 and 2009, all revenues were generated from the United States. As of December 31, 2010 and 2009, $1,182,263 and $1,662,243, respectively, of property, plant and equipment is located at the air testing facility in Pennsylvania and all remaining long lived assets are located in Concord, Ontario.
NOTE 3 — RECENTLY ISSUED ACCOUNTING STANDARDS
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In January 2010, the FASB issued Accounting Standards Update (“ASU” or “Update”) No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”) (codified within ASC Topic 820, Fair Value Measurements and Disclosures). ASU 2010-06 improves disclosures originally required under SFAS No. 157. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2009, and for interim periods within those years. The adoption of the guidance did not have a material effect on the Company’s consolidated financial position, results of operations, cash flows or related disclosures.
In December 2009, the FASB issued ASU 2009-16, Transfers and Servicing (Topic 860) — Accounting for Transfers of Financial Assets (“ASU 2009-16”). ASU 2009-16 amends the accounting for transfers of financials assets and will require more information about transfers of financial assets, including securitizations, and where entities have continuing exposure to the risks related to transferred financial assets. ASU 2009-16 is effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, with early adoption not permitted. The adoption of the guidance did not have a material effect on the Company’s consolidated financial position, results of operations, cash flows or related disclosures.
In October 2009, the FASB issued ASU 2009-15, Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing (“ASU 2009-15”). ASU 2009-15 amends the accounting and reporting guidance for debt (and certain preferred stock) with specific conversion features or other
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options. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009. The adoption of the guidance did not have a material effect on the Company’s consolidated financial position, results of operations, cash flows or related disclosures.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2010, the FASB issued ASU No. 2010-22, Accounting for Various Topics — Technical Corrections to SEC Paragraphs this update amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends or rescinds portions of certain SAB topics. The Company is assessing the potential effect this guidance will have on its consolidated financial statements.
In August 2010, the FASB issued ASU No. 2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This updates various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies. The Company is assessing the potential effect this guidance will have on its consolidated financial statements.
In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition — Milestone Method. The objective of this Update is to provide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. The amendments in this Update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. The Company does not anticipate that the adoption of this pronouncement will have a significant effect on its consolidated financial statements.
In April 2010, the FASB issued ASU No. 2010-013, Compensation — Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades a consensus of the FASB Emerging Issues Task Force. ASU 2010-13 addresses the classification of an employee share-based award with an exercise price denominated in the currency of a market in which the underlying equity security trades. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The Company will comply with the additional disclosures required by this guidance upon its adoption in January 2011.
In October 2009, the FASB issued ASU No. 2009-13, Multiple Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”) (codified within ASC Topic 605). ASU 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company is currently assessing the impact of ASU 2009-13 on its consolidated financial position, results of operations and cash flows.
NOTE 4 — CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and highly liquid investments purchased with an original or remaining maturity of 90 days or less at the date of purchase. At December 31, 2010 and 2009 all of the Company’s cash and cash equivalents consisted of cash.
NOTE 5 — INVENTORY
Inventory consists of:
| | | | December 31,
| |
|---|
INVENTORY
| | | | 2010
| | 2009
|
|---|
| Raw materials | | | | $ | 1,669,481 | | | $ | 844,649 | |
| Work-in-process | | | | | 2,737,545 | | | | 640,286 | |
| Finished goods | | | | | 7,492 | | | | 23,479 | |
| TOTAL | | | | $ | 4,414,518 | | | $ | 1,508,414 | |
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NOTE 6 — PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
| | | | December 31,
| |
|---|
CLASSIFICATION
| | | | 2010
| | 2009
|
|---|
| Plant, machinery and equipment | | | | $ | 5,790,507 | | | $ | 5,539,017 | |
| Office equipment | | | | | 384,902 | | | | 325,626 | |
| Furniture and fixtures | | | | | 461,817 | | | | 451,281 | |
| Vehicles | | | | | 18,288 | | | | 17,951 | |
| Leasehold improvements | | | | | 1,041,023 | | | | 1,016,511 | |
| | | | | | 7,696,537 | | | | 7,350,386 | |
| Less: accumulated depreciation | | | | | (5,765,164 | ) | | | (4,663,281 | ) |
| | | | | $ | 1,931,373 | | | $ | 2,687,105 | |
| | | | December 31,
| |
|---|
Depreciation Expense
| | | | 2010
| | 2009
|
|---|
| Depreciation expense included in cost of sales | | | | $ | 174,013 | | | $ | 56,436 | |
| Depreciation expense included in operating expenses | | | | | 624,233 | | | | 910,713 | |
| Depreciation expense included in research and development costs | | | | | 246,849 | | | | 139,109 | |
| Total depreciation expense | | | | $ | 1,045,096 | | | $ | 1,106,258 | |
At December 31, 2010 and 2009, the Company had $185,542 and $138,800, respectively, of customized equipment under construction.
The office equipment above includes $0 and $19,121 in assets under capital lease with a corresponding accumulated depreciation of $0 and $15,493 as of December 31, 2010 and 2009, respectively.
The plant, machinery and equipment above include $37,939 and $36,294 in assets under capital lease with a corresponding accumulated depreciation of $25,723 and $18,592 as of December 31, 2010 and 2009, respectively.
NOTE 7 — NOTE PAYABLE TO RELATED PARTY
On December 29, 2009, the Company issued a $500,000 unsecured subordinated promissory note to a shareholder and a member of the Company’s Board of Directors with interest accruing at the annual rate of 9%. In accordance with the terms of the note, upon the Company completing a financing for the gross sum of $2 million dollars or more, or in the event the Company did not complete a financing by March 31, 2010, this note would have been payable upon demand of the holder.
Effective March 31, 2010 the Company repaid $500,000 principal and $11,342 in interest from the proceeds of the March 19, 2010 convertible debentures issuance. (see Note 10).
As of December 31, 2010, principal and corresponding accrued interest outstanding on note payable to related party was $0 and $0, respectively. As of December 31, 2009, principal and interest outstanding on note payable to related party was $500,000 and $0, respectively.
NOTE 8 — BANK LOANS
In 2007, ESW’s subsidiary, ESWC entered into a $2.5 million revolving credit facility with Royal Bank of Canada (“RBC”), to finance orders on hand. Effective September 2, 2008, the agreement was amended to extend the term of the agreement through to June 30, 2009 and effective August 21, 2009, the term of the secured commercial loan agreement with RBC was extended through to April 30, 2010. The amended arrangement provided for a revolving facility available by way of a series of term loans of up to $750,000 to finance future production orders. The credit facility was guaranteed by the Company and its subsidiary ESWC, through the pledge of their assets to RBC. The facility had been guaranteed to the bank under Export Development Canada (“EDC”) pre-shipment financing program. Borrowings under the revolving credit agreement bore interest at 1.5% above the
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bank’s prime rate of interest. Repayments of any loans were required no later than one year from the date of the advancement of that loan. Obligations under the revolving credit agreement were collateralized by a first-priority lien on the assets of the Company and its subsidiary ESWC, including, accounts receivable, inventory, equipment and other tangible and intangible property, including the capital stock of all direct subsidiaries.
Effective March 31, 2010, all borrowings under the RBC facility were repaid and the facility with RBC was closed.
Effective March 31, 2010, ESW’s subsidiary, ESWC, entered into the Credit Agreement with a Canadian chartered bank, CIBC, to meet working capital requirements. The facility has a credit limit of $4 million Canadian. Borrowings under the facility are limited to a percentage of accounts receivable plus a percentage of inventories (capped at $1 million Canadian or 50% of the accounts receivable portion) less any prior ranking claims. The credit facility is guaranteed by the Company and its subsidiaries, ESWC, ESWA, BBL, and ESWT, through a general security agreement over all assets to CIBC. The facility has been guaranteed to CIBC under EDC’s Export Guarantee Program. Borrowings under the credit facility bear interest at 2.25% above CIBC’s prime rate of interest. Obligations under the revolving credit agreement are collateralized by a first-priority lien on the assets of the Company and its subsidiaries, including accounts receivable, inventory, equipment and other tangible and intangible property, including the capital stock of all direct subsidiaries.
The terms relating to the Credit Agreement specifically note that the Company maintain a tangible net worth of at least $4.0 million Canadian. The credit agreement contains, among other things, covenants, representations and warranties and events of default customary for a facility of this type for the Company and its subsidiaries. Such covenants include certain restrictions on the incurrence of additional indebtedness, liens, acquisitions and other investments, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other repurchases in respect of capital stock, voluntary prepayments of certain other indebtedness, capital expenditures and transactions with affiliates, subject to certain exceptions. Under certain conditions amounts outstanding under the credit agreements may be accelerated. Such events include failure to comply with covenants, breach of representations or warranties in any material respect, non-payment or acceleration of other material debt, entry of material judgments not covered by insurance, or a change of control of the Company.
On November 8, 2010, November 26, 2010, and December 23, 2010, the Company’s wholly owned subsidiary, ESWC, received the first, second and third waivers, respectively, of certain financial covenants under its Credit Agreement with CIBC. Without the waiver, the Company’s subsidiary would not be in compliance with the current ratio and effective tangible net worth covenants as set forth in the Credit Agreement. In the event the Company and its subsidiary, ESWC, fail to comply with the terms of the waiver and meet the current ratio and effective tangible net worth covenants prior to the end of the waiver period, same would constitute an event of default and the bank loan may need to be repaid unless a further waiver or modification to the Credit Agreement can be obtained.
The third waiver provided by CIBC was through January 31, 2011 and also provides for a fee payable to the lender for the extension, as well as a reduction in the maximum security margin deficit as defined under the Credit Agreement (by either reducing borrowing or increasing the borrowing base) and an increase in the annual interest rate to CIBC’s prime rate plus 4.50% from CIBC’s prime rate plus 2.25% effective January 1, 2011.
As at December 31, 2010, $3,424,889 was owed under the credit facility to CIBC. As at December 31, 2009, $713,037 was owed under a former credit facility with RBC.
NOTE 9 — REDEEMABLE CLASS A SPECIAL SHARES
700,000 Class A special
shares authorized,
issued, and outstanding. | | | | 453,900 (based on the historical
exchange rate at the time of
issuance.) |
The redeemable Class A special shares were issued by the Company’s wholly owned subsidiary, BBL, without par value, and are redeemable on demand by the holder of the shares, which is a private Ontario Corporation, at $700,000 Canadian (which translates to $703,801 US and $660,032 US at December 31, 2010 and 2009, respectively). As the redeemable Class A special shares were issued by the Company’s wholly owned subsidiary, BBL, the maximum value upon which the Company is liable is the net book value of BBL. As of December 31,
F-14
2010 and 2009, BBL had an accumulated deficit of $1,192,858 US ($1,845,375 Canadian) and $1,187,506 US ($1,839,864 Canadian) as of December 31, 2010 and 2009, respectively, and therefore, the holder would be unable to redeem the redeemable Class A special shares at their ascribed value.
NOTE 10 — CONVERTIBLE DEBENTURES
Convertible debentures issued by the Company are summarized as follows:
| | | | 2008
Debentures
| | 2009
Debentures
| | 2010
Debentures
| | Total
March 31,
2010
| | Total
December 31,
2009
|
|---|
| Face value of convertible debenture | | | | $ | 9,000,000 | | | $ | 1,600,000 | | | $ | 3,000,000 | | | $ | 13,600,000 | | | $ | 10,600,000 | |
| Less: Beneficial conversion feature | | | | | — | | | | (256,000 | ) | | | (540,000 | ) | | | (796,000 | ) | | | (256,000 | ) |
| Deferred costs | | | | | (59,738 | ) | | | — | | | | (80,625 | ) | | | (140,363 | ) | | | (59,738 | ) |
| Book value upon issuance | | | | | 8,940,262 | | | | 1,344,000 | | | | 2,379,375 | | | | 12,663,637 | | | | 10,284,262 | |
| Accretion of the debt discount | | | | | — | | | | 256,000 | | | | 540,000 | | | | 796,000 | | | | 27,019 | |
| Amortization of deferred costs | | | | | 59,738 | | | | — | | | | 80,625 | | | | 140,363 | | | | 23,232 | |
| Carrying Value | | | | | 9,000,000 | | | | 1,600,000 | | | | 3,000,000 | | | | 13,600,000 | | | $ | 10,334,513 | |
| Conversion (March 25,2010) | | | | | (9,000,000 | ) | | | (1,600,000 | ) | | | (3,000,000 | ) | | | (13,600,000 | ) | | | | |
| Carrying Value (December 31,2010) | | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | | | |
Effective March 19, 2010, the Company issued $3,000,000 of its 9% convertible debentures (the “2010 Debentures”) to five (5) accredited investors under Rule 506 of Regulation D of Section 4(2) of the Securities Act. The 2010 Debentures were for a term of three (3) years and were convertible into shares of the Company’s common stock at the option of the holder by dividing the principal amount of the 2010 Debenture to be converted by $0.50. The 2010 Debentures earned interest at a rate of 9% per annum payable in cash or in shares of the Company’s common stock at the option of the holder. If the holder elected to receive interest in shares of common stock, the number of shares of common stock to be issued for interest would be determined by dividing accrued interest by $0.50. The 2010 Debentures had a mandatory conversion feature that required the holders to convert in the event a majority of the Company’s pre-existing outstanding 9% convertible debentures converted. Subject to the holder’s right to convert and the mandatory conversion feature, the Company had the right to redeem the 2010 Debentures at a price equal to one hundred and ten percent (110%) multiplied by the then outstanding principal amount plus unpaid interest to the date of redemption. Upon maturity, the debenture and interest was payable in cash or common stock at the option of the Holder. The Company also had provided the holders of the Debentures registration rights. The 2010 Debentures contained customary price adjustment protections.
At the time the 2010 Debentures were issued, the Company recorded a debt discount for a beneficial conversion feature in the amount of $540,000. The debt discount being the aggregate intrinsic value calculated as the difference between the market price of the Company’s share of stock on March 19, 2010 and the conversion price of the 2010 Debentures. The debt discount was being accreted over the three (3) year life of the debentures using the effective yield method. The effective yield on the debentures was 16.36%.
On August 28, 2009, the Company completed a transaction whereby it issued $1.6 million of 9% convertible debentures (the “2009 Debentures”) to six (6) accredited investors. Of the $1.6 million received by the Company, $500,000 was received from a director of the Company through the exchange of a $300,000 unsecured 9% subordinated demand short term loan previously provided to the Company on August 11, 2009 and an additional $200,000 investment made by the director in the offering. The 2009 Debentures were for a term of three (3) years and were convertible into shares of the Company’s common stock at the option of the holder by dividing the principal amount of the 2009 Debenture to be converted by $0.50. The 2009 Debentures earned interest at a rate of 9% per annum payable in cash or in shares of the Company’s common stock at the option of the holder. If the holder elected to receive interest in shares of common stock, the number of shares of common stock to be issued for interest would be determined by dividing accrued interest by $0.50. Subject to the holder’s right to convert, the Company had the right to redeem the 2009 Debentures at a price equal to one hundred and ten percent (110%) multiplied by the then outstanding principal amount plus unpaid interest to the date of redemption. Upon maturity, the debenture and interest was payable in cash or common stock at the option of the holder. The 2009 Debentures contained customary price adjustment protections.
F-15
At the time the 2009 Debentures were issued, the Company recorded a debt discount for a beneficial conversion feature in the amount of $256,000. The debt discount being the aggregate intrinsic value calculated as the difference between the market price of the Company’s share of stock on August 28, 2009 and the conversion price of the 2009 Debentures. The debt discount was being accreted over the three (3) year life of the debentures using the effective yield method. The effective yield on the debentures was 15.52%.
On November 3, 2008, the Company completed a transaction whereby it issued $6.0 million of 9% convertible debentures (the “2008 Debentures”) to six accredited investors. The 2008 Debentures were for a term of three (3) years and were convertible into shares of the Company’s common stock at the option of the holder at any time six (6) months after the date of issuance of the 2008 Debentures by dividing the principal amount of the 2008 Debentures to be converted by $0.25. The 2008 Debentures earned interest at a rate of 9% per annum payable in cash or in shares of the Company’s common stock at the option of the holder. If the holder elected to receive interest in shares of common stock, the number of shares of common stock to be issued for interest would be determined by dividing accrued interest by $0.25. Subject to the holder’s right to convert, the Company had the right to redeem the 2008 Debentures at a price equal to one hundred and ten percent (110%) multiplied by the then outstanding principal amount plus unpaid interest to the date of redemption. Upon maturity, the debenture and interest was payable in cash or common stock at the option of the holder. The Debentures contained customary price adjustment protections. The effective yield on the 2008 Debentures was 9%.
From the proceeds of the 2008 Debentures, the Company repaid $2,200,000, the principal portion only of a previously issued Consolidated Note in the amount of $2,308,148 to a company controlled by a trust to which a director and shareholder of the Company is the beneficiary. The debt holder agreed to have the remaining amount of $433,923, due under the Consolidated Note, applied to a subscription of a Debenture under the November 3, 2008 offering. Concurrently, the Company repaid a Consolidated Subordinated Note that it had previously issued to a debt holder who is a director and shareholder of the Company, in the principal amount of $1,002,589. The debt holder agreed to have the full amount of principal and accumulated interest, in the amount of $1,158,024 due under the Consolidated Subordinated Note, applied to a subscription of a Debenture under the offering. Additionally the Company’s $1.5 million credit facility also provided by the same debt holder, from which the Company had drawn down the sum of $1,103,000 as of November 3, 2008, was also satisfied by way of issuance of debentures under the November 3, 2008 offering. With the agreement to settle all the notes previously issued the debt holder subscribed to an aggregate of $2,566,077 of debentures under the offering.
Effective March 25, 2010, the November 2008 and the August 2009 debenture holders agreed to convert all outstanding convertible debentures as per the terms of the respective debenture agreements. The early conversion of the debentures was a condition precedent to the Company’s wholly owned subsidiary, ESWC, entering into a new credit facility with CIBC (see Note 8). A total of $10,600,000 in principal and $1,176,445 of accrued interest was converted into 43,756,653 shares of restricted common stock. The conversion of the November 2008 and the August 2009 debentures also triggered the mandatory conversion feature on the March 19, 2010 debentures. A total of $3,000,000 in principal and $3,797 in accrued interest was converted into 6,007,595 shares of restricted common stock. With these transactions effective March 25, 2010, the Company has $0 of convertible debentures and accrued interest on convertible debenture.
As part of the agreement to convert all existing convertible debentures, the Company was committed to pay a premium as an inducement to convert all debentures. The premium was payable to all converting debenture holders and was subject to a positive fairness opinion, approval by a Fairness Committee consisting of independent Directors of the Company’s Board of Directors and an increase in the share capital of the Company. The premium consists of 4,375,668 shares of common stock. As the Company did not have sufficient authorised shares as of the date of conversion of the debentures to fulfill the premium, the premium had been recorded as an advance share purchase agreement at a fair market value of $2,909,872 as of March 31, 2010. The agreement is without interest, subordinated to the bank’s position and payable in a fixed number of common shares (4,375,668 shares) of the Company upon increase in the authorized share capital of the Company.
Up to October 14, 2010, the Company did not have sufficient authorized and unissued shares to fulfill the advance share subscription. Under these conditions, FASB ASC Subtopic 815-40, Contracts in Entity’ Own Equity, precludes equity classification of this obligation. As such, the advance share subscription was classified as a liability and periodically marked to market. The fair value of the obligation was determined to be $1,662,753 at October 14,
F-16
2010. The fair value of the obligation was determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock. The decrease in fair value of this liability of $1,247,119 was recorded as a mark to market adjustment on advance share subscription in the consolidated statement of operations and comprehensive loss.
Effective October 14, 2010, the Company’s Board of Directors ratified certain corporate action approved by the written consent of a majority of the Company’s shareholders pursuant to a Definitive Information Statement on Schedule 14C that the Company filed with the Securities and Exchange Commission on September 3, 2010 (the “Definitive Information Statement”) and distributed to shareholders of record. The Board of Directors ratified an amendment to the Company’s articles of incorporation whereby the Company proceeded to file an amendment to its articles of incorporation increasing its authorized shares of common stock from 125,000,000 to 250,000,000 shares.
Effective November 30, 2010 the Company issued an aggregate of 4,375,668 restricted shares of common stock to thirteen (13) prior debenture holders in connection with the early conversion of their debentures.
Included in the consolidated financial statements of the Company at December 31, 2010 is the effect of an exchange feature included in the terms of the Share Subscription Agreement for $3,000,000 of Convertible Debentures issued on March 19, 2010 (“2010 Debentures”) and fully converted including interest into 6,007,595 shares of common stock on March 25, 2010. The exchange feature provides that if within twelve months from March 19, 2010, the Company enters into or closes another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the Securities) on terms and conditions more favourable to another purchaser, the terms and conditions of the 2010 Debentures shall be adjusted to reflect the more favourable terms. The exchange feature was determined by the Company to be freestanding financial instrument and also to be a liability within the scope of ASC 480 Distinguishing Liabilities from Equity since there is an inverse relationship between the stock price of the Company and the Company’s obligation. On December 31, 2010, the Company evaluated the fair value of the exchange feature based on the probability of closing another financing by March 18, 2011 and the fair value of the number of incremental shares to be issued at a lower estimated issue price. The probability of closing another financing by March 18, 2011 was estimated to be 100% on December 31, 2010. The fair value of the Company’s common stock is determined by the closing price on the valuation date. On December 31, 2010, an exchange feature liability of $1,680,000 is recorded for the 2010 Debentures in these consolidated financial statements (see also note 12).
As of December 31, 2010, total convertible debentures and corresponding accrued interest amounted to $0 and $0, respectively. As of December 31, 2009, total convertible debentures amounted to $10,334,513 net of deferred costs of $36,506 and debt discount of $228,981, with corresponding accrued interest of $996,385.
As of December 31, 2010, the debt discount of $768,981 and deferred cost of $117,131 were fully amortized and expensed due to the conversion of the debentures effective March 25, 2010.
LEGAL FEES RELATED TO 2008 AND 2010 CONVERTIBLE DEBENTURES
The Company had recorded a deferred cost asset of $59,738 for legal fees paid in relation to the issuance of the 2008 Debentures. The deferred costs were being amortized over the term of the 2008 Debentures using the straight line method. The Company had also recorded a deferred cost asset of $80,625 for legal fees paid in relation to the issuance of the 2010 Debentures. The deferred costs were being amortized over the term of the 2010 Debentures using the straight line method.
At December 31, 2010, the deferred cost assets were fully amortized due to the conversion of the debentures effective March 25, 2010. As at December 31, 2010 and 2009, the deferred cost assets were $0 and $36,506, respectively, and related amortization expense for the years then ended was $117,131 and $19,912, respectively. As of December 31, 2009, deferred cost assets have been presented net against the related convertible debentures.
F-17
NOTE 11 — INCOME TAXES
As at December 31, 2010, there are tax loss carry forwards for Federal income tax purposes of approximately $25,718,074 available to offset future taxable income in the United States. The tax loss carry forwards expire in various years through 2030. The Company does not expect to incur a Federal income tax liability in the foreseeable future. Accordingly, a valuation allowance for the full amount of the related deferred tax asset of approximately $9,001,326 has been established until realizations of the tax benefit from the loss carry forwards meet the “more likely than not” criteria.
YEAR
| | | | Loss Carry
Forward
|
|---|
| 1999 | | | | $ | 407,067 | |
| 2000 | | | | | 2,109,716 | |
| 2001 | | | | | 2,368,368 | |
| 2002 | | | | | 917,626 | |
| 2003 | | | | | 637,458 | |
| 2004 | | | | | 1,621,175 | |
| 2005 | | | | | 2,276,330 | |
| 2006 | | | | | 3,336,964 | |
| 2007 | | | | | 3,378,355 | |
| 2008 | | | | | 3,348,694 | |
| 2009 | | | | | 2,927,096 | |
2010 | | | | | 2,389,225 | |
| |
| Total | | | | $ | 25,718,074 | |
Additionally, as at December 31, 2010, the Company’s two wholly owned Canadian subsidiaries had non-capital tax loss carry forwards of approximately $10,197,881 be used, in future periods, to offset taxable income. The loss carry forwards expire in various years through 2030. The deferred tax asset of approximately $2,549,470 has been fully offset by a valuation allowance until realization of the tax benefit from the non-capital tax loss carry forwards are more likely than not.
YEAR
| | | | Loss Carry
Forward
Foreign
Operations
|
|---|
| 2006 | | | | $ | 573,271 | |
| 2007 | | | | | 7,211 | |
| 2008 | | | | | 4,049,972 | |
| 2009 | | | | | 2,774,833 | |
2010 | | | | | 2,792,594 | |
| |
| Total | | | | $ | 10,197,881 | |
F-18
| | | | For the year ended December 31,
| |
|---|
| | | | 2010
| | 2009
|
|---|
Statutory tax rate:
| | | | | | | | | | |
| U.S. | | | | | 35.00 | % | | | 35.00 | % |
| Foreign | | | | | 31.00 | % | | | 33.00 | % |
Loss before income taxes:
| | | | | | | | | | |
| U.S. | | | | $ | (6,603,329 | ) | | $ | (3,260,449 | ) |
| Foreign | | | | | (2,844,312 | ) | | | (2,676,503 | ) |
| | | | | $ | (9,447,641 | ) | | $ | (5,936,952 | ) |
| Expected income tax recovery | | | | $ | (3,192,617 | ) | | $ | (2,024,403 | ) |
Differences in income tax resulting from:
| | | | | | | | | | |
| Depreciation (Foreign operations) | | | | | 44,330 | | | | 31,936 | |
| Change in fair value of exchange feature liability | | | | | 707,424 | | | | — | |
| Inducement premium on conversion of Debentures | | | | | 1,018,455 | | | | — | |
| Stock based compensation | | | | | 32,616 | | | | — | |
| Market to market adjustment on advance share subscription | | | | | (436,492 | ) | | | — | |
| Long-term debt accretion | | | | | 269,143 | | | | — | |
| Accrued interest on loans | | | | | (116,212 | ) | | | 304,721 | |
| | | | | | (1,673,353 | ) | | | (1,687,746 | ) |
| Benefit of losses not recognized | | | | | 1,673,353 | | | | 1,687,746 | |
| Income tax provision (recovery) per financial statements | | | | $ | — | | | $ | — | |
Components of deferred income tax assets are as follows:
| | | | As at December 31,
| |
|---|
| | | | 2010
| | 2009
|
|---|
| Property, plant and equipment | | | | $ | 119,226 | | | $ | 102,872 | �� |
| Tax loss carry forwards | | | | | 11,550,796 | | | | 10,147,984 | |
| |
| Total | | | | | 11,670,022 | | | | 10,250,856 | |
| Valuation allowance | | | | | (11,670,022 | ) | | | (10,250,856 | ) |
| |
| Carrying Value | | | | $ | — | | | $ | — | |
Effective January 1, 2007, the Company adopted FASB’s guidance on accounting for uncertainty in income taxes. This guidance prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in an income tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. There was no material impact on the Company’s consolidated financial position and results of operations as a result of the adoption of this guidance. The Company does not believe there will be any material changes in its unrecognized tax positions over the next twelve months.
The Company will recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the consolidated statement of operations and comprehensive loss. Accrued interest and penalties will be included within the related tax liability line in the consolidated balance sheet.
In many cases the Company’s uncertain tax positions are related to tax years that remain subject to examination by tax authorities. The following describes the open tax years, by major tax jurisdiction, as of December 31, 2010:
| United States — Federal | | | | | 2006–present | |
| United States — State | | | | | 2006–present | |
| Canada — Federal | | | | | 2007–present | |
| Canada — Provincial | | | | | 2007–present | |
Valuation allowances reflect the deferred tax benefits that management is uncertain of the Company’s ability to utilize in the future.
F-19
NOTE 12 — STOCKHOLDERS’ EQUITY / (DEFICIT)
On June 24, 2009, the Company received $425,000 from the exercise of options at $0.50 per share and issued 850,000 shares of restricted common stock.
On March 25, 2010, the Company issued 43,756,653 shares of common stock in connection with the conversion of 2008 Debentures and 2009 Debentures into equity (see Note 10).
On March 25, 2010, the Company issued 6,007,595 shares of restricted common stock in connection with the conversion of 2010 Debentures into equity (see Note 10).
On November 30, 2010, the Company issued 4,375,668 shares as an inducement premium to the holders to convert all convertible debentures outstanding as of March 25, 2010 (see Note 10). As fully disclosed in Note 10 to the consolidated financial statements, the Company’s Board of Directors approved the increase in the authorized share capital effective October 14, 2010.
Effective November 9, 2010 and December 8, 2010, the Company closed on its first tranche and second tranche of a unit offering in the amount of $300,000 per tranche for gross proceeds of $600,000 whereby the Company issued 1,500,000 units. The unit offering is for up to $5 million. The units are in the form of shares of the Company’s common stock, par value $0.001 at $0.40 per share plus for each share of Common Stock subscribed to under the unit offer the investor will receive one warrant, the exercise price will be $0.55; if an Investor Warrant is exercised between the first and second years from issuance, the exercise price will be $0.65. All investor warrants as issued will be subject to adjustment in all respects in the event of a stock split or similar adjustment by the Company. A commission of 4% of the gross proceeds was paid from the proceeds of the unit offering and 7.5 units for every $100 of the gross proceeds raised are payable for brokers fees are treated as a cost of capital and no income statement recognition is required.
The Share Subscription Agreement for the units contains an exchange feature which provides that if within six months from effective date of closing, the Company enters into or closes another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the Securities) on terms and conditions more favourable to another purchaser, the terms and conditions of the unit offering shall be adjusted to reflect the more favourable terms. The exchange feature was determined by the Company to be freestanding financial instrument and also to be a liability within the scope of ASC 480 Distinguishing Liabilities from Equity since there is an inverse relationship between the stock price of the Company and the Company’s obligation. On November 9, 2010, December 8, 2010 and December 31, 2010, the Company evaluated the fair value of the exchange feature based on the probability of closing another financing within six months and the fair value of the number of incremental shares and warrants to be issued at a lower estimated issue price for units. The probability of closing another financing in the next six months on November 9, 2010 and December 8, 2010 was estimated to be 50% and on December 31, 2010 was estimated to be 100%.
The fair value of the Company’s common stock is determined by the closing price on the valuation date and the fair value of the warrants is determined using a binomial option valuation model. Key assumptions for the binomial option valuation were as follows:
November 9, 2010 Offering
| |
|---|
Valuation Date
| | | | Nov. 9, 2010
| | Nov. 9, 2010 —
lower estimated
strike price
| | Dec. 31, 2010
| | Dec. 31, 2010 —
lower estimated
strike price
|
|---|
| Strike Price — second year | | | | $ | 0.65 | | | $ | 0.63 | | | $ | 0.65 | | | $ | 0.36 | |
| Strike Price — first year | | | | $ | 0.55 | | | $ | 0.54 | | | $ | 0.55 | | | $ | 0.30 | |
| Closing market price | | | | $ | 0.39 | | | $ | 0.39 | | | $ | 0.22 | | | $ | 0.22 | |
| Volatility | | | | | 135.72 | % | | | 135.72 | % | | | 113.47 | % | | | 113.47 | % |
| Time to expiration | | | | | 2 years | | | | 2 years | | | | 1.83 years | | | | 1.83 years | |
| Risk free rate | | | | | 0.46 | % | | | 0.46 | % | | | 0.61 | % | | | 0.61 | % |
| Dividend yield | | | | | 0 | % | | | 0 | % | | | 0 | % | | | 0 | % |
F-20
December 8, 2010 Offering
| |
|---|
Valuation Date
| | | | Dec. 8, 2010
| | Dec. 8, 2010 —
lower estimated
strike price
| | Dec. 31, 2010
| | Dec. 31, 2010 —
lower estimated
strike price
|
|---|
| Strike Price — second year | | | | $ | 0.65 | | | $ | 0.39 | | | $ | 0.65 | | | $ | 0.36 | |
| Strike Price — first year | | | | $ | 0.55 | | | $ | 0.33 | | | $ | 0.55 | | | $ | 0.30 | |
| Closing market price | | | | $ | 0.24 | | | $ | 0.24 | | | $ | 0.22 | | | $ | 0.22 | |
| Volatility | | | | | 132.07 | % | | | 132.07 | % | | | 117.03 | % | | | 117.03 | % |
| Time to expiration | | | | | 2 years | | | | 2 years | | | | 1.92 years | | | | 1.92 years | |
| Risk free rate | | | | | 0.63 | % | | | 0.63 | % | | | 0.61 | % | | | 0.61 | % |
| Dividend yield | | | | | 0 | % | | | 0 | % | | | 0 | % | | | 0 | % |
On December 31, 2010, an exchange feature liability of $453,861 is recorded for the unit offering in these consolidated financial statements.
NOTE 13 — STOCK OPTIONS AND WARRANT GRANTS
On April 15, 2010 the Board of Directors granted an aggregate award of 900,000 stock options to one executive officer and director and one director. The options vest over a period of three years with an exercise price of $0.65 (fair market value of the Company’s common stock as of the date of grant) with expiry five years from the date of award. The total stock option expense for the April 15, 2010 grant is $372,761 and will be expensed on a straight line basis over the vesting term of the award, as per the terms of the option agreements, as follows:
DATE
| | | | Stock Option
Expense
|
|---|
| April 15, 2011 | | | | $ | 124,254 | |
| April 15, 2012 | | | | $ | 124,254 | |
| April 15, 2013 | | | | $ | 124,253 | |
A total of $93,189 for stock based compensation has been recorded for the year ended December 31, 2010. During fiscal year 2009 no stock options or warrants were granted.
A summary of option transactions, including those granted pursuant to the terms of certain employment and other agreements is as follows:
DETAILS
| | | | Stock
Purchase
Options
| | Weighted
Average
Exercise Price
|
|---|
| OUTSTANDING, JANUARY 1, 2009 | | | | | 6,120,000 | | | $ | 0.65 | |
| Expired | | | | | (1,600,000 | ) | | | ($0.50 | ) |
| Exercised | | | | | (850,000 | ) | | | ($0.50 | ) |
| |
| OUTSTANDING, JANUARY 1, 2010 | | | | | 3,670,000 | | | $ | 0.76 | |
| Granted | | | | | 900,000 | | | $ | 0.65 | |
| Expired | | | | | (1,765,000 | ) | | | ($0.97 | ) |
| OUTSTANDING, DECEMBER 31, 2010 | | | | | 3,600,000 | | | $ | 0.68 | |
At December 31, 2010, the outstanding options have a weighted average remaining life of 23 months. All options issued prior to 2010 have vested, and the April 15, 2010 options vest over a period of three years, in three equal parts each year.
The weighted average fair value of options granted during 2010 was $0.41 and was estimated using the Black-Scholes option-pricing model, using the following assumptions:
| | | | 2010
|
|---|
| Expected volatility | | | | | 117 | % |
| Risk-free interest Rate | | | | | 1.08 | % |
| Expected life | | | | | 4 | yrs |
F-21
| | | | 2010
|
|---|
| Dividend yield | | | | | 0.00 | % |
| Forfeiture rate | | | | | 0.00 | % |
The Black-Scholes options-pricing model used by the Company to calculate options and warrant values, was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock purchase options and warrants. The model also requires highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated values. Accordingly, management believes that this model does not necessarily provide a reliable single measure of the fair value of the Company’s stock options and warrants.
At December 31, 2010, the Company had outstanding options as follows:
Number Of
Options
| | | | | | Exercise
Price
| | Expiration Date
|
|---|
| 100,000 | | | | | | $0.71 | | | February 6,2011 | |
| 100,000 | | | | | | $1.00 | | | February 6,2011 | |
| 2,150,000 | | | | | | $0.71 | | | February 16, 2012 | |
| 100,000 | | | | | | $1.00 | | | February 8, 2013 | |
| 250,000 | | | | | | $0.27 | | | August 6, 2013 | |
| 900,000 | | | | | | $0.65 | | | April 15, 2015 | |
| 3,600,000 | | | | | | | | | | |
Warrants issued in connection with various private placements of equity securities, are treated as a cost of capital and no income statement recognition is required. A summary of warrant transactions is as follows:
DETAILS
| | | | Warrant
Shares
| | Weighted Average
Exercise Price
|
|---|
| OUTSTANDING, JANUARY 1, 2010 | | | | | — | | | $ | — | |
| Granted | | | | | 1,545,000 | | | $ | 0.65 | |
| Exercised | | | | | — | | | $ | — | |
| Expired | | | | | — | | | $ | — | |
| OUTSTANDING, DECEMBER 31, 2010 | | | | | 1,545,000 | | | $ | 0.65 | |
Effective November 9, 2010 and December 8, 2010, the Company closed on its first tranche and second tranche of a unit offering in the amount of $300,000 per tranche for gross proceeds of $600,000 whereby the Company issued 1,500,000 units. The unit offering is for up to $5 million. The units are in the form of shares of the Company’s common stock, par value $0.001 at $0.40 per share plus for each share of Common Stock subscribed to under the unit offer the investor will receive one warrant exercisable for of issuance, the exercise price will be $0.55; if an Investor Warrant is exercised between the first and second years from issuance, the exercise price will be $0.65. All investor warrants as issued will be subject to adjustment in all respects in the event of a stock split or similar adjustment by the Company. A commission of 4% of the gross proceeds was paid and 7.5 units for every $100 of the gross proceeds raised are payable for brokers fees.
NOTE 14 — RELATED PARTY TRANSACTIONS
During the year ended December 31, 2010 transactions with related parties included $6,134,024 related to conversion of convertible debentures including interest of $634,024 thereon into common stock; $1,032,849 related to inducement on early conversion of convertible debentures; the repayment of $511,342 principal and interest on promissory note and $144,967 for various services in addition to salaries and reimbursement of business expenses. During the year ended December 31, 2009 the Company paid shareholders and their affiliates $238,750 for various services, principal and interest on promissory notes and fees rendered in addition to salaries and reimbursement of business expenses. All transactions are recorded at the exchange amounts. Any one transaction or combination attributed to one individual or entity exceeding $120,000 on an annual basis has been disclosed as follows:
F-22
NOTE PAYABLE TO RELATED PARTY
The information required by this item is included in Note 7 to the consolidated financial statements.
CONVERTIBLE DEBENTURE ISSUED TO RELATED PARTY
On August 28, 2009, the Company completed a transaction whereby it issued $1.6 million of 9% convertible debentures to six accredited investors. A shareholder who was also a director of the Company participated in the August convertible debenture offering with a principal investment of $500,000.
Effective March 25, 2010, the November 2008 and the August 2009 debenture holders agreed to convert all outstanding convertible debentures as per the terms of the respective debenture agreements. The early conversion of the debentures was a condition precedent to the Company’s wholly-owned subsidiary ESWC entering into a new credit facility with a chartered commercial bank. A total of $5,500,000 in principal and $634,024 of accrued interest due to related parties was converted into 23,489,494 shares of restricted common stock.
As part of the agreement to convert all existing convertible debentures, the Company was committed to pay a premium as an inducement to convert all debentures. The premium is payable to all converting debenture holders and was subject to a positive fairness opinion, approval by a Fairness Committee consisting of independent Directors of the Company’s Board of Directors and an increase in the share capital of the Company. The premium consists of 4,375,668 shares of common stock. As the Company did not have sufficient authorised shares as of the date of conversion of the debentures to fulfill the premium, the premium has been recorded as an advance share purchase agreement at a fair market value of $2,909,872 as at March 31, 2010. The agreement is without interest, subordinated to the bank’s position and payable in a fixed number of common shares of the Company upon increase in the authorized share capital of the Company.
Up to October 14, 2010, the Company did not have sufficient authorized and unissued shares to fulfill the advance share subscription. Under these conditions, FASB ASC Subtopic 815-40, Contracts in Entity’s Own Equity, precludes equity classification of this obligation. As such, the advance share subscription was classified as a liability and periodically marked to market. The fair value of the obligation was determined to be $1,662,753 and $2,909,872 at October 14, 2010 and March 31, 2010, respectively. The fair value of the obligation was determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock. The decrease in fair value of this liability of $1,247,119 was recorded as a mark to market adjustment on advance share subscription in the consolidated statement of operations and comprehensive loss. Of the total amount $784,965 (fair market value of 2,065,697 shares of common stock) was attributed to related parties.
Effective November 30, 2010, the Company issued an aggregate of 4,375,668 restricted shares of common stock to thirteen (13) prior debenture holders in connection with the early conversion of their debentures. Of these shares of common stock, 2,065,697 shares were issued to related parties.
As of December 31, 2010, principal and interest on total convertible debentures due to related parties was $0. As of December 31, 2009, the principal amount of convertible debentures, net of accretion, due to related party amounted to $5,428,443 with a corresponding accrued interest of $540,128, and debt discount of $71,557.
CONTRACTS AND AGREEMENTS
Mr. Nitin Amersey who is a director of the Company is listed as a control person with the Securities and Exchange Commission of Bay City Transfer Agency Registrar Inc. the Company’s transfer agent. He has no ownership equity in Bay City Transfer Agency Registrar Inc. nor is he an officer or a director of Bay City Transfer Agency Registrar Inc. For the years ended December 31, 2010 and 2009, the Company paid Bay City Transfer Agency Registrar Inc. $7,363 and $1,683, respectively.
For the year ended December 31, 2010, Mr. Nitin Amersey received $25,500 for consulting services to the Company. In 2009 Mr. Amersey did not provide any services to the Company.
Mr. Peter Bloch who is a director of the Company provided consulting services to the Company. For the year ended December 31, 2010, the Company paid Mr. Bloch $112,104 for consulting services. In 2009 Mr. Bloch did not provide any services to the Company.
F-23
NOTE 15 — COMMITMENTS AND CONTINGENCIES
LEASES
Effective November 24, 2004, the Company’s wholly-owned subsidiary, ESWA, entered into a lease agreement for approximately 40,220 square feet of leasehold space at 2 Bethlehem Pike Industrial Center, Montgomery Township, Pennsylvania. The leasehold space houses the Company’s research and development facilities. The lease commenced on January 15, 2005 and expired January 31, 2010. Effective October 16, 2009, the Company’s wholly-owned subsidiary ESW America, Inc. entered into a lease renewal agreement with Nappen & Associates for the leasehold property at Pennsylvania. There were no modifications to the original economic terms of the lease under the lease renewal agreement. Under the terms of the lease renewal, the lease term will now expire February 28, 2013.
Effective December 20, 2004, the Company’s wholly-owned subsidiary, ESWC, entered into an offer to lease agreement for approximately 50,000 square feet of leasehold space in Concord, Ontario, Canada. The leasehold space houses the Company’s executive offices and a high volume manufacturing plant. The possession of the leasehold space took place on May 24, 2005 and the term of the lease was extended to September 30, 2010. ESWC renewed its lease agreement at the current property for an additional five year term. The renewed lease period commenced on October 1, 2010 and ends on September 30, 2015.
The following is a summary of the minimum annual lease payments, for both leases.
YEAR
| | | | |
|---|
| 2011 | | | | $ | 460,801 | |
| 2012 | | | | | 460,801 | |
| 2013 | | | | | 312,520 | |
| 2014 | | | | | 289,986 | |
| 2015 | | | | | 217,489 | |
| | | | | $ | 1,741,597 | |
LEGAL MATTERS
From time to time, the Company may be involved in a variety of claims, suits, investigations and proceedings arising from the ordinary course of our business, breach of contract claims, labor and employment claims, tax and other matters. Although claims, suits, investigations and proceedings are inherently uncertain and their results cannot be predicted with certainty, ESW believes that the resolution of current pending matters will not have a material adverse effect on its business, consolidated financial position, results of operations or cash flow. Regardless of the outcome, litigation can have an adverse impact on ESW because of legal costs, diversion of management resources and other factors. In addition, it is possible that an unfavourable resolution of one or more such proceedings could in the future materially and adversely affect ESW’s financial position, results of operations or cash flows in a particular period.
CAPITAL LEASE OBLIGATION
The Company is committed to the following lease payments in connection with the acquisition of equipment under capital leases:
YEAR
| | | | |
|---|
| 2011 | | | | $ | 4,385 | |
| 2012 | | | | | 1,047 | |
| TOTAL | | | | | 5,432 | |
| Less imputed interest | | | | | (390 | ) |
| Total obligation under capital lease | | | | | 5,042 | |
| Less current portion | | | | | (3,552 | ) |
| TOTAL LONG-TERM PORTION | | | | $ | 1,490 | |
F-24
The Company incurred $2,374 and $6,354 of interest expense on capital lease obligation for the years ended December 31, 2010 and 2009, respectively.
NOTE 16 — LOSS PER SHARE
Potential common shares of 3,600,000 related to ESW’s outstanding stock options and 1,500,000 shares related to ESW’s outstanding warrants were excluded from the computation of diluted loss per share for the year ended December 31, 2010. Potential common shares of 3,670,000 related to ESW’s outstanding stock options and potential common shares of 42,583,901 related to the 2008 and 2009 convertible debentures were excluded from the computation of diluted loss per share for the year ended December 31, 2009.
The reconciliation of the number of shares used to calculate the diluted loss per share is calculated as follows:
| | | | For the Year ended
December 31,
| |
|---|
| | | | 2010
| | 2009
|
|---|
NUMERATOR
| | | | | | | | | | |
| Net loss for the year | | | | $ | (9,447,641 | ) | | $ | (5,936,952 | ) |
| Interest on long term debt | | | | | 183,858 | | | | 870,632 | |
| Amortization of deferred costs | | | | | 117,131 | | | | 19,912 | |
| Long term debt accretion | | | | | 768,981 | | | | 27,019 | |
| Inducement premium | | | | | 2,909,872 | | | | — | |
| Mark to market adjustment on advance share subscription | | | | | (1,247,119 | ) | | | — | |
| Change in fair value of exchange feature liability | | | | | 2,021,213 | | | | — | |
| Interest on note payable to related party | | | | | 11,342 | | | | — | |
| | | | | $ | (4,664,363 | ) | | $ | (5,019,389 | ) |
DENOMINATOR
| | | | | | | | | | |
| Weighted average number of shares outstanding | | | | | 112,793,477 | | | | 73,416,317 | |
Dilutive effect of :
| | | | | | | | | | |
| Stock options | | | | | — | | | | — | |
| Warrants | | | | | — | | | | — | |
| Convertible debentures | | | | | — | | | | — | |
| DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING | | | | | 112,793,477 | | | | 73,416,317 | |
NOTE 17 — COMPARATIVE FIGURES
Certain 2009 figures have been reclassified to conform to the current financial statement presentation.
NOTE 18 — SUBSEQUENT EVENTS
AMENDED BYLAWS
Effective January 25, 2011 by written action and vote of Sedam Limited, Bengt Odner, Black Family 1997 Trust, Leon D. Black, Leon D. Black Trust UAD 11/30/92 FBO Joshua Black, Leon D. Black Trust UAD 11/30/92 FBO Benjamin Black, Leon D. Black Trust UAD 11/30/92 FBO Alexander Black, Leon D. Black Trust UAD 11/30/92 FBO Victoria Black, John Hannan, Orchard Investments LLC and Richard Ressler (the “Majority Shareholders”) representing 66,134,887 shares of the Company’s common stock, a majority or 51.08% of the outstanding shares based upon the Company’s certified list of shareholders, pursuant to Title XXXVI, Chapter 607, Section 607.0704 of the Florida Statutes and the Company’s Bylaws, Article II Section 5 of the Company’s Bylaws was amended so that the Company shall have a minimum of one (1) director but no more than eleven (11) directors. The amendment to the Bylaws increases the maximum number of directors the Company is permitted from seven (7) to eleven (11).
F-25
WAIVER OF LOAN COVENANTS
Effective February 4, 2011, the Company’s wholly owned subsidiary, ESWC, received a fourth waiver of certain financial covenants under its Credit Agreement with CIBC. Without the waiver, the Company’s subsidiary would not be in compliance with the current ratio and effective tangible net worth covenants as set forth in the Credit Agreement. The fourth waiver provided by CIBC extends the waiver period from January 31, 2011 through February 14, 2011 and also provides for a fee payable to CIBC for the extension as well as requiring the elimination of any margin deficit by February 14, 2011. In the event the Company and its subsidiary, ESWC, fail to comply with the terms of the waiver and meet the current ratio and effective tangible net worth covenants prior to the end of the waiver period, same will constitute an event of default as set forth in the Credit Agreement unless a further waiver or modification to the Credit Agreement can be obtained.
LOAN AGREEMENTS
On February 17, 2011, the Company entered into certain note subscription agreements and issued unsecured subordinated promissory notes (collectively, the “Loan Agreements”) with Orchard Investments, LLC; Black Family 1997 Trust; Leon D. Black Trust UAD 11/30/92 FBO Alexander Black; Leon D. Black Trust UAD 11/30/92 FBO Benjamin Black; Leon D. Black Trust UAD 11/30/92 FBO Joshua Black; Leon D. Black Trust UAD 11/30/92 FBO Victoria Black; Leon D. Black; John J. Hannan and Richard Ressler (each individually a “Subordinated Lender” or “Holder” and collectively the “Subordinated Lenders” or “Holders”) who are current shareholders and may be deemed affiliates of certain members of the Board of Directors of the Company. The Loan Agreements were approved by the independent directors of the Company. Pursuant to the Loan Agreements, the Subordinated Lenders agreed to make, and made, loans to the Company in the principal aggregate amount of $3 million (the “Loan”), subject to the terms and conditions set forth in the Loan Agreements and represented by unsecured subordinated promissory notes (the “Notes”), dated February 17, 2011.
Proceeds of the Loan, along with available cash, will be used to fund working capital, planned capital investments and other general corporate purposes. With the proceeds of the Loan, the Company and its subsidiaries will be in compliance with covenant obligations under the Credit Agreement with CIBC for which the Company and its subsidiaries had previously obtained waivers of covenant obligations that expired February 14, 2011.
The Notes provide that the Loan bears interest at a rate of 10% per annum, payable in-kind on a monthly basis commencing March 17, 2011, up to the date on which the Note has been paid in full. The maturity date of the Loan is the earlier of: (i) the consummation of a rights offering of the Company’s common stock, par value $.001 per share (the “Common Stock”) registered under the Securities Act of 1933, as Amended (the “Act”), at a sale price of $0.12 per share (as adjusted for any stock split, stock dividend or other similar adjustment) pursuant to which the Company plans to offer rights to purchase approximately $6.5 million in shares of Common Stock, which is expected to raise at least an incremental $3.5 million of cash for the Company and will also permit all Subordinated Lenders to exchange their Notes (and the other Notes paid in-kind for the payment of interest under the Notes) for shares of Common Stock at such price per share (with such offering referred to as the “Qualified Offering”) or (ii) June 17, 2011 (the “Outside Date”). The Qualified Offering has also been approved by the independent directors of the Company. There can be no assurance, however, that the Company will successfully complete the Qualified Offering on or prior to the Outside Date or thereafter.
In the event the Qualified Offering does not take place on or before the Outside Date, then the Subordinated Lenders at their sole option may require the Company to refrain from making any and all payments on any of the outstanding principal and accrued interest outstanding under the Notes. However the Company will not be prohibited from paying any accrued interest in-kind through the issuance of substantially similar notes, at any time. The Holders at their sole option may extend the Outside Date.
In the event the Qualified Offering closes on or prior to the Outside Date and for any reason a Holder shall have failed to have exchanged in the Qualified Offering any and all principal or accrued interest outstanding under its Notes and such Holder wishes to exchange his or her Note for Common Stock at a price of $0.12 per share (as adjusted for any stock split, stock dividend or other similar adjustment), then the Company has agreed to offer such Holder the immediate right to purchase additional shares of Common Stock at such price, so that all principal and accrued interest outstanding under the Notes shall have been exchanged for shares of Common Stock at such price.
F-26
In the event the Qualified Offering closes on or prior to the Maturity Date and, for any reason, certain Holders (the “Qualified Holders”) collectively shall have failed to have invested at least $1 million in the Qualified Offering or pursuant to exchange of their Notes and the Qualified Holders wish to invest the balance of such $1 million aggregate amount to purchase Common Stock at a price of $0.12 per share (as adjusted for any stock split, stock dividend or other similar adjustment), then the Company will be required to offer to the Qualified Holders the immediate right to invest the balance of such investment amount to purchase additional shares of Common Stock at such price, so that in the aggregate, the Qualified Holders shall collectively invested such $1 million amount.
Concurrent with entering into the Loan Agreements and issuance of the Notes, CIBC, the Company and its subsidiaries; and the Subordinated Lenders entered into a Postponement and Subordination Agreement (the “Subordination Agreement”) whereby the Subordinated Lenders agreed that the obligations of the Company and its subsidiaries under the Notes as issued would be subordinate to the obligations of the Company and its subsidiaries under the Credit Agreement.
As previously reported, pursuant to securities subscription agreements entered into by the Company on or about March 23, 2010, the Company issued $3 million of 9% convertible debentures to five (5) accredited investors which have since been converted into 6 million shares of the Company’s Common Stock. Additionally, on November 9, 2010 and December 8, 2010, the Company completed an offering in the aggregate gross proceeds of $600,000 to one (1) accredited investor whereby it issued units comprised of 1.5 million shares of common stock and a like number of warrants to purchase 1 share of Common Stock (collectively the “Prior Subscription Agreements”). The investors under the Prior Subscription Agreements will receive an approximate aggregate of 22,500,000 additional shares of Common Stock in conjunction with certain rights under the Prior Subscription Agreements in the event the Qualified Offering closes.
CHANGES IN EXECUTIVE OFFICERS
Effective March 9, 2011, the Company and David J. Johnson, entered into an Employment Separation and General Release Agreement (the “Agreement”), whereby Mr. Johnson resigned as President and Chief Executive Officer of the Company as well as all of its subsidiaries wherein he served as an executive officer. Additionally, Mr. Johnson resigned from the Company’s Board of Directors as well from the Board of Directors of each of the Company’s wholly owned subsidiaries wherein he served. Mr. Johnson resigned without any disputes or disagreements with the Company or any of its subsidiaries. Under the terms of the Agreement, Mr. Johnson will receive a severance payment based upon his regular salary of $360,000 per annum as prorated. The severance payments will be made on a quarterly basis for the remainder of the calendar year. Mr. Johnson will also continue to receive customary medical benefits and a car allowance of $1,000 a month for the remainder of the calendar year.
Concurrent to entering into the Agreement, the Company and Mr. Johnson entered into a Consultancy Agreement for the remainder of the calendar year whereby Mr. Johnson will receive compensation on a per diem basis when engaged by the Company per the agreement. Additionally, Mr. Johnson was also awarded options as part of the Consultancy Agreement.
Effective March 11, 2011, Mr. Stefan Boekamp, resigned on mutually agreeable terms from his position as Vice President of Operations of the Company. Mr. Boekamp resigned without any disputes or disagreements with the Company or any of its subsidiaries.
Effective March 9, 2011, Mr. Praveen Nair, the Company’s Chief Accounting Officer was promoted to the position of Chief Financial Officer of the Company. Mr. Nair will receive an annual salary of $150,000 Canadian. The Company and Mr. Nair intend to enter into a new employment agreement in the near future with terms similar to those set forth in Mr. Nair’s prior employment agreement with the Company.
Effective March 9, 2011, Mr. Frank Haas was appointed the Company’s Chief Technology Officer and Chief Regulatory Officer. Mr. Haas will receive an annual salary of $160,000 Canadian and will receive an incentive compensation for each of the first two achieved verification/certifications of certain of the Company’s products within the first year of his appointment.
Effective March 9, 2011, Mr. Virendra Kumar was appointed Vice President of Operations of the Company. Mr. Kumar will receive an annual salary of $150,000. Mr. Kumar has been General Manager of ESWA, Inc. since 2010 and is responsible for the overall operations related to Air Testing Services.
F-27
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
| | | | (Unaudited)
March 31,
2011
| | December 31,
2010
|
|---|
ASSETS
| | | | | | | | | | |
Current Assets
| | | | | | | | | | |
| Cash and cash equivalents (Note 4) | | | | $ | 956,337 | | | $ | 13,328 | |
Accounts receivable, net of allowance
for doubtful accounts of $0 (2010 — $70,028) (Note 2) | | | | | 1,241,213 | | | | 2,279,149 | |
| Inventory, net of reserve of $100,623 (2010 — 0) (Note 5) | | | | | 3,514,465 | | | | 4,414,518 | |
| Prepaid expenses and sundry assets | | | | | 307,630 | | | | 261,176 | |
| Total current assets | | | | | 6,019,645 | | | | 6,968,171 | |
| Property, plant and equipment under construction (Note 6) | | | | | 78,807 | | | | 185,542 | |
| Property, plant and equipment, net of accumulated depreciation of $6,044,872 (2010 — $5,765,164) (Note 6) | | | | | 1,836,992 | | | | 1,931,373 | |
| Internal use software under development (Note 2) | | | | | 129,603 | | | | 126,340 | |
Patents and trademarks, net of accumulated amortization of $2,131,423
(2010 — $2,115,091) (Note 2) | | | | | — | | | | 16,145 | |
| | | | | $ | 8,065,047 | | | $ | 9,227,571 | |
LIABILITIES AND STOCKHOLDERS’ EQUITY / (DEFICIT)
| | | | | | | | | | |
Current Liabilities
| | | | | | | | | | |
| Bank loan (Note 8) | | | | $ | 1,636,444 | | | $ | 3,424,889 | |
| Accounts payable | | | | | 2,040,120 | | | | 2,495,070 | |
| Accrued liabilities (Note 15) | | | | | 880,369 | | | | 512,964 | |
| Exchange feature liability (Note 10 and 12) | | | | | 2,712,600 | | | | 2,133,862 | |
Notes payable to related party, net of debt discount (Note 7)
of $1,950,000 (2010 — $0) | | | | | 1,050,00 | | | | — | |
| Convertible derivative liability (Note 7) | | | | | 2,148,656 | | | | — | |
| Customer deposits | | | | | 3,794 | | | | 29,322 | |
| Redeemable class A special shares (Note 9) | | | | | 453,900 | | | | 453,900 | |
| Current portion of capital lease obligation (Note 15) | | | | | 1,806 | | | | 3,552 | |
| Total current liabilities | | | | | 10,927,689 | | | | 9,053,559 | |
Long-term liabilities
| | | | | | | | | | |
| Capital lease obligation (Note 15) | | | | | 1,319 | | | | 1,490 | |
| Total long-term liabilities | | | | | 1,319 | | | | 1,490 | |
| Total liabilities | | | | | 10,929,008 | | | | 9,055,049 | |
Commitments and Contingencies (Note 15)
| | | | | | | | | | |
Stockholders’ Equity / (Deficit) (Notes 12 and 13)
| | | | | | | | | | |
Common stock, $0.001 par value, 250,000,000
(2010 — 250,000,000) shares authorized;
129,463,767 shares issued and outstanding
(2010 — 129,463,767) | | | | | 129,463 | | | | 129,463 | |
| Additional paid-in capital | | | | | 43,593,417 | | | | 43,567,531 | |
| Accumulated other comprehensive income | | | | | 518,813 | | | | 446,549 | |
| Accumulated deficit | | | | | (47,105,653 | ) | | | (43,971,021 | ) |
| Total stockholders’ equity / (deficit) | | | | | (2,863,960 | ) | | | 172,522 | |
| | | | | $ | 8,065,047 | | | $ | 9,227,571 | |
The accompanying notes are an integral part of these consolidated condensed financial statements.
F-28
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
FOR THE THREE MONTH PERIOD ENDED MARCH 31,
(UNAUDITED)
| | | | 2011
| | 2010
|
|---|
Revenue
| | | | | | | | | | |
| Net sales | | | | $ | 2,045,737 | | | $ | 2,248,596 | |
| Cost of sales | | | | | 2,092,081 | | | | 1,510,490 | |
| Gross (loss) / profit | | | | | (46,344 | ) | | | 738,106 | |
Operating expenses
| | | | | | | | | | |
| Marketing, office and general costs | | | | | 1,051,753 | | | | 995,802 | |
| Restructuring charges (Note 15) | | | | | 518,809 | | | | — | |
| Research and development costs | | | | | 183,626 | | | | 125,314 | |
| Officers’ compensation and directors’ fees | | | | | 211,644 | | | | 198,357 | |
| Consulting and professional fees | | | | | 27,102 | | | | 105,975 | |
| Foreign exchange loss | | | | | 60,126 | | | | 56,223 | |
| Depreciation and amortization | | | | | 120,350 | | | | 262,845 | |
| | | | | | 2,173,410 | | | | 1,744,516 | |
| Loss from operations | | | | | (2,219,754 | ) | | | (1,006,410 | ) |
| |
| Interest on long-term debt | | | | | — | | | | (183,858 | ) |
| Amortization of deferred costs | | | | | — | | | | (117,131 | ) |
| Long-term debt accretion | | | | | — | | | | (768,981 | ) |
| Inducement premium | | | | | — | | | | (2,909,872 | ) |
| Change in fair value of exchange feature liability | | | | | (578,739 | ) | | | — | |
| Interest on notes payable to related party | | | | | (34,521 | ) | | | (11,342 | ) |
| Interest accretion expense | | | | | (1,050,000 | ) | | | — | |
| Financing charge on embedded derivative liability | | | | | (485,101 | ) | | | — | |
| Gain on convertible derivative | | | | | 1,336,445 | | | | — | |
| Bank fees related to credit facility covenant waivers | | | | | (106,512 | ) | | | — | |
| Gain on disposal of property and equipment | | | | | 3,550 | | | | — | |
| Interest income | | | | | — | | | | 35 | |
| Net loss | | | | | (3,134,632 | ) | | | (4,997,559 | ) |
Other comprehensive income:
| | | | | | | | | | |
| Foreign currency translation of Canadian subsidiaries | | | | | 72,264 | | | | 103,865 | |
| Net comprehensive loss | | | | $ | (3,062,368 | ) | | $ | (4,893,694 | ) |
| Net loss per share (basic and diluted) (Note 16) | | | | $ | (0.02 | ) | | $ | (0.06 | ) |
Weighted average number of shares outstanding
(basic and diluted) (Note 16) | | | | | 129,463,767 | | | | 77,694,404 | |
The accompanying notes are an integral part of these consolidated condensed financial statements.
F-29
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(DEFICIT)
AND COMPREHENSIVE INCOME FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2011
(UNAUDITED)
| | | | Common Stock
| |
|---|
| | | | Shares
| | Amount
| | Additional
Paid-in
Capital
| | Accumulated
Other
Comprehensive
Income
| | Accumulated
Deficit
| | Total
|
|---|
| Balance, January 1, 2010 | | | | | 73,823,851 | | | | 73,822 | | | | 26,083,635 | | | | 425,383 | | | | (34,523,380 | ) | | | (7,940,540 | ) |
| Net loss | | | | | — | | | | — | | | | — | | | | — | | | | (9,447,641 | ) | | | (9,447,641 | ) |
| Stock-based compensation | | | | | — | | | | — | | | | 93,189 | | | | — | | | | — | | | | 93,189 | |
| Common stock issued from share subscription | | | | | 1,500,000 | | | | 1,500 | | | | 598,500 | | | | — | | | | — | | | | 600,000 | |
Broker fees related to share
subscription | | | | | — | | | | — | | | | (24,000 | ) | | | — | | | | — | | | | (24,000 | ) |
| Fair value of exchange feature liability | | | | | — | | | | — | | | | (112,649 | ) | | | — | | | | — | | | | (112,649 | ) |
| Inducement on conversion of debentures with related party | | | | | 4,375,668 | | | | 4,376 | | | | 1,658,377 | | | | — | | | | — | | | | 1,662,753 | |
| Common stock issued on conversion of debentures | | | | | 49,764,248 | | | | 49,765 | | | | 14,730,479 | | | | — | | | | — | | | | 14,780,244 | |
| Intrinsic value of beneficial conversion feature of convertible debentures | | | | | — | | | | — | | | | 540,000 | | | | — | | | | — | | | | 540,000 | |
| Foreign currency translation of Canadian subsidiaries | | | | | — | | | | — | | | | — | | | | 21,166 | | | | — | | | | 21,166 | |
| Balance, January 1, 2011 | | | | | 129,463,767 | | | $ | 129,463 | | | $ | 43,567,531 | | | $ | 446,549 | | | $ | (43,971,021 | ) | | $ | 172,522 | |
| Net loss | | | | | — | | | | — | | | | — | | | | — | | | | (3,134,632 | ) | | | (3,134,632 | ) |
| Stock-based compensation | | | | | — | | | | — | | | | 25,886 | | | | — | | | | — | | | | 25,886 | |
| Foreign currency translation of Canadian subsidiaries | | | | | — | | | | — | | | | — | | | | 72,264 | | | | — | | | | 72,264 | |
| Balance, March 31, 2011 | | | | | 129,463,767 | | | $ | 129,463 | | | $ | 43,593,417 | | | $ | 518,813 | | | $ | (47,105,653 | ) | | $ | (2,863,960 | ) |
The accompanying notes are an integral part of these consolidated condensed financial statements.
F-30
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTH PERIOD ENDED MARCH 31,
(UNAUDITED)
| | | | 2011
| | 2010
|
|---|
| Net loss | | | | $ | (3,134,632 | ) | | $ | (4,997,559 | ) |
Adjustments to reconcile net loss to net cash used in operating activities:
| | | | | | | | | | |
| Interest accretion expense | | | | | 1,050,000 | | | | — | |
| Change in fair value of exchange feature liability | | | | | 578,739 | | | | — | |
| Financing charge on embedded derivative liability | | | | | 485,101 | | | | — | |
| Depreciation of property, plant and equipment | | | | | 206,824 | | | | 281,492 | |
| Loss on disposal of inventory | | | | | 124,972 | | | | — | |
| Interest on notes payable to related party | | | | | 34,521 | | | | — | |
| Stock-based compensation | | | | | 25,886 | | | | — | |
| Amortization of patents and trademarks | | | | | 16,145 | | | | 53,414 | |
| Inducement premium | | | | | — | | | | 2,909,872 | |
| Long-term debt accretion | | | | | — | | | | 768,981 | |
| Interest on long-term debt | | | | | — | | | | 183,858 | |
| Amortization of deferred costs | | | | | — | | | | 36,506 | |
| Provision for doubtful accounts | | | | | — | | | | 3,242 | |
| Gain on disposal of property, plant and equipment | | | | | (3,450 | ) | | | — | |
| Gain on convertible derivative | | | | | (1,336,445 | ) | | | — | |
| | | | | | 1,182,293 | | | | 4,237,365 | |
Increase (decrease) in cash flows from operating activities resulting from changes in:
| | | | | | | | | | |
| Accounts receivable | | | | | 1,101,029 | | | | (464,671 | ) |
| Inventory | | | | | 839,762 | | | | (910,526 | ) |
| Prepaid expenses and sundry assets | | | | | (91,199 | ) | | | (15,322 | ) |
| Accounts payable and accrued liabilities | | | | | (99,301 | ) | | | 615,258 | |
| Customer deposits | | | | | (25,528 | ) | | | 4,770 | |
| | | | | | 1,724,763 | | | | (770,491 | ) |
| Net cash used in operating activities | | | | | (227,576 | ) | | | (1,530,685 | ) |
Investing activities:
| | | | | | | | | | |
| Proceeds from sale of property and equipment | | | | | 3,450 | | | | — | |
| Acquisition of property, plant and equipment | | | | | (93,144 | ) | | | (81,096 | ) |
| Reduction in property, plant and equipment under construction | | | | | 105,423 | | | | — | |
| Addition to property, plant and equipment under construction | | | | | — | | | | (19,902 | ) |
| Net cash used in investing activities | | | | | 15,729 | | | | (100,998 | ) |
Financing activities:
| | | | | | | | | | |
| Proceeds from convertible debentures placement | | | | | — | | | | 3,000,000 | |
| Repayment of bank loan | | | | | (1,823,319 | ) | | | (720,510 | ) |
| Notes payable to related party | | | | | 3,000,000 | | | | — | |
| Repayment of notes payable to related party | | | | | — | | | | (500,000 | ) |
| Repayment of capital lease obligation | | | | | (1,956 | ) | | | (3,668 | ) |
| Net cash provided by financing activities | | | | | 1,174,725 | | | | 1,775,822 | |
| Net decrease in cash and equivalents | | | | | 962,878 | | | | 144,139 | |
| Foreign exchange loss (gain) on foreign operations | | | | | (19,869 | ) | | | 172,277 | |
| Cash and cash equivalents, beginning of year | | | | | 13,328 | | | | 632,604 | |
| Cash and cash equivalents, end of year | | | | $ | 956,337 | | | $ | 949,021 | |
Supplemental disclosures:
| | | | | | | | | | |
| Cash interest paid | | | | $ | — | | | $ | 11,844 | |
| Other non-cash conversion of debentures and related interest | | | | $ | — | | | $ | 14,780,243 | |
The accompanying notes are an integral part of these consolidated condensed financial statements.
F-31
NOTE 1 — NATURE OF BUSINESS AND BASIS OF PRESENTATION
Environmental Solutions Worldwide, Inc. (the “Company” or “ESW”) through its wholly owned subsidiaries is engaged in the design, development, manufacturing and sales of environmental technologies and testing services with its primary focus on the international on-road and off-road diesel retrofit market. ESW currently manufactures and markets a line of catalytic emission control and enabling technologies for a number of applications.
The unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”), which contemplates continuation of the Company as a going concern.
The Company has sustained recurring operating losses. As of March 31, 2011, the Company had an accumulated deficit of $47,105,653 and cash and cash equivalents of $956,337. Net cash used in operating activities for the three month period ended March 31, 2011 amounted to $227,576 as compared to $1,530,685 for the three month period ended March 31, 2010. There is no assurance that the Company will be successful in achieving sufficient cash flow from operations in the near future and there can be no assurance that it will either achieve or maintain profitability in the future. As a result, there is substantial doubt regarding the Company’s ability to continue as a going concern. The Company will require additional financing to fund its continuing operations. The Company is seeking additional funds by way of equity and debt financing. The Company’s ability to continue as a going concern is dependent on obtaining additional financing and achieving and maintaining a profitable level of operations. The outcome of these matters cannot be predicted at this time.
On February 17, 2011, the Company raised $3 million through the issuance of unsecured subordinated promissory notes (“the Notes”) to current shareholders and deemed affiliates of certain members of the board of directors of the Company. Proceeds of the Notes were targeted at funding working capital, planned capital investments and other general corporate purposes. With the proceeds of the Notes, the Company and its subsidiaries are in compliance with covenant obligations under the Demand Credit Agreement with the Canadian Imperial Bank of Commerce (“CIBC”) dated March 10, 2010 for which the Company and its subsidiaries had previously obtained waivers of covenant obligations through to February 15, 2011.
On May 3, 2011, the Company raised an additional $1 million through the issuance of unsecured subordinated promissory notes (“Bridge Loan”), which were effective as April 27, 2011, to current shareholders and deemed affiliates of certain members of the board of directors of the Company. Proceeds of the Bridge Loan, along with available cash, are targeted at funding the Company’s working capital.
Effective May 10, 2011, the Company entered into an Investment Agreement with current shareholders and subordinated lenders under unsecured promissory notes (“the Bridge Lenders”) in the aggregate amount of $4.0 million. As per the Investment Agreement, the Bridge Lenders have agreed to provide a backstop commitment (“Backstop Commitment”) to a rights offering targeted by the Company to raise up to $8 million (“the Qualified Offering”). Under the Backstop Commitment, the Bridge Lenders agree to purchase any shares offered in the Qualified Offering that are not purchased by the Company’s shareholders of record, who are entitled to participate in the rights offering, after giving effect to any oversubscriptions. The Backstop Commitment will result in the Bridge Lenders purchasing up to 29,166,667 shares of Common Stock from the Company at a subscription price of $0.12 per share of Common Stock for a total purchase price of $3.5 million. The Company will also permit all Subordinated Lenders to exchange their Notes or Bridge Loan and any accrued interest thereon for shares of Common Stock under the Qualified Offering. The offering is expected to be completed by June 17, 2011.
These unaudited consolidated condensed financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. All adjustments considered necessary for fair presentation and of a normal recurring nature have been included in these consolidated condensed financial statements.
These statements have not been audited and should be read in conjunction with the consolidated financial statements and the notes thereto included in ESW’s Annual Report on Form 10-K, as filed with the United States Securities and Exchange Commission for the year ended December 31, 2010. The methods and policies set forth in the year-end audited consolidated financial statements are followed in these interim consolidated condensed financial statements.
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All adjustments considered necessary for fair presentation and of a normal recurring nature have been included in these interim consolidated condensed financial statements. Revenues and operating results for the three month period ended March 31, 2011 are not necessarily indicative of the results to be expected for the full year.
NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, ESW America Inc. (“ESWA”), ESW Technologies Inc. (“ESWT”), ESW Canada Inc. (“ESWC”) and BBL Technologies Inc. (“BBL”). All inter-company transactions and balances have been eliminated on consolidation. Amounts in the consolidated financial statements are expressed in US dollars.
ESTIMATES
The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reported period. Actual results could differ from those estimates. Significant estimates include amounts for inventory valuation, impairment of property plant and equipment and intangible assets, share based compensation, redeemable class A special shares, valuation of the warrants, the exchange feature liability, and the convertible derivative liability, accrued liabilities and accounts receivable exposures.
CONCENTRATIONS OF CREDIT RISK
The Company’s cash balances are maintained in various banks in Canada and the United States. Deposits held in banks in the United States are insured up to $250,000 per depositor for each bank by the Federal Deposit Insurance Corporation. Deposits held in banks in Canada are insured up to $100,000 Canadian per depositor for each bank by The Canada Deposit Insurance Corporation a federal Crown corporation. Actual balances at times may exceed these limits.
Accounts Receivable and Concentrations of Credit Risk: The Company performs on-going credit evaluations of its customers’ financial condition and generally does not require collateral from its customers. Four of its customers accounted for 29%, 23%, 17% and 16%, respectively, of the Company’s revenue during the three month period ended March 31, 2011 and 28%, 21%, and 19%, respectively, of its accounts receivable as of March 31, 2011. Three of its customers accounted for 21%, 19%, and 13% respectively, of the Company’s revenue in the fiscal year 2010 and 48%, 21%, and 13% respectively, of its accounts receivable as of December 31, 2010.
As at March 31, 2011, the Company believes that there are no uncollectible accounts and accordingly has not recorded an allowance.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated credit risk by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is estimated and recorded based on management’s assessment of the credit history with the customer and current relationships with them. On this basis management has determined that an allowance for doubtful accounts of $0 and $70,028 was appropriate as of March 31, 2011 and 2010, respectively.
INVENTORY
Inventory is stated at the lower of cost or market determined using the first-in first-out method. Inventory is periodically reviewed for use and obsolescence, and adjusted as necessary. Inventory consists of raw materials, work in progress and finished goods.
F-33
PROPERTY, PLANT AND EQUIPMENT UNDER CONSTRUCTION
The Company capitalizes customized equipment built to be used in the future day to day operations at cost. Once complete and available for use, the cost for accounting purposes is transferred to property, plant and equipment, where normal depreciation rates apply.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, generally 5 to 7 years. Maintenance and repairs are charged to operations as incurred. Significant renewals and betterments are capitalized. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated discounted cash flow used in determining the fair value of the asset. ESW conducted a test for impairment as of December 31, 2010 and found no impairment.
INTERNAL-USE SOFTWARE
ESW capitalizes costs related to computer software obtained or developed for internal use. Software obtained for internal use is enterprise-level business and finance software that ESW is customizing to meet specific operational needs. Costs incurred in the development phase are capitalized and amortized over the useful life of the internal use software, which is generally from three to five years. Capitalized internal-use software development costs for a project which is not yet complete is included as Internal-use Software under Development in the consolidated balance sheet. Capitalization of such costs ceases at the point at which the project is substantially complete and ready for its intended purpose. Costs capitalized for the period ended March 31, 2011 and year ended December 31, 2010 were $129,603 and $126,340, respectively.
PATENTS AND TRADEMARKS
Patents and trademarks consist primarily of the costs incurred to acquire them from an independent third party. Accounting Standards Codification (“ASC”) Topic 350 requires intangible assets with a finite life be tested for impairment whenever events or circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated discounted cash flow used in determining the fair value of the asset. ESW conducted a test for impairment as of December 31, 2010 and found no impairment.
Patents and trademarks are being amortized on a straight-line basis over their estimated life of ten years. Amortization expense for the period ended March 31, 2011 and 2010 was $16,145 and $53,414 respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC Topic 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.
Included in the ASC Topic 820 framework is a three level valuation inputs hierarchy with Level 1 being inputs and transactions that can be effectively fully observed by market participants spanning to Level 3 where estimates are unobservable by market participants outside of the Company and must be estimated using assumptions developed by the Company. The Company discloses the lowest level input significant to each category of asset or liability valued within the scope of ASC Topic 820 and the valuation method as exchange, income or use. The Company uses inputs which are as observable as possible and the methods most applicable to the specific situation of each company or valued item.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, notes payable to related party, bank loan, redeemable Class A special shares and capital lease obligation approximate fair value because of the short-term nature of these items. Per ASC Topic 820 framework these are considered Level 2 inputs where estimates are unobservable by market participants outside of the Company and must be estimated using assumptions developed by the Company.
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The advance share subscription was classified as a liability and periodically marked to market until October 14, 2010 (see Note 10). The fair value of the advance share subscription obligation was determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock and might be adversely affected by a change in the price of the Company’s common stock. Per ASC Topic 820 framework this was considered a Level 2 input.
The exchange feature liability and convertible derivative liability are classified as a liability and periodically marked to market. The fair value of the exchange feature liability and convertible derivative liability are determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock and might be adversely affected by a change in the price of the Company’s common stock. Per FAS 157 framework these are considered a Level 1 input.
Interest rate risk is the risk that the value of a financial instrument might be adversely affected by a change in the interest rates. In seeking to minimize the risks from interest rate fluctuations, the Company manages exposure through its normal operating and financing activities.
REVENUE RECOGNITION
The Company derives revenue primarily from the sale of its catalytic products. In accordance with ASC Topic 605, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the amount is fixed or determinable, risk of ownership has passed to the customer and collection is reasonably assured.
The Company also derives revenue (less than 2.7% of total revenue during the three month period ended March 31, 2011 and 1.3% during the three month period ended March 31, 2010.) from providing air testing and environmental certification services. Revenues from these services are recognized upon performance.
RESEARCH AND DEVELOPMENT
The Company is engaged in research and development work. Research and development costs, are charged as operating expense of the Company as incurred. Any grant money received for research and development work is used to offset these expenditures. For the three month periods ended March 31, 2011 and 2010, the Company expensed $183,626 and $125,314 net of grant revenues, respectively, towards research and development costs. The expense excluding grant revenues used to offset research and development costs for the three month periods ended March 31, 2011 and 2010 amounted to $413,625 and $226,840 and grant money amounted to $229,999 and $101,526, respectively.
PRODUCT WARRANTIES
The Company provides for estimated warranty costs at the time of sale and accrues for specific items at the time their existence is known and the amounts are determinable. The Company estimates warranty costs using standard quantitative measures based on industry warranty claim experience and evaluation of specific customer warranty issues. The Company currently records warranty costs as 2% of revenue. As of March 31, 2011 and year ended December 31, 2010, $122,590 and $91,336, respectively, was accrued against warranty provision and included in accrued liabilities. For the three month periods ended March 31, 2011 and 2010, the total warranty, service, service travel and installation costs included in cost of sales was $78,886 and $49,001, respectively.
SEGMENTED REPORTING
ASC Topic 280 changed the way public companies report information about segments of their business in their quarterly reports issued to shareholders. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues and its major customers.
The Company also derives revenue (less than 2.7% of total revenue during the three month period ended March 31, 2011 and 1.3% during the three month period ended March 31, 2010) from providing air testing and environmental certification services. For the three month periods ended March 31, 2011 and 2010, all revenues were generated from the United States. During the three month periods ended March 31, 2011 and 2010, expenses incurred in the United States were cost of sales of $28,359 and $10,639, officers’ compensation and directors fees
F-35
of $30,871 and $26,958, marketing, office and general costs of $228,677 and $241,584, consulting and professional fees of $5,538 and $16,717, depreciation and amortization of $82,360 and $96,116 and research and development of $129,422 and $136,444, respectively.
As of the period ended March 31, 2011 and the year ended 2010, $1,069,699 and $1,182,263, respectively, of property, plant and equipment, net of depreciation, is located at the air testing facility in Pennsylvania and all remaining long lived assets are located in Concord, Ontario.
NOTE 3 — RECENTLY ISSUED ACCOUNTING STANDARDS
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In January 2010, the FASB issued Accounting Standards Update (“ASU” or “Update”) No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 improves disclosures originally required under SFAS No. 157. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2009, and for interim periods within those years. The adoption of the guidance did not have a material effect on the Company’s consolidated condensed financial position, results of operations, cash flows or related disclosures.
In December 2009, the FASB issued ASU 2009-16, Transfers and Servicing (Topic 860) — Accounting for Transfers of Financial Assets (“ASU 2009-16”). ASU 2009-16 amends the accounting for transfers of financials assets and will require more information about transfers of financial assets, including securitizations, and where entities have continuing exposure to the risks related to transferred financial assets. ASU 2009-16 is effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, with early adoption not permitted. The adoption of the guidance did not have a material effect on the Company’s consolidated condensed financial position, results of operations, cash flows or related disclosures.
In October 2009, the FASB issued ASU 2009-15, Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing (“ASU 2009-15”). ASU 2009-15 amends the accounting and reporting guidance for debt (and certain preferred stock) with specific conversion features or other options. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009. The adoption of the guidance did not have a material effect on the Company’s consolidated condensed financial position, results of operations, cash flows or related disclosures.
In August 2010, the FASB issued ASU No. 2010-22, Accounting for Various Topics — Technical Corrections to SEC Paragraphs this update amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends or rescinds portions of certain SAB topics. The adoption of this ASU had no effect on the Company’s consolidated condensed financial statements.
In August 2010, the FASB issued ASU No. 2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This updates various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies. The adoption of this ASU had no effect on the Company’s consolidated condensed financial statements.
In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition — Milestone Method. The objective of this Update is to provide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. The amendments in this Update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The adoption of this ASU had no effect on the Company’s consolidated condensed financial statements.
In April 2010, the FASB issued ASU No. 2010-013, Compensation — Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades a consensus of the FASB Emerging Issues Task Force. ASU 2010-13 addresses the classification of an employee share-based award with an exercise price denominated in the currency of a market
F-36
in which the underlying equity security trades. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The adoption of this ASU had no effect on the Company’s consolidated condensed financial statements.
In October 2009, the FASB issued ASU No. 2009-13, Multiple Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”) (codified within ASC Topic 605). ASU 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The adoption of this ASU had no effect on the Company’s consolidated condensed financial statements.
NOTE 4 — CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and highly liquid investments purchased with an original or remaining maturity of 90 days or less at the date of purchase. At March 31, 2011 and December 31, 2010 all of the Company’s cash and cash equivalents consisted of cash.
NOTE 5 — INVENTORY
Inventory consists of:
Inventory
| | | | March 31,
2011
| | December 31,
2010
|
|---|
| Raw materials | | | | $ | 1,516,848 | | | $ | 1,669,481 | |
| Work-in-process | | | | | 2,070,702 | | | | 2,737,545 | |
| Finished goods | | | | | 27,538 | | | | 7,492 | |
Less:
| | | | | | | | | | |
Reserve for
Obsolescence | | | | | 100,623 | | | | — | |
| TOTAL | | | | $ | 3,514,465 | | | $ | 4,414,518 | |
As of March 31, 2011, the Company recorded a $100,623 (March 31, 2010, — $0) reserve for obsolescence related to contemplated sale of inventory that has been earmarked for sale at an amount lower than cost in order to recover cash.
NOTE 6 — PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
Classification
| | | | March 31,
2011
| | December 31,
2010
|
|---|
| Plant, machinery and equipment | | | | $ | 5,954,815 | | | $ | 5,790,507 | |
| Office equipment | | | | | 392,896 | | | | 384,902 | |
| Furniture and fixtures | | | | | 467,493 | | | | 461,817 | |
| Vehicles | | | | | 18,450 | | | | 18,288 | |
| Leasehold improvements | | | | | 1,048,210 | | | | 1,041,023 | |
| | | | | | 7,881,864 | | | | 7,696,537 | |
| Less: accumulated depreciation | | | | | (6,044,872 | ) | | | (5,765,164 | ) |
| | | | | $ | 1,836,992 | | | $ | 1,931,373 | |
F-37
| | | | March 31,
| |
|---|
Depreciation Expense
| | | | 2011
| | 2010
|
|---|
| Depreciation expense included in cost of sales | | | | $ | 76,191 | | | $ | 41,511 | |
| Depreciation expense included in operating expenses | | | | | 104,204 | | | | 209,427 | |
Depreciation expense included in research
and development costs | | | | | 29,163 | | | | 34,109 | |
| Total depreciation expense | | | | $ | 209,558 | | | $ | 285,047 | |
At March 31, 2011 and December 31, 2010, the Company had $78,807 and $185,542, respectively, of customized equipment under construction.
The office equipment above includes $0 in assets under capital lease with a corresponding accumulated depreciation of $0 as of March 31, 2011. The office equipment above includes $19,784 in assets under capital lease with a corresponding accumulated depreciation of $16,615 for the three month period ended March 31, 2010.
The plant, machinery and equipment above include $39,343 and $37,939 in assets under capital lease with a corresponding accumulated depreciation of $30,165 and $25,723 as of March 31, 2011 and December 31, 2010, respectively.
NOTE 7 — NOTES PAYABLE TO RELATED PARTIES
On February 17, 2011, the Company entered into note subscription agreements (collectively, the “Loan Agreements”) with, and issued unsecured subordinated promissory notes to, Orchard Investments, LLC; Black Family 1997 Trust; Leon D. Black Trust UAD 11/30/92 FBO Alexander Black; Leon D. Black Trust UAD 11/30/92 FBO Benjamin Black; Leon D. Black Trust UAD 11/30/92 FBO Joshua Black; Leon D. Black Trust UAD 11/30/92 FBO Victoria Black; Leon D. Black; John J. Hannan and Richard Ressler (each individually a “Subordinated Lender” or “Holder” and collectively the (“Subordinated Lenders” or “Holders”) who are current shareholders and deemed affiliates of certain members of the board of directors of the Company. The Loan Agreements were approved by the independent directors of the Company.
As per the Loan Agreements, the Subordinated Lenders made loans to the Company in the principal aggregate amount of $3 million, represented by unsecured subordinated promissory notes (the “Notes”), dated February 17, 2011. Proceeds of the Loan, along with available cash, will be used to fund working capital, planned capital investments and other general corporate purposes. With the proceeds of the Loan, the Company and its subsidiaries will be in compliance with covenant obligations under the Demand Credit Agreement (the “Credit Agreement”) with the Canadian Imperial Bank of Commerce (“CIBC”) dated March 10, 2010 for which the Company and subsidiaries had previously obtained waivers of covenant obligations that expired February 15, 2011.
The Notes bear interest at a rate of 10% per annum, payable in-kind on a monthly basis commencing March 17, 2011, up to the date on which the Note has been paid in full. The maturity date of the Loan is the earlier of: (i) the closing of a rights offering of the Company’s common stock, par value $.001 per share, at a sale price of $0.12 per share (adjusted for any stock split, stock dividend or other similar adjustment) pursuant to which the Company plans to offer rights to purchase approximately $8 million in shares of Common Stock (the “Qualified Offering”), and will also permit all Subordinated Lenders to exchange their Notes, accrued interest (and the any Notes that may be issued for payment of interest) for shares of Common Stock at $0.12 per share or (ii) June 17, 2011 (the “Outside Date”). The Qualified Offering has also been approved by the independent directors of the Company.
In the event the Qualified Offering does not take place on or before the Outside Date, then the Subordinated Lenders at their sole option, may require the Company to refrain from making any payments on any of the outstanding principal and accrued interest outstanding under the Notes; however, the Company will not be prohibited from paying any accrued interest in-kind through the issuance of substantially similar Notes, at any time. The Holders at their sole option may extend the Outside Date.
In the event the Qualified Offering closes on or prior to the Outside Date and for any reason a Holder shall have failed to have exchanged in the Qualified Offering the principal or accrued interest outstanding under its Notes and the Holder wishes to exchange his or her Note(s) for Common Stock at a price of $0.12 per share (adjusted
F-38
for any stock split, stock dividend or other similar adjustment), then the Company has agreed to offer such Holder the immediate right to purchase additional shares of Common Stock at the $0.12 price, so that all principal and accrued interest outstanding under the Notes shall have been exchanged for shares of Common Stock.
In the event the Qualified Offering closes on or prior to the Maturity Date and, for any reason, certain Holders (the “Qualified Holders”) collectively shall have failed to have invested at least $1 million in the Qualified Offering or pursuant to exchange of their Notes and the Qualified Holders wish to invest the balance of such $1 million aggregate amount to purchase Common Stock at a price of $0.12 per share (adjusted for any stock split, stock dividend or other similar adjustment), then the Company will be required to offer to the Qualified Holders the immediate right to invest the balance of such investment amount to purchase additional shares of Common Stock at such price, so that in the aggregate, the Qualified Holders shall collectively invested such $1 million amount.
If after the Maturity Date, any principal or interest is outstanding, the Holder may exchange at their option any or all outstanding interest or principal in any offering or other sale made by the Company for any shares in Common Stock.
Concurrent with entering into the Loan Agreements and issuance of the Notes, CIBC, the Company and its subsidiaries; and the Subordinated Lenders entered into a Postponement and Subordination Agreement (the “Subordination Agreement”) whereby the Subordinated Lenders agreed that the obligations of the Company and its subsidiaries under the Notes as issued would be subordinate to the obligations of the Company and its subsidiaries under the Credit Agreement.
The terms of the Loan Agreements were analyzed in accordance with ASC 815 Derivatives and Hedging. The Loan Agreements allows for the price for Notes exchanged for Common Stock to be adjusted in certain circumstances. The potential adjustment in the exchange price precludes the Company from being qualified for the exemption from being considered to be a derivative instrument. As such, the option of the Holders to exchange Notes for Common Stock and the option of the Qualified Holders to invest the balance of $1 million aggregate amount to purchase Common Stock were determined to be derivatives embedded in the Notes. These embedded derivatives are bundled together as a single, compound embedded derivative and recorded and valued as a liability at the time of issuance on February 17, 2011 and on March 31, 2011.
The fair value of the embedded derivatives issued under the Loan Agreements on February 17, 2011 and March 31, 2011 was determined to be $3,485,101 and $2,148,656, respectively with the following assumptions: (1) risk free interest rate of 0.15% and 0.17%, (2) remaining contractual life of 4 and 2.5 months, (3) expected stock price volatility of 194% and 201%, and (4) expected dividend yield of zero. Since the fair value of the embedded derivatives was in excess of the proceeds, the Company recorded an immediate expense of $485,101 to the condensed consolidated statement of operations as a financing charge on embedded derivative liability. The embedded derivatives liability was recorded as a discount to the Notes at the time of issuance. The discount is recorded as interest accretion expense in the consolidated condensed statements of operations using the effective-interest method. The change in the fair value of $1,336,445 of the embedded derivatives is recorded as gain in the consolidated condensed statements of operations.
At March 31, 2011 and December 31, 2010, the $1,050,000 and $0 net outstanding balance of notes payable to related parties comprises $3,000,000 and $0 of debt, net of unamortized debt discount of $1,950,000 and $0, respectively.
NOTE 8 — BANK LOAN
Effective March 31, 2010, ESW’s subsidiary, ESW Canada, entered into a demand revolving credit facility agreement with a Canadian chartered bank, Canadian Imperial Bank of Commerce (“CIBC”) to meet working capital requirements (the “Demand Credit Agreement”). The Demand Credit Agreement has a credit limit of $4 million Canadian. Borrowings under the facility are limited to a percentage of accounts receivable plus a percentage of inventories (capped at $1 million Canadian or 50% of the accounts receivable portion) less any prior ranking claims. The Demand Credit Agreement is guaranteed by the Company and its subsidiaries, ESWC, ESWA, BBL, and ESWT, through a general security agreement over all assets to CIBC. The facility has been guaranteed to CIBC under EDC’s Export Guarantee Program. Borrowings under the Demand Credit Agreement bear interest at 2.25%
F-39
above CIBC’s prime rate of interest. Obligations under the Demand Credit Agreement are collateralized by a first-priority lien on the assets of the Company and its subsidiaries, including accounts receivable, inventory, equipment and other tangible and intangible property, including the capital stock of all direct subsidiaries.
The terms relating to the Demand Credit Agreement specifically note that the Company maintain a tangible net worth of at least $4.0 million Canadian. The Demand Credit Agreement contains, among other things, covenants, representations and warranties and events of default customary for a facility of this type for the Company and its subsidiaries. Such covenants include certain restrictions on the incurrence of additional indebtedness, liens, acquisitions and other investments, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other repurchases in respect of capital stock, voluntary prepayments of certain other indebtedness, capital expenditures and transactions with affiliates, subject to certain exceptions. Under certain conditions amounts outstanding under the Demand Credit Agreement may be accelerated. Such events include failure to comply with covenants, breach of representations or warranties in any material respect, non-payment or acceleration of other material debt, entry of material judgments not covered by insurance, or a change of control of the Company.
On November 8, 2010, November 26, 2010, and December 23, 2010, the Company’s wholly owned subsidiary, ESWC, received the first, second and third waivers, respectively, of certain financial covenants under its Demand Credit Agreement with CIBC. Without the waiver, the Company’s subsidiary would not be in compliance with the current ratio and effective tangible net worth covenants as set forth in the Demand Credit Agreement. In the event the Company and its subsidiary, ESWC, fail to comply with the terms of the waiver and meet the current ratio and effective tangible net worth covenants prior to the end of the waiver period, same would constitute an event of default and the bank loan may need to be repaid unless a further waiver or modification to the Demand Credit Agreement can be obtained.
The third waiver provided by CIBC was through January 31, 2011 and also provides for a fee payable to the lender for the extension, as well as a reduction in the maximum security margin deficit as defined under the Demand Credit Agreement (by either reducing borrowing or increasing the borrowing base) and an increase in the annual interest rate to CIBC’s prime rate plus 4.50% from CIBC’s prime rate plus 2.25% effective January 1, 2011.
Effective February 4, 2011, the Company’s wholly owned subsidiary, ESWC, received a fourth waiver of certain financial covenants under its Demand Credit Agreement with CIBC. Without the waiver, the Company’s subsidiary would not be in compliance with the current ratio and effective tangible net worth covenants as set forth in the Demand Credit Agreement. The fourth waiver provided by CIBC extends the waiver period from January 31, 2011 through February 14, 2011 and also provides for a fee payable to CIBC for the extension as well as requiring the elimination of any margin deficit by February 14, 2011. In the event the Company and its subsidiary, ESWC, failed to comply with the terms of the waiver and meet the current ratio and effective tangible net worth covenants prior to the end of the waiver period, same will constitute an event of default as set forth in the Demand Credit Agreement unless a further waiver or modification to the Demand Credit Agreement could be obtained.
The closing of the $3 million unsecured subordinated promissory notes effective February 17, 2011 allowed the Company and its subsidiaries to comply with covenants and obligations under the Demand Credit Agreement with CIBC dated March 10, 2010. ESW is working on upgrading or renewing the Demand Credit Agreement and reviewing options with other senior lenders. The Company has obtained an extension to the Demand Credit Agreement to May 31, 2011 from its current senior lender and is working to extend this date.
As of March 31, 2011 and December 31, 2010, $1,636,444 and $3,424,889, respectively, was owed under the credit facility to CIBC.
NOTE 9 — REDEEMABLE CLASS A SPECIAL SHARES
700,000 Class A special
shares authorized,
issued, and outstanding. | | | | $453,900 (based on the historical
exchange rate at the time of
issuance.) |
The redeemable Class A special shares were issued by the Company’s wholly owned subsidiary, BBL, without par value, and are redeemable on demand by the holder of the shares, which is a private Ontario Corporation, at $700,000 Canadian (which translates to $721,980 US and $703,801 US at March 31, 2011 and December 31, 2010,
F-40
respectively). As the redeemable Class A special shares were issued by the Company’s wholly owned subsidiary, BBL, the maximum value upon which the Company is liable is the net book value of BBL. As of March 31, 2011 and December 31, 2010, BBL had an accumulated deficit of $1,192,858 US ($1,845,375 Canadian), and therefore, the holder would be unable to redeem the redeemable Class A special shares at their ascribed value.
NOTE 10 — CONVERTIBLE DEBENTURES
Convertible debentures issued by the Company are summarized as follows:
| | | | 2008
Debentures
| | 2009
Debentures
| | 2010
Debentures
| | Total
March 31, 2010
|
|---|
| Face value of convertible debenture | | | | $ | 9,000,000 | | | $ | 1,600,000 | | | $ | 3,000,000 | | | $ | 13,600,000 | |
| Less: Beneficial conversion feature | | | | | — | | | | (256,000 | ) | | | (540,000 | ) | | | (796,000 | ) |
| Deferred costs | | | | | (59,738 | ) | | | — | | | | (80,625 | ) | | | (140,363 | ) |
| |
| Book value upon issuance | | | | | 8,940,262 | | | | 1,344,000 | | | | 2,379,375 | | | | 12,663,637 | |
| Accretion of the debt discount | | | | | — | | | | 256,000 | | | | 540,000 | | | | 796,000 | |
| Amortization of deferred costs | | | | | 59,738 | | | | — | | | | 80,625 | | | | 140,363 | |
| |
| Carrying Value | | | | | 9,000,000 | | | | 1,600,000 | | | | 3,000,000 | | | | 13,600,000 | |
| |
| Conversion (March 25,2010) | | | | | (9,000,000 | ) | | | (1,600,000 | ) | | | (3,000,000 | ) | | | (13,600,000 | ) |
| |
| Carrying Value (March 32, 2011) | | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Effective March 19, 2010, the Company issued $3,000,000 of its 9% convertible debentures (the “2010 Debentures”) to five (5) accredited investors under Rule 506 of Regulation D of Section 4(2) of the Securities Act. The 2010 Debentures were for a term of three (3) years and were convertible into shares of the Company’s common stock at the option of the holder by dividing the principal amount of the 2010 Debenture to be converted by $0.50. The 2010 Debentures earned interest at a rate of 9% per annum payable in cash or in shares of the Company’s common stock at the option of the holder. If the holder elected to receive interest in shares of common stock, the number of shares of common stock to be issued for interest would be determined by dividing accrued interest by $0.50. The 2010 Debentures had a mandatory conversion feature that required the holders to convert in the event a majority of the Company’s pre-existing outstanding 9% convertible debentures converted. Subject to the holder’s right to convert and the mandatory conversion feature, the Company had the right to redeem the 2010 Debentures at a price equal to one hundred and ten percent (110%) multiplied by the then outstanding principal amount plus unpaid interest to the date of redemption. Upon maturity, the debenture and interest was payable in cash or common stock at the option of the Holder. The Company also had provided the holders of the Debentures registration rights. The 2010 Debentures contained customary price adjustment protections.
At the time the 2010 Debentures were issued, the Company recorded a debt discount for a beneficial conversion feature in the amount of $540,000. The debt discount being the aggregate intrinsic value calculated as the difference between the market price of the Company’s share of stock on March 19, 2010 and the conversion price of the 2010 Debentures. The debt discount was being accreted over the three (3) year life of the debentures using the effective yield method. The effective yield on the debentures was 16.36%.
Effective March 25, 2010, the November 2008 and the August 2009 debenture holders agreed to convert all outstanding convertible debentures as per the terms of the respective debenture agreements. The early conversion of the debentures was a condition precedent to the Company’s wholly owned subsidiary, ESWC, entering into a new credit facility with CIBC (see Note 8). A total of $10,600,000 in principal and $1,176,445 of accrued interest was converted into 43,756,653 shares of restricted common stock. The conversion of the November 2008 and the August 2009 debentures also triggered the mandatory conversion feature on the March 19, 2010 debentures. A total of $3,000,000 in principal and $3,797 in accrued interest was converted into 6,007,595 shares of restricted common stock. With these transactions effective March 25, 2010, the Company has $0 of convertible debentures and accrued interest on convertible debenture.
As part of the agreement to convert all existing convertible debentures, the Company was committed to pay a premium as an inducement to convert all debentures. The premium was payable to all converting debenture holders and was subject to a positive fairness opinion, approval by a Fairness Committee consisting of independent Directors
F-41
of the Company’s Board of Directors and an increase in the share capital of the Company. The premium consists of 4,375,668 shares of common stock. As the Company did not have sufficient authorised shares as of the date of conversion of the debentures to fulfill the premium, the premium had been recorded as an advance share purchase agreement at a fair market value of $2,909,872 as of March 31, 2010. The agreement is without interest, subordinated to the bank’s position and payable in a fixed number of common shares (4,375,668 shares) of the Company upon increase in the authorized share capital of the Company.
Up to October 14, 2010, the Company did not have sufficient authorized and unissued shares to fulfill the advance share subscription. Under these conditions, FASB ASC Subtopic 815-40, Contracts in Entity’ Own Equity, precludes equity classification of this obligation. As such, the advance share subscription was classified as a liability and periodically marked to market. The fair value of the obligation was determined to be $1,662,753 at October 14, 2010. The fair value of the obligation was determined by the cash settlement value at the end of each period based on the closing price of the Company’s common stock. The decrease in fair value of this liability of $1,247,119 was recorded as a mark to market adjustment on advance share subscription in the consolidated statement of operations and comprehensive loss.
Effective October 14, 2010, the Company’s Board of Directors ratified certain corporate action approved by the written consent of a majority of the Company’s shareholders pursuant to a Definitive Information Statement on Schedule 14C that the Company filed with the Securities and Exchange Commission on September 3, 2010 (the “Definitive Information Statement”) and distributed to shareholders of record. The Board of Directors ratified an amendment to the Company’s articles of incorporation whereby the Company proceeded to file an amendment to its articles of incorporation increasing its authorized shares of common stock from 125,000,000 to 250,000,000 shares.
Effective November 30, 2010, the Company issued an aggregate of 4,375,668 restricted shares of common stock to thirteen (13) prior debenture holders in connection with the early conversion of their debentures.
Included in the condensed consolidated financial statements of the Company at March 31, 2011 is the effect of an exchange feature included in the terms of the Share Subscription Agreement for $3,000,000 of Convertible Debentures issued on March 19, 2010 (“2010 Debentures”) and fully converted including interest into 6,007,595 shares of common stock on March 25, 2010. The exchange feature provides that if within twelve months from March 19, 2010, the Company enters into or closes another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the Securities) on terms and conditions more favorable to another purchaser, the terms and conditions of the 2010 Debentures shall be adjusted to reflect the more favorable terms. The exchange feature was determined by the Company to be freestanding financial instrument and also to be a liability within the scope of ASC 480 Distinguishing Liabilities from Equity since there is an inverse relationship between the stock price of the Company and the Company’s obligation. On December 31, 2010, the Company evaluated the fair value of the exchange feature based on the probability of closing another financing by March 18, 2011 and the fair value of the number of incremental shares to be issued at a lower estimated issue price. The probability of closing another financing by March 18, 2011 was estimated to be 100% on December 31, 2010. The fair value of the Company’s common stock is determined by the closing price on the valuation date. On December 31, 2010, an exchange feature liability of $1,680,000 was recorded for the 2010 Debentures (see also note 12).
Effective February 17, 2011, the Company and the 2010 Debenture investors reached an agreement whereby the investors will receive an approximate aggregate of 19,000,000 additional shares of Common Stock at an estimated price of $0.12 in conjunction with certain rights under the Prior Subscription Agreements in the event the Company closes a Qualified Offering (see note 7 for details). At March 31, 2011 the exchange feature liability related to the 2010 Debenture was recorded at a fair value of $2,280,000 with the change in fair value of exchange feature liability of $600,000 recorded as an expense in the consolidated condensed statements of operations and comprehensive loss.
F-42
Transaction Detail
|
|
|
| Original Instrument
|
| Additional
Shares
|
| Exchange
Feature
Liability
December 31,
2010
|
| Change in
fair value
of exchange
feature
liability
March 31,
2011
|
| Exchange
Feature
Liability
March 31,
2011
|
| Comments
|
|---|
| March 2010 Offering | | | | Convertible Debenture | | | 19,000,000 | | | $ | 1,680,000 | | | $ | 600,000 | | | $ | 2,280,000 | | | | See Note 10 | |
| November 2010 Offering | | | | Common Stock and Warrants | | | 1,750,000 | | | | 219,168 | | | | (9,299 | ) | | | 209,869 | | | | See Note 12 | |
| December 2010 Offering | | | | Common Stock and Warrants | | | 1,750,000 | | | | 228,262 | | | | (11,962 | ) | | | 216,300 | | | | See Note 12 | |
| | | | | Totals | | | 22,500,000 | | | $ | 2,127,430 | | | $ | 578,739 | | | $ | 2,706,169 | | | | | |
As of March 31, 2011 and December 31, 2010, total convertible debentures and corresponding accrued interest amounted to $0 and $0, respectively. As of December 31, 2010, the debt discount of $768,981 and deferred cost of $117,131 were fully amortized and expensed due to the conversion of the debentures effective March 25, 2010.
LEGAL FEES RELATED TO 2008 AND 2010 CONVERTIBLE DEBENTURES
The Company had also recorded a deferred cost asset of $80,625 for legal fees paid in relation to the issuance of the 2010 Debentures. The deferred costs were being amortized over the term of the 2010 Debentures using the straight line method.
At December 31, 2010, the deferred cost assets were fully amortized due to the conversion of the debentures effective March 25, 2010. As of December 31, 2010, deferred cost assets have been presented net against the related convertible debentures.
NOTE 11 — INCOME TAXES
As of March 31, 2011, there are tax loss carry forwards for Federal income tax purposes of approximately $26,375,614 available to offset future taxable income in the United States. The tax loss carry forwards expire in various years through 2031. The Company does not expect to incur a Federal income tax liability in the foreseeable future. Accordingly, a valuation allowance for the full amount of the related deferred tax asset of approximately $9,231,465 has been established until realizations of the tax benefit from the loss carry forwards meet the “more likely than not” criteria.
Year
| | | | Loss Carry
Forward
|
|---|
| 1999 | | | | $ | 407,067 | |
| 2000 | | | | | 2,109,716 | |
| 2001 | | | | | 2,368,368 | |
| 2002 | | | | | 917,626 | |
| 2003 | | | | | 637,458 | |
| 2004 | | | | | 1,621,175 | |
| 2005 | | | | | 2,276,330 | |
| 2006 | | | | | 3,336,964 | |
| 2007 | | | | | 3,378,355 | |
| 2008 | | | | | 3,348,694 | |
| 2009 | | | | | 2,927,096 | |
| 2010 | | | | | 2,389,225 | |
| 2011 | | | | | 657,540 | |
| Total | | | | $ | 26,375,614 | |
Additionally, as of March 31, 2011, the Company’s two wholly owned Canadian subsidiaries had non-capital tax loss carry forwards of approximately $12,182,415 be used, in future periods, to offset taxable income. The loss carry forwards expire in various years through 2031. The deferred tax asset of approximately $3,775,331 has been fully offset by a valuation allowance until realization of the tax benefit from the non-capital tax loss carry forwards are more likely than not.
F-43
Year
| | | | Loss Carry
Forward Foreign
Operations
|
|---|
| 2006 | | | | $ | 588,051 | |
| 2007 | | | | | 7,397 | |
| 2008 | | | | | 4,154,396 | |
| 2009 | | | | | 2,846,379 | |
| 2010 | | | | | 2,900,652 | |
| 2011 | | | | | 1,685,540 | |
| Total | | | | $ | 12,182,415 | |
| | | | For the period ended March 31, | |
|---|
| | | | 2011
| | 2010
|
|---|
Statutory tax rate:
| | | | | | | | | | |
| U.S. | | | | | 35.00 | % | | | 35.00 | % |
| Foreign | | | | | 31.00 | % | | | 33.00 | % |
Loss before income taxes:
| | | | | | | | | | |
| U.S. | | | | $ | (1,460,821 | ) | | $ | (4,653,428 | ) |
| Foreign | | | | | (1,673,811 | ) | | | (344,131 | ) |
| | | | | $ | (3,134,632 | ) | | $ | (4,997,559 | ) |
| Expected income tax recovery | | | | $ | (1,030,001 | ) | | $ | (1,742,263 | ) |
Differences in income tax resulting from:
| | | | | | | | | | |
| Depreciation (Foreign operations) | | | | | 3,311 | | | | 17,876 | |
| Change in fair value of exchange feature liability | | | | | 202,559 | | | | — | |
| Financing charge on embedded derivative liability | | | | | 169,785 | | | | — | |
| Inducement premium on conversion of Debentures | | | | | — | | | | 1,018,455 | |
| Stock based compensation | | | | | 9,060 | | | | — | |
| Gain on convertible derivative | | | | | (467,756 | ) | | | — | |
| Long-term debt accretion | | | | | 367,500 | | | | 269,143 | |
| Accrued interest on loans | | | | | — | | | | 64,350 | |
| | | | | | (745,542 | ) | | | (372,439 | ) |
| Benefit of losses not recognized | | | | | 745,542 | | | | 372,439 | |
| Income tax provision (recovery) per financial statements | | | | $ | — | | | $ | — | |
Components of deferred income tax assets are as follows:
| | | | As at March 31, | |
|---|
| | | | 2011
| | 2010
|
|---|
| Property, plant and equipment | | | | $ | 110,255 | | | $ | 94,203 | |
| Tax loss carry forwards | | | | | 13,006,796 | | | | 10,757,068 | |
| Total | | | | | 13,117,051 | | | | 10,851,271 | |
| Valuation allowance | | | | | (13,117,051 | ) | | | (10,851,271 | ) |
| Carrying Value | | | | $ | — | | | $ | — | |
Effective January 1, 2007, the Company adopted FASB’s guidance on accounting for uncertainty in income taxes. This guidance prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in an income tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. There was no material impact on the Company’s consolidated financial position and results of operations as a result of the adoption of this guidance. The Company does not believe there will be any material changes in its unrecognized tax positions over the next twelve months.
F-44
The Company will recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the consolidated statement of operations and comprehensive loss. Accrued interest and penalties will be included within the related tax liability line in the consolidated balance sheet.
In many cases the Company’s uncertain tax positions are related to tax years that remain subject to examination by tax authorities. The following describes the open tax years, by major tax jurisdiction, as of March 31, 2011:
| United States — Federal | | | | | 2007–present | |
| United States — State | | | | | 2007–present | |
| Canada — Federal | | | | | 2008–present | |
| Canada — Provincial | | | | | 2008–present | |
Valuation allowances reflect the deferred tax benefits that management is uncertain of the Company’s ability to utilize in the future.
NOTE 12 — STOCKHOLDERS’ EQUITY / (DEFICIT)
On March 25, 2010, the Company issued 43,756,653 shares of common stock in connection with the conversion of 2008 Debentures and 2009 Debentures into equity (see Note 10).
On March 25, 2010, the Company issued 6,007,595 shares of restricted common stock in connection with the conversion of 2010 Debentures into equity (see Note 10).
On November 30, 2010, the Company issued 4,375,668 shares as an inducement premium to the holders to convert all convertible debentures outstanding as of March 25, 2010 (see Note 10). As fully disclosed in Note 10 to the consolidated financial statements, the Company’s Board of Directors approved the increase in the authorized share capital effective October 14, 2010.
Effective November 9, 2010 and December 8, 2010, the Company closed on its first tranche and second tranche of a unit offering in the amount of $300,000 per tranche for gross proceeds of $600,000 whereby the Company issued 1,500,000 (“Unit Offering”) units. The unit offering is for up to $5 million. The units are in the form of shares of the Company’s common stock, par value $0.001 at $0.40 per share plus for each share of Common Stock subscribed to under the unit offer the investor will receive one warrant, the exercise price will be $0.55; if an Investor Warrant is exercised between the first and second years from issuance, the exercise price will be $0.65. All investor warrants as issued will be subject to adjustment in all respects in the event of a stock split or similar adjustment by the Company. A commission of 4% of the gross proceeds was paid from the proceeds of the unit offering and 7.5 units for every $100 of the gross proceeds raised are payable for brokers fees are treated as a cost of capital and no income statement recognition is required.
The Share Subscription Agreement for the units contains an exchange feature which provides that if within six months from effective date of closing, the Company enters into or closes another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the Securities) on terms and conditions more favorable to another purchaser, the terms and conditions of the unit offering shall be adjusted to reflect the more favorable terms. The exchange feature was determined by the Company to be freestanding financial instrument and also to be a liability within the scope of ASC 480 Distinguishing Liabilities from Equity since there is an inverse relationship between the stock price of the Company and the Company’s obligation. On November 9, 2010, December 8, 2010 and December 31, 2010, the Company evaluated the fair value of the exchange feature based on the probability of closing another financing within six months and the fair value of the number of incremental shares and warrants to be issued at a lower estimated issue price for units. The probability of closing another financing in the next six months on November 9, 2010 and December 8, 2010 was estimated to be 50% and on December 31, 2010 was estimated to be 100%.
F-45
The fair value of the Company’s common stock is determined by the closing price on the valuation date and the fair value of the warrants is determined using a binomial option valuation model. Key assumptions for the binomial option valuation were as follows:
November 9, 2010 Offering
| | | |
|---|
Valuation Date
| | | | Nov. 9, 2010
| | Nov. 9, 2010 —
lower estimated
strike price
| | Dec. 31, 2010
| | Dec. 31, 2010 —
lower estimated
strike price
|
|---|
| Strike Price — second year | | | | $ | 0.65 | | | $ | 0.63 | | | $ | 0.65 | | | $ | 0.36 | |
| Strike Price — first year | | | | $ | 0.55 | | | $ | 0.54 | | | $ | 0.55 | | | $ | 0.30 | |
| Closing market price | | | | $ | 0.39 | | | $ | 0.39 | | | $ | 0.22 | | | $ | 0.22 | |
| Volatility | | | | | 135.72 | % | | | 135.72 | % | | | 113.47 | % | | | 113.47 | % |
| Time to expiration | | | | | 2 years | | | | 2 years | | | | 1.83 years | | | | 1.83 years | |
| Risk free rate | | | | | 0.46 | % | | | 0.46 | % | | | 0.61 | % | | | 0.61 | % |
| Dividend yield | | | | | 0 | % | | | 0 | % | | | 0 | % | | | 0 | % |
December 8, 2010 Offering
| | | |
|---|
Valuation Date
| | | | Dec. 8, 2010
| | Dec. 8, 2010 —
lower estimated
strike price
| | Dec. 31, 2010
| | Dec. 31, 2010 —
lower estimated
strike price
|
|---|
| Strike Price — second year | | | | $ | 0.65 | | | $ | 0.39 | | | $ | 0.65 | | | $ | 0.36 | |
| Strike Price — first year | | | | $ | 0.55 | | | $ | 0.33 | | | $ | 0.55 | | | $ | 0.30 | |
| Closing market price | | | | $ | 0.24 | | | $ | 0.24 | | | $ | 0.22 | | | $ | 0.22 | |
| Volatility | | | | | 132.07 | % | | | 132.07 | % | | | 117.03 | % | | | 117.03 | % |
| Time to expiration | | | | 2 years | | 2 years | | 1.92 years | | 1.92 years |
| Risk free rate | | | | | 0.63 | % | | | 0.63 | % | | | 0.61 | % | | | 0.61 | % |
| Dividend yield | | | | | 0 | % | | | 0 | % | | | 0 | % | | | 0 | % |
On December 31, 2010, an exchange feature liability of $453,861 was recorded for the unit offering.
Effective February 17, 2011, the Company and the Unit Offering investors reached an agreement whereby the investors will receive an approximate aggregate of 3,500,000 additional shares of Common Stock at an estimated price of $0.12 in conjunction with certain rights under the Share Subscription Agreements in the event the Company closes a Qualified Offering (see note 7 for details). At March 31, 2011 the exchange feature liability related to the shares in the Unit Offering was recorded at a fair value of $432,600. At March 31, 2011 the exchange feature liability related to the warrants in the Unit Offering was recorded at a fair value of $0 since the probability of Company exchanging warrants with a lower strike price is estimated to be 0%. The change in fair value of exchange feature liability related to the Unit Offering of $(21,261) is recorded as a reduction of the loss on fair value of exchange feature liability related to the 2010 Debentures.
Transaction Detail
|
|
|
| Original Instrument
|
| Additional
Shares
|
| Exchange
Feature
Liability
December 31,
2010
|
| Change in
fair value
of exchange
feature
liability
March 31,
2011
|
| Exchange
Feature
Liability
March 31,
2011
|
| Comments
|
|---|
| March 2010 Offering | | | | Convertible Debenture | | | 19,000,000 | | | $ | 1,680,000 | | | $ | 600,000 | | | $ | 2,280,000 | | | | See Note 10 | |
| November 2010 Offering | | | | Common Stock and Warrants | | | 1,750,000 | | | | 219,168 | | | | (9,299 | ) | | | 209,869 | | | | See Note 12 | |
| December 2010 Offering | | | | Common Stock and Warrants | | | 1,750,000 | | | | 228,262 | | | | (11,962 | ) | | | 216,300 | | | | See Note 12 | |
| | | | | Totals | | | 22,500,000 | | | $ | 2,127,430 | | | $ | 578,739 | | | $ | 2,706,169 | | | | | |
NOTE 13 — STOCK OPTIONS AND WARRANT GRANTS
On April 15, 2010 the Board of Directors granted an aggregate award of 900,000 stock options to a former executive officer and former director and one director. The options vest over a period of three years with an exercise price of $0.65 (fair market value of the Company’s common stock as of the date of grant) with expiry five years from the date of award. Effective February 7, 2011, with the resignation of a director, the unvested portion of the
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stock options has lapsed, and ceases to vest. The balance of the stock option expense of the April 15, 2010 award is as follows:
Date
| | | | Stock Option
Expense
|
|---|
| April 15, 2011 | | | | $ | 62,127 | |
| April 15, 2012 | | | | $ | 82,836 | |
| April 15, 2013 | | | | $ | 20,709 | |
As of March 31, 2011 and 2010, $25,886 and $0, respectively, has been recorded in the consolidated condensed statements of operations and comprehensive loss for stock based compensation.
During the three month period ended March 31, 2011, no stock options or warrants were issued.
A summary of option transactions, including those granted pursuant to the terms of certain employment and other agreements is as follows:
Details
| | | | Stock
Purchase
Options
| | Weighted
Average
Exercise Price
|
|---|
| OUTSTANDING, JANUARY 1, 2010 | | | | | 3,670,000 | | | $ | 0.76 | |
| Granted | | | | | 900,000 | | | | ($0.65 | ) |
| Expired | | | | | (1,765,000 | ) | | | ($0.97 | ) |
| |
| OUTSTANDING, DECEMBER 31, 2010 | | | | | 3,600,000 | | | | ($0.68 | ) |
| |
| Expired | | | | | (200,000 | ) | | | ($0.65 | ) |
| |
| OUTSTANDING, DECEMBER 31, 2010 | | | | | 3,400,000 | | | $ | 0.67 | ) |
At December 31, 2010, the outstanding options have a weighted average remaining life of 20 months. All options issued prior to 2010 have vested, and the April 15, 2010 options vest over a period of three years, in three equal parts each year.
The weighted average fair value of options granted during 2010 was $0.41 and was estimated using the Black-Scholes option-pricing model, using the following assumptions:
| | | | 2010
|
|---|
| Expected volatility | | | | 117% |
| Risk-free interest Rate | | | | 1.08% |
| Expected life | | | | 4 yrs |
| Dividend yield | | | | 0.00% |
| Forfeiture rate | | | | 0.00% |
The Black-Scholes options-pricing model used by the Company to calculate options and warrant values, was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock purchase options and warrants. The model also requires highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated values. Accordingly, management believes that this model does not necessarily provide a reliable single measure of the fair value of the Company’s stock options and warrants.
At March 31, 2011, the Company had outstanding options as follows:
Number of
Options
| | | | Exercise
Price
| | Expiration Date
|
|---|
| 2,150,000 | | | | $ | 0.71 | | | | February 16, 2012 | |
| 100,000 | | | | $ | 1.00 | | | | February 8, 2013 | |
| 250,000 | | | | $ | 0.27 | | | | August 6 ,2013 | |
| 900,000 | | | | $ | 0.65 | | | | April 15, 2015 | |
| 3,400,000 | | | | | | | | | | |
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Warrants issued in connection with various private placements of equity securities, are treated as a cost of capital and no income statement recognition is required. A summary of warrant transactions is as follows:
Details
| | | | Warrant
Shares
| | Weighted
Average
Exercise Price
|
|---|
| OUTSTANDING, JANUARY 1, 2010 | | | | | — | | | $ | — | |
| Granted | | | | | 1,545,000 | | | $ | 0.65 | |
| Exercised | | | | | — | | | $ | — | |
| Expired | | | | | — | | | $ | — | |
| |
| OUTSTANDING, DECEMBER 31, 2010 & MARCH 31, 2011 | | | | | 1,545,000 | | | $ | 0.65 | |
Effective November 9, 2010 and December 8, 2010, the Company closed on its first tranche and second tranche of a unit offering in the amount of $300,000 per tranche for gross proceeds of $600,000 whereby the Company issued 1,500,000 units. The unit offering is for up to $5 million. The units are in the form of shares of the Company’s common stock, par value $0.001 at $0.40 per share plus for each share of Common Stock subscribed to under the unit offer the investor will receive one warrant exercisable for 1 share of common stock, the exercise price will be $0.55; if an Investor Warrant is exercised between the first and second years from issuance, the exercise price will be $0.65. All investor warrants as issued will be subject to adjustment in all respects in the event of a stock split or similar adjustment by the Company. A commission of 4% of the gross proceeds was paid and 7.5 units for every $100 of the gross proceeds raised are payable for brokers fees.
No warrants were issued during the three month period ended March 31, 2011.
NOTE 14 — RELATED PARTY TRANSACTIONS
In addition to fees and salaries and reimbursement of business expenses, during the three month period ended March 31, 2011 transactions with related parties include:
| • | | $3,000,000 issuance of unsecured subordinated promissory notes (the information required by this item is included in Note 7 to the consolidated financial statements). |
| • | | The effect of an exchange feature included in the terms of the Share Subscription Agreement for $3,000,000 of Convertible Debentures issued on March 19, 2010 (“2010 Debentures”) and fully converted including interest into 6,007,595 shares of common stock on March 25, 2010. The exchange feature provides that if within twelve months from March 19, 2010, the Company enters into or closes another financing or other transaction (which for securities law purposes would be integrable with the offer and sale of the Securities) on terms and conditions more favorable to another purchaser, the terms and conditions of the 2010 Debentures shall be adjusted to reflect the more favorable terms. The exchange feature was determined by the Company to be freestanding financial instrument and also to be a liability within the scope of ASC 480 Distinguishing Liabilities from Equity since there is an inverse relationship between the stock price of the Company and the Company’s obligation. On December 31, 2010, the Company evaluated the fair value of the exchange feature based on the probability of closing another financing by March 18, 2011 and the fair value of the number of incremental shares to be issued at a lower estimated issue price. The probability of closing another financing by March 18, 2011 was estimated to be 100% on December 31, 2010. The fair value of the Company’s common stock is determined by the closing price on the valuation date. On December 31, 2010, an exchange feature liability of $1,680,000 was recorded for the 2010 Debentures (see also note 12). Effective February 17, 2011, the Company and the 2010 Debenture investors reached an agreement whereby the investors will receive an approximate aggregate of 19,000,000 additional shares of Common Stock in conjunction with certain rights under the Prior Subscription Agreements in the event the Company closes a qualified offering (see note 7 for details). At March 31, 2011 the exchange feature liability related to the convertible debentures was re-valued to $2,258,739 with the change in fair value of exchange feature liability of $578,739 expense recorded in the consolidated condensed statements of operations and comprehensive loss. In March 2010, Orchard Investments, LLC invested $1 million in the $3 million convertible debentures offering; of the exchange feature liability $752,913 is attributed to the investment made by Orchard Investments, LLC (“Orchard”) based on their relative contribution to the March 2010 |
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| | subscription. Orchard will receive 6,333,333 additional shares of Common Stock in conjunction with certain rights under the Prior Subscription Agreements in the event the Company closes the Qualified Offering (see note 7 for details of the Qualified Offering) |
| • | | $50,000 related to services provided by Orchard Capital Corporation under a services agreement effective January 30, 2011 as further disclosed in Note 18. |
Mr. Nitin Amersey who is a director of the Company is listed as a control person with the Securities and Exchange Commission of Bay City Transfer Agency Registrar Inc. the Company’s transfer agent. He has no ownership equity in Bay City Transfer Agency Registrar Inc. nor is he an officer or a director of Bay City Transfer Agency Registrar Inc. For the three month period ended March 31, 2011 and 2010, the Company paid Bay City Transfer Agency Registrar Inc. $1,325 and $0, respectively.
During the three month period ended March 31, 2010 transactions with related parties included $6,134,024 related to conversion of convertible debentures including interest of $634,024 thereon into common stock; $1,292,894 related to inducement on early conversion of convertible debentures; and the repayment of $511,342 principal and interest on promissory note in addition to salaries and reimbursement of business expenses.
NOTE 15 — COMMITMENTS AND CONTINGENCIES
LEASES
Effective November 24, 2004, the Company’s wholly-owned subsidiary, ESWA, entered into a lease agreement for approximately 40,220 square feet of leasehold space at 2 Bethlehem Pike Industrial Center, Montgomery Township, Pennsylvania. The leasehold space houses the Company’s research and development facilities. The lease commenced on January 15, 2005 and expired January 31, 2010. Effective October 16, 2009, the Company’s wholly-owned subsidiary ESW America, Inc. entered into a lease renewal agreement with Nappen & Associates for the leasehold property at Pennsylvania. There were no modifications to the original economic terms of the lease under the lease renewal agreement. Under the terms of the lease renewal, the lease term will now expire February 28, 2013. Effective March 31, 2011, ESW America, Inc. entered into a lease amendment agreement with Nappen & Associates for the leasehold property at Pennsylvania, whereby ESWA has the sole option to extend the expiry of the lease agreement by an additional 3 years six months prior to February 28, 2013; there were no modifications to the original economic terms of the lease.
Effective December 20, 2004, the Company’s wholly-owned subsidiary, ESWC, entered into an offer to lease agreement for approximately 50,000 square feet of leasehold space in Concord, Ontario, Canada. The leasehold space houses the Company’s executive offices and a high volume manufacturing plant. The possession of the leasehold space took place on May 24, 2005 and the term of the lease was extended to September 30, 2010. ESWC renewed its lease agreement at the current property for an additional five year term. The renewed lease period commenced on October 1, 2010 and ends on September 30, 2015.
The following is a summary of the minimum annual lease payments, for both leases.
Year
| | | |
|---|
| 2011 | | | | $ | 351,021 | |
| 2012 | | | | | 468,029 | |
| 2013 | | | | | 319,813 | |
| 2014 | | | | | 297,476 | |
| 2015 | | | | | 223,107 | |
| | | | | $ | 1,659,446 | |
LEGAL MATTERS
From time to time, the Company may be involved in a variety of claims, suits, investigations and proceedings arising from the ordinary course of our business, breach of contract claims, labor and employment claims, tax and other matters. Although claims, suits, investigations and proceedings are inherently uncertain and their results cannot be predicted with certainty, ESW believes that the resolution of current pending matters will not have a
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material adverse effect on its business, consolidated financial position, results of operations or cash flow. Regardless of the outcome, litigation can have an adverse impact on ESW because of legal costs, diversion of management resources and other factors. In addition, it is possible that an unfavorable resolution of one or more such proceedings could in the future materially and adversely affect ESW’s financial position, results of operations or cash flows in a particular period.
CAPITAL LEASE OBLIGATION
The Company is committed to the following lease payments in connection with the acquisition of equipment under capital leases:
Year
| | | |
|---|
| 2011 | | | | $ | 2,124 | |
| 2012 | | | | | 1,180 | |
| TOTAL | | | | | 3,304 | |
| Less imputed interest | | | | | (179 | ) |
| Total obligation under capital lease | | | | | 3,125 | |
| Less current portion | | | | | (1,806 | ) |
| TOTAL LONG-TERM PORTION | | | | $ | 1,319 | |
The Company incurred $80 and $515 of interest expense on capital lease obligation for the periods ended March 31, 2011 and 2010, respectively.
RESTRUCTURING EXPENSES AND SEVERANCE AGREEMENTS
Restructuring charges relate to changes in the management and reductions in work force of the Company’s subsidiary ESW Canada Inc., and consist of mainly of severance agreements amounting to $478,274, travel costs of $24,127 and legal fees of $16,408 associated with restructuring activities. The Company accrued a portion of the expenses related to severance agreements with a former Chief Executive Officer, Vice President of Operations and Director of Sales. As of March 31, 2011, $310,947 (March 31, 2010 — $0) was included in accrued liabilities towards the balance of severance payments owing.
NOTE 16 — LOSS PER SHARE
Potential common shares of 3,400,000 related to ESW’s outstanding stock options, 1,500,000 shares related to ESW’s outstanding warrants, potential common shares of 33,333,333 from the exchange of unsecured subordinated promissory notes and 22,500,000 shares of common stock under the exchange feature liability were excluded from the computation of diluted loss per share for the three month period ended March 31, 2011.
Potential common shares of 3,495,000 related to ESW’s outstanding stock options were excluded from the computation of diluted loss per share for the period ended March 31, 2010.
The reconciliation of the number of shares used to calculate the diluted loss per share is calculated as follows:
| | | | For the three month period ended
March 31, | |
|---|
| | | | 2011
| | 2010
|
|---|
NUMERATOR
| | | | | | | | | | |
| Net loss for the period | | | | $ | (3,134,632 | ) | | $ | (4,997,559 | ) |
| Interest on long term debt | | | | | — | | | | 183,858 | |
| Amortization of deferred costs | | | | | — | | | | 117,131 | |
| Long term debt accretion | | | | | — | | | | 768,981 | |
| Inducement premium | | | | | — | | | | 2,909,872 | |
| Change in fair value of exchange feature liability | | | | | 578,739 | | | | — | |
| Interest accretion expense | | | | | 1,050,000 | | | | — | |
| Financing charge on embedded derivative liability | | | | | 485,101 | | | | — | |
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| | | | For the three month period ended
March 31, | |
|---|
| | | | 2011
| | 2010
|
|---|
| Gain on convertible derivative | | | | $ | (1,336,445 | ) | | $ | — | |
| Bank fees related to credit facility covenant waivers | | | | | 106,512 | | | | — | |
| Interest on note payable to related party | | | | | 34,521 | | | | 11,307 | |
| | | | | $ | (2,219,754 | ) | | $ | (1,006,410 | ) |
DENOMINATOR
| | | | | | | | | | |
| Weighted average number of shares outstanding | | | | | 129,463,767 | | | | 77,694,404 | |
Dilutive effect of :
| | | | | | | | | | |
| Stock options | | | | | — | | | | — | |
| Warrants | | | | | — | | | | — | |
| Exchange of unsecured subordinated promissory notes | | | | | — | | | | — | |
| Exchange feature liability shares | | | | | — | | | | — | |
| DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING | | | | | 129,463,767 | | | | 77,694,404 | |
NOTE 17 — COMPARATIVE FIGURES
Certain 2010 figures have been reclassified to conform to the current financial statement presentation.
NOTE 18 — SUBSEQUENT EVENTS
CONTRACTS AND AGREEMENTS
On April 19, 2011, the Company’s board of directors ratified a Services Agreement (“Agreement”) between the Company and Orchard Capital Corporation (“Orchard”) which was approved by the Company’s Compensation Committee. Under the Agreement, which will be effective as of January 30, 2011, Orchard will provide services that may be mutually agreed to by and between Orchard and the Company including those duties customarily performed by the Chairman of the Board and executive of the Company as well as providing advice and consultation on general corporate matters and other projects as may be assigned by the Company’s Board of Directors as needed. Orchard has agreed to appoint Mark Yung, who is also employed by Orchard, as the Company’s Executive Chairman to act on Orchard’s behalf and provide the services to the Company under the Agreement. Orchard reserves the right to replace Mr. Yung as the provider of services under the Agreement at its sole option. The Agreement may be terminated by either party upon thirty (30) days written notice unless otherwise provided for under the Agreement. Compensation under the agreement is the sum of $300,000 per annum plus reimbursement for out-of-pocket expenses incurred by Orchard. The agreement includes other standard terms including indemnification and limitation liability provisions. Orchard is controlled by Richard Ressler; affiliated entities of Orchard as well as Richard Ressler own shares of the Company.
COMPENSATION
On April 19, 2011, the Company’s board of directors ratified a modification of the board compensation structure as approved by the Company’s Compensation Committee. As a part of the modified compensation policy the board of directors ratified and approved a reduction and change in the composition in the fees paid to the chairpersons of the various board committees and other board members, as well as an amendment to the Company’s 2010 Stock Incentive Plan (the “Plan”) so as to permit the issuance of restricted shares of the Company’s Common Stock to directors in addition to executive officers and employees as previously provided for under the Plan. The amendment to the Plan permits for board fees to be paid in the form of the Company’s restricted common stock for all non-executive board members, with a cash component for the chairpersons of the various board committees. Previously, the board fee policy consisted of cash and options for all board members.
Previously, the board fee policy consisted of cash of $2,500 per month and an additional $1,000 per month for audit committee chairperson and additional $2,000 per month for Chairman of the board.
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The revised board compensation structure is as follows:
| • | | Chairperson for the Company’s Audit and Compensation Committees each receive cash compensation of two thousand five hundred ($2,500) dollars per month effective April 1, 2011 as well as 200,000 shares of the Company’s restricted common stock annually (prorated for the current fiscal year so that said amount would be 150,000 shares) under the Company’s 2010 Incentive Stock Option Plan (the “Plan”). |
| • | | For outside directors who do not serve as a Chairperson of the Company’s Audit or Compensation Committee, there would be no cash compensation for previously accrued Board fees through March 31, 2011, said fees would be converted into shares of the Company’s restricted common stock issued under the Plan in addition, the outside directors not serving as Chairpersons of either the Audit or Compensation Committees would receive the Company’s restricted common stock in the amount of 200,000 shares annually (prorated for the current fiscal year so that said amount would be 150,000 shares) under the Plan. |
| • | | For inside Board members and the Company’s current Executive Chairman, there would be no cash compensation for previously accrued Board fees through February 28, 2011, said fees would be converted into shares of the Company’s restricted common stock issued under the Plan if permitted under the Plan. |
UNSECURED SUBORDINATED PROMISSORY NOTES
On May 3, 2011, the Company entered into certain note subscription agreements and issued unsecured subordinated promissory notes (collectively the “Loan Agreements”) with Orchard Investments, LLC (“Orchard”); Black Family 1997 Trust; Leon D. Black, UAD 11/30/92 FBO Alexander Black; Leon D. Black, UAD 11/30/92 FBO Benjamin Black; Leon D. Black, UAD 11/30/92 FBO Joshua Black; Leon D. Black, UAD 11/30/92 FBO Victoria Black; Leon D. Black; John J. Hannan and Richard Ressler (“Ressler”)(each individually a “Subordinated Lender” or “Holder” and collectively the “Subordinated Lenders” or “Holders”) who are current shareholders and subordinated lenders under prior loan agreements in the aggregate amount of $3 million with the Company entered into February 17, 2011 and may be deemed affiliates of the Company. The Loan Agreements were approved by the Company’s independent directors. Pursuant to the Loan Agreements, the Subordinated Lenders agreed to make, and made, loans to the Company in the principal aggregate amount of $1 million (the “Loan”), subject to the terms and conditions set forth in the Loan Agreements and represented by unsecured subordinated convertible promissory notes (the “Notes”), effective as of April 27, 2011.
Proceeds of the Loan, along with available cash, will be used by the Company to fund working capital.
The Loan bears interest at a rate of 10% per annum, payable in-kind on a monthly basis commencing May 27, 2011, up to the date on which the Notes have been paid in full. The maturity date of the Loan is the earlier of: (i) the consummation of a rights offering of the Company’s Common Stock, par value $.001 (the “Common Stock”) registered under the Securities Act of 1933, as Amended (the “Act”), at a sale price of $0.12 per share (as adjusted for any stock split, stock dividend or other similar adjustment) pursuant to a rights offering targeted at $8 million by the Company that raises at least an incremental $2.5 million of cash for the Company and also permits all Subordinated Lenders to exchange their Notes (and the other notes paid in-kind for the payment of interest under the Notes) for shares of Common Stock at such price (with such offering referred to as the “Qualified Offering”) or (ii) June 14, 2011 (the “Outside Date”). The Qualified Offering has also been approved by the independent directors of the Company. There can be no assurance, however, that the Company will successfully complete the Qualified Offering on or prior to the Outside Date or thereafter.
In the event the Qualified Offering does not take place on or before the Outside Date, then the Subordinated Lenders at their sole option, may require the Company to refrain from making any and all payments on any of the outstanding principal and accrued interest outstanding under the Notes, however the Company will not be prohibited from paying any accrued interest in-kind through the issuance of substantially similar Notes, at any time. The Holders of the Note at their sole option may extend the Outside Date.
In the event the Qualified Offering closes on or prior to the Outside Date and for any reason Ressler or Orchard as Holders collectively shall have failed to have invested at least $1 million in the Qualified Offering or pursuant to the Investment Agreement, and Ressler or Orchard wish to invest the balance of such $1 million aggregate amount to purchase Common Stock at a price of $0.12 per share (as adjusted for any stock split, stock dividend or other
F-52
similar adjustment), then the Company will be required to offer Ressler or Orchard the immediate right to invest the balance of such investment amount to purchase additional shares of Common Stock at such price, so that in the aggregate, Ressler and Orchard shall have collectively invested such $1 million amount.
Concurrent with entering into the Loan Agreements and issuance of the Notes, the commercial lender of the Company and its subsidiaries; the Company and its subsidiaries; and the Subordinated Lenders entered into an Amendment to the Postponement and Subordination Agreement (the “Subordination Agreement”) whereby the Subordinated Lenders agreed that the Notes as issued, in addition to the notes issued on February 17, 2011 by the Company to the Subordinated Lenders, would be subordinate to the obligations of the Company and its subsidiaries under the Credit Agreement with the Company’s commercial lender.
INVESTMENT AGREEMENT
Effective May 10, 2011, the Company entered into an Investment Agreement (the “Investment Agreement”) with Orchard Investments, LLC (“Orchard”); Black Family 1997 Trust; Leon D. Black, UAD 11/30/92 FBO Alexander Black; Leon D. Black, UAD 11/30/92 FBO Benjamin Black; Leon D. Black, UAD 11/30/92 FBO Joshua Black; Leon D. Black, UAD 11/30/92 FBO Victoria Black; Leon D. Black; John J. Hannan and Richard Ressler (“Ressler”) (each individually a “Bridge Lender” and collectively the “Bridge Lenders”), who are current shareholders and subordinated lenders under unsecured promissory notes in the aggregate amount of $4.0 million with the Company effective February 17, 2011 and April 27, 2011 (the “Notes”).
Pursuant to the Investment Agreement, the Bridge Lenders have agreed to provide a backstop commitment to the Qualified Offering and have agreed to collectively backstop the Qualified Offering by purchasing from the Company at a subscription price of $0.12 per share of Common Stock any shares not purchased by the Company’s shareholders of record who are entitled to participate in the rights offering (after giving effect to any oversubscriptions) up to 29,166,667 shares of Common Stock for a total purchase price of $3.5 million (the “Backstop Commitment”). In addition to their rights to purchase shares pursuant to the Qualified Offering and the Backstop Commitment, the Bridge Lenders have the option, in their sole discretion, to purchase from the Company, at the subscription price, any other shares not purchased by the Company’s stockholders through the Qualified Offering (the “Purchase Option”). If, after giving effect to the Qualified Offering, the Backstop Commitment and the Purchase Option, any of the Bridge Lenders shall have been unable to exchange any portion of his or its Notes, the Company will also offer each Bridge Lender the right to purchase additional shares of Common Stock at the subscription price (payable through the exchange of Bridge Loans for Common Stock) such that each Bridge Lender shall have exchanged all of his or its notes for shares of Common Stock (the “Additional Subscription Offer”). In addition, if Ressler and Orchard collectively acquire less than $1.0 million worth of shares of Common Stock as part of the Qualified Offering, the Backstop Commitment, the Purchase Option and the Additional Subscription Offer, the Company has agreed to offer to Ressler and Orchard an additional number of shares of Common Stock equal to the shortfall amount at the subscription price.
The transactions with the Bridge Lenders under the Investment Agreement are being made in reliance on an exemption from the registration requirements of the Act, and any shares issued pursuant to the Investment Agreement will not be covered by a registration statement filed pursuant to the Act.
The closing of the Investment Agreement is subject to satisfaction or waiver of customary conditions, including compliance with covenants and the accuracy of representations and warranties provided in the Investment Agreement, consummation of the Qualified Offering and the receipt of all requisite approvals and authorizations under applicable law. In addition, a condition to the closing the Investment Agreement provides that the Company will enter into a registration rights agreement with the Bridge Lenders to provide certain customary registration rights, which include demand and “piggyback” registration rights under the Act with respect to the shares of Common Stock purchased under the Investment Agreement and any other securities owned by the Bridge Lenders.
The Investment Agreement may be terminated at any time prior to the closing of the Backstop Commitment and the Additional Subscription Rights, if any: (1) by mutual written agreement of the Bridge Lenders and the Company; (2) by either party, in the event the rights offering does not close; and (3) by either party, if any governmental entity shall have taken action prohibiting any of the contemplated transactions.
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The Company has agreed to indemnify the Bridge Lenders and their affiliates and each of their respective officers, directors, partners, employees, agents and representatives for losses arising out of (1) the Company’s breach of any representation or warranty set forth in the Investment Agreement, (2) the Qualified Offering, or (3) claims, suits or proceedings challenging the authorization, execution, delivery, performance or termination of the Qualified Offering, the Investment Agreement, or any of the transactions contemplated thereby (other than any such losses attributable to the acts, errors or omissions on the part of the Bridge Lenders in violation of the Investment agreement).
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