UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
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| Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
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For the fiscal year ended May 31, 2008 | ||
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| Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission file number 000-50450
OPEN ENERGY CORPORATION
(Name of small business issuer in its charter)
Nevada |
| 98-0370750 |
(State or other jurisdiction of incorporation or organization) |
| (I.R.S. Employer Identification No.) |
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514 Via de la Valle, Suite 200 |
| 92075 |
(Address of principal executive offices) |
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(858) 794-8800
(Issuer’s telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Exchange Act:
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Securities registered pursuant to Section 12 (g) of the Exchange Act:
Common Stock, par value $0.001 per share
(Title of class)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
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Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act.
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Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
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The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant (based on the average bid and asked price of such stock on such date) as of November 30, 2007 (the last business day of the registrants most recently completed second fiscal quarter) was approximately $32,035,000. (See definition of affiliate in Rule 12b-2 of the Exchange Act.) Without acknowledging that any individual director of registrant is an affiliate, all directors have been included as affiliates with respect to shares owned by them.
At August 22, 2008, there were 127,952,397 shares outstanding of the issuer’s common stock, the only class of common equity.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the information required by Part III of this Form 10-K are incorporated by reference from our definitive proxy statement to be delivered to stockholders in connection with our 2007 Annual Meeting of Stockholders.
Transitional Small Business Disclosure Format (Check one) Yes o No x
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CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM |
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth under the heading “Risk Factors” and elsewhere in, or incorporated by reference into, this report.
In some cases, you can identify forward looking statements by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “ believe, “ “ anticipate, “ “estimate,” “predict,” “potential,” or the negative of these terms, and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date hereof. Except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. The forward-looking statements in this report are based upon management’s current expectations and belief, which management believes are reasonable. These statements represent our estimates and assumptions only as of the date of this Annual Report on Form 10-K. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor or combination of factors, or factors we are aware of, may cause actual results to differ materially from those contained in any forward looking statements. You are cautioned not to place undue reliance on any forward-looking statements.
You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including:
· significant uncertainty inherent in the renewable energy industry including, without limitation the current scheduled expiration of the Federal Investment tax credit on December 31, 2008;
· intense and increasing competition from other “clean” renewable energy companies and conventional fossil fuel based energy companies; new competitors are likely to emerge and new technologies may further increase competition;
· our operating costs may increase beyond our current expectations and we may be unable to fully implement our current business plan;
· our ability to obtain future financing or funds when needed;
· our ability to successfully obtain a diverse customer base;
· our ability to protect our intellectual property through patents, trademarks, copyrights and confidentiality agreements;
· our ability to attract and retain a qualified employee base;
· our ability to respond to new developments in technology and new applications of existing technology before our competitors;
· acquisitions, business combinations, strategic partnerships, divestures, and other significant transactions may involve additional uncertainties;
· our ability to maintain and execute a successful business strategy; and
· we may face other risks described from time to time in periodic and current reports we file with the United States Securities and Exchange Commission, or SEC.
Other risks and uncertainties include such factors, among others, as market acceptance and market demand for the Company’s technologies and services, pricing, the changing regulatory environment, the effect of the Company’s accounting policies, potential seasonality, industry trends, adequacy of the Company’s financial resources to execute its business plan, the Company’s ability to attract, retain and motivate key technical, marketing and management personnel, possible disruption in commercial activities occasioned by terrorist activity and armed conflict, and other risk factors detailed in the Company’s other SEC filings. You also should consider carefully the statements under “Risk Factors” and other sections of this report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.
In this report, unless the context indicates otherwise, the terms “Open Energy,” “Company,” “we,” “us,” and “our” refer to Open Energy Corporation, a Nevada corporation, and its subsidiaries.
Company History
Open Energy Corporation is a renewable energy company focused on the development and commercialization of a portfolio of solar technologies for residential, commercial and industrial applications. The Company currently designs, manufactures and distributes building-integrated photovoltaic (BIPV) roofing tiles, roofing membranes and architectural photovoltaic glass products under the SolarSave® trade name. The Company maintains two facilities: A corporate office in Solana Beach for senior management, marketing, sales, customer service, legal and finance and a facility in Grass Valley, California for product design, project engineering, prototyping, custom glass manufacturing, and materials management.
Our company was originally incorporated in the State of Nevada on April 11, 2002 under the name Barnabus Enterprises Ltd., as a traditional oil and gas developer. By 2005, it had acquired gas leases and a number of existing and proposed gas wells, and a small refinery in Alberta, Canada. This network tied into a transport pipeline leading into the United States, where a premium for production could be obtained. In June 2005, we made a strategic business decision to shift our focus to renewable energy. Motivated by the growth in wind, solar and other alternative technologies and believing that market forces and legislative incentives were in place to support rapid growth of the domestic solar industry, we decided to transform the Company.
In August 2005, we signed an exclusive international license for SunCone™ CSP (concentrating solar power) technology. SunCone™ CSP was invented by Dr. Melvin Prueitt, a physicist, inventor and former senior research scientist at the Los Alamos National Laboratory. SunCone ™ CSP utilizes curved geometries and reflective surfaces to collect solar thermal energy, which can then be used to perform work. Potentially, this energy can drive a turbine to produce electricity, or purify water using multi-stage flash distillation or membrane filtration devices. The first prototype was designed and built by Hytec Engineering of Los Alamos, New Mexico, and initial testing of this prototype system was successful.
In December 2005, we sold our oil and gas holdings. In the first half of calendar 2006, we acquired Toronto-based Solar Roofing Systems, Inc. (SRS), which was engaged in the manufacture of SolarSave® photovoltaic (PV) roofing membrane, and California-based Connect Renewable Energy, Inc. (CRE), which was engaged in the manufacture of PV integrated roofing tiles. Both companies’ products were light-weight, fire-rated, weather-resistant, building-integrated PV roofing materials, and these acquisitions provided our company with proprietary, photoelectric products, and expanded our manufacturing, marketing, sales and service capabilities. In April 2006, we changed our name to Open Energy Corporation to better reflect our mission, vision and strategic objectives.
In December 2006, we acquired WaterEye, a Grass Valley, California based company with proprietary, web-enabled water monitoring software. WaterEye provided ongoing revenues, water treatment expertise and, potentially, a technology platform for monitoring and displaying our PV installations.
In April 2007, we signed a master distribution agreement with privately held Eagle Roofing Products, one of the largest manufacturers of cement tiles in North America. This strategic alliance provides our company with access to major home developers and roofing contractors across the country. We sell our residential tile products through this distribution pipeline, and utilize roofing contractors, electricians, and other members of the traditional building trades as our installation and service providers.
Realizing that the solar industry was quickly becoming commoditized and that we would never be competitive as a low-cost manufacturer, in May of 2007, we signed a memorandum of understanding with Suntech Power Holdings (NYSE: STP) to manufacture our tile and PV glass products in China. We believe this relationship has the potential to provide the production volume required to compete for a significant share of the U.S. residential and commercial solar electric marketplace. We also hired Chris Gopal as our Executive Vice President of Worldwide Operations, a highly qualified executive in the field of supply chain management and outsourcing strategies.
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In November 2007, we signed a distribution agreement with Petersen-Dean Roofing Systems, one of the largest residential and commercial roofing contractors in the U.S., to distribute SolarSave® PV Tiles on homes across the country. The agreement includes a minimum commitment to purchase the Company’s products, including tiles, membranes and balance of system equipment.
In December 2007, our board of directors approved a plan to shut down operations at our Aurora, Ontario, facility in Canada. Existing operations and specified assets at our Aurora facility were transferred to our Grass Valley, California facility and, by January 31, 2008, substantially all of our employees at the Aurora facility were terminated.
The Energy Industry
Continued Growth in Global Energy Use Is Projected
According to the Energy Information Administration’s “Annual Energy Outlook 2007,” over the course of the next 22 years, the global consumption of electricity is expected to increase from 3,660 billion kilowatt hours in 2005 to over 5,000 billion kilowatt hours by 2030. Approximately 63% of this increase in demand is predicted to come from the commercial sector, 39% from the residential sector, and 17% from the industrial sector. Population growth, escalating demand for more electrical products and manufacturing equipment, the lighting, heating and cooling of our built environment, and a shift toward electric powered vehicles will all contribute to this growth in electricity usage.
Approximately 70% of the world’s electricity is generated by burning fossil fuels (coal, oil and natural gas) to create steam and turn turbines. Nuclear reactors contribute about 21% of our power, hydroelectric dams account for 6%, with just over 3% of mankind’s energy demand currently being met by renewable resources such as solar, wind, geothermal, biofuels and biomass conversion, and small hydro.
Expanding Global Demand for Renewable Energy Alternatives
A number of factors are currently contributing to the rapid growth of renewable energy (RE) alternatives. The first factor is the recognition that fossil fuels are a limited, non-renewable resource. The World Energy Council has estimated that based on proven operable reserves, the world will run out of oil in approximately 44 years and burn through readily available natural gas in 63 years. Most of these resources exist in politically unstable territories, or environmentally sensitive regions such as the polar circle or coastal waters. Finite fossil fuel availability coupled with dramatically rising energy demands from Asia have driven the cost of oil and gas to unprecedented heights. There are over 230 years of coal in the ground, but the environmental impacts of burning coal are devastating, accounting for 51% of all green house gas (GHG) emissions.
At the same time, there is a growing recognition by the scientific community and the public at large that GHG emissions from our power plants, motor vehicles, factories and buildings are contributing to global warming. The United Nations Framework Convention on Climate Change (the Kyoto Protocol), signed into law by 154 nations, provided a basis for international cooperation on the issue of global warming. The 2007 Stern Report on the Economics of Climate Change concluded that if we do not collectively reduce the use of fossil fuels, adopt energy efficiency technologies and slow deforestation, the cost impacts of global warming will exceed 5% of world GDP per year. In contrast, taking action to reduce the levels of CO2 in the atmosphere will cost less than 1% of GDP and will more likely represent significant opportunities for economic growth and development.
Rising fuel and electricity prices, a desire for energy security, and concerns about global climate change have led to the rapid growth of alternative energy technologies. According to Eric Martinot, senior research fellow at Worldwatch Institute, over $100 billion was invested in 2007 in renewable energy.
Installations of photovoltaic systems connected to electrical grids experienced over 50% annual increases in both 2006 and 2007 on a worldwide basis. Motivated by solid government subsidies, tax incentives and feed-in tariffs (requiring utilities to buy power generated by privately owned PV systems), Germany and Japan have led the world in PV production capacity and solar installations. Germany accounted for fully half of the solar electric market in 2006, but now Spain, California, France, Greece, and Italy are gaining traction. According to Renewable Energy World’s Global Status Report, there is now an estimated 7.8 gigawatts of installed solar capacity, or about 1.5 million homes.
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Distributed Generation and the Growth of Domestic Solar
An underlying consideration concerning the delivery of electricity is the location of the generation source relative to the location of the end-use consumption. Over the past century, the economics of power plant construction supported larger and larger central station sites linked to transmission lines spanning great distances to reach the ultimate consumer. The economic considerations of centralized power plants have been altered by the advent of smaller scale technologies that can provide electricity at competitive prices near the place of consumption. The combination of economic factors and of advances in generation technologies opens the market to an opportunity for “distributed generation” of electricity in combination with traditional grid resources. Our PV products are directed at this renewable distributed generation environment.
The market for PV modules and cell shipments in the United States has undergone significant growth in the last several years. According to the U.S. Department of Energy, solar power production expanded from 48,664 peak kilowatts in 2003, to over 78,000 in 2004, and over 134,000 kW in 2005. Demand for residential and commercial solar systems is dependent upon: government policies and incentive programs; technological developments (i.e. higher cell efficiencies, lower system costs); investment in manufacturing capacity (particularly polysilicon plants); market development; and consumer behavior.
U.S. Energy Policy & Pending Legislation
At the federal level, the United States has been relatively slow to commit to solid, long-term support for renewable energy. The Federal Energy Policy Act signed into law by President Bush in January 2006, provided for 30% investment tax credits (capped for residential installations at $2,000, but uncapped for corporations installing commercial systems), as well as 5-year accelerated depreciation, and a modest renewable energy portfolio standard. These investment tax credits (ITC’s) have led to significant domestic investment in commercial PV installations. Unfortunately, these federal solar incentives are set to expire at the end of 2008 and, as of the date of this filing, Congress has failed to extend the ITC’s, creating uncertainty in the solar energy industry, generally.
Fortunately, a number of U.S. states and cities have enacted a wide range of support programs including cash rebates, net metering policies, renewable energy credits, green building standards and other incentives to support the installation of solar electric systems. California’s 2007 $3.3 billion Solar Initiative, funded through the California Public Utilities Commission through 2017, leads the nation in financial incentives, providing rebates of the cost of specified solar generation systems for both residential and commercial systems. California further strengthened its commitment to develop a comprehensive approach to address climate change with the passage of Assembly Bill 32, which requires a reduction in greenhouse gas emissions to 1990 levels by 2020. The scoping plan for this bill includes reduced dependence on oil, increases use of solar power, expansion of California’s renewable energy portfolio standards, and a cap-and-trade program which will monetize the value of reducing carbon emissions.
Photovoltaic Systems
One of the most significant drawbacks of PV is the high initial system cost, which is due almost entirely to the high cost of PV cells, which in turn is dependent upon the cost and availability of semi-conductor grade silicon. Several new silicon processing plants are currently under construction, which are expected to ease the current silicon shortage. In 2005, 76% of U.S. module shipments were based upon crystalline silicon cells, with the remaining 24% being thin-film.
We currently utilize crystalline silicon PV cells in our products. PV cells offer high power generation per square foot. They are also highly reliable, with proven, long term, power output performance. Despite billions of dollars pouring into solar PV in the form of government incentive programs, subsidies and private investments, the industry remains less than 1% of the electrical power utilized globally today. Wide scale adoption of solar electric generation has been hampered by two important limiting factors: a shortage of silicon, and the high cost per watt of manufacturing traditional PV. Several new technologies show promise of overcoming these barriers. One of our key strategies is to remain technology agnostic. As these alternative technologies become commercially viable, we will incorporate them in products designed to provide customers with better solutions for their energy needs.
Our Strategy
According to the U.S. Department of Energy, every hour of every day the earth receives enough solar radiation to meet mankind’s entire energy requirements for a year. It is this power we intend to utilize in order to deliver safe, clean, cost competitive power to our residential, commercial and industrial customers. We participate in a marketplace that, while highly competitive, is experiencing
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significant growth. We do so with superior building-integrated products, an experienced leadership team, and a unique go to market strategy that we believe will lead to growth and shareholder value.
The following three strategic initiatives distinguish our approach from others in an industry that is increasingly becoming commoditized and price-driven:
1. We utilize the roofing products industry as our primary channel partner, co-designing, co-marketing and distributing our solar products through this well established industry.
We believe that the lowest cost per installed watt for rooftop solar applications can best be achieved by partnering with those already engaged in the production, distribution, installation and servicing of traditional roofing products. The channel begins with our established relationships with companies such as Eagle Roofing Products and Petersen-Dean and ends with trained roofers who seamlessly install our building-integrated products onto rooftops simultaneous with the installation of standard tile, membrane and shingle products. This avoids the problems created when multiple trades are engaged in the installation process, which can actually void existing roof warranties, as well as create construction and service issues.
Our focus on customer needs includes co-designing products with our channel partners to drive innovation, lower installation costs, and provide bundled services. Channel support services include system engineering and design, installation training, pre-sales and point-of-sales training, post-sales support, on-line real-time monitoring and display, warranty registration, and rebate processing. We have participated with our channel partners in the training of over 350 roofers and sales personnel to sell and install our products, which offers significant sales leverage at a relatively low cost to our company.
2. We outsource production in order to lower our costs, increase our capacity and better balance demand and supply of our proprietary best-in-class building integrated PV products.
We strive to be a leading edge designer of innovative PV products. We offer a suite of building-integrated photovoltaic, or “BIPV” products designed to blend seamlessly into and form a part of building materials already in use. While we will continue to develop innovative products, we will also evaluate licensing and purchasing options to acquire technologies developed by others. As thin film, nano-materials, vapor deposition and other innovations become commercially viable, we intend to use them to develop commercial products and bring them to market. We do not spend extensively on research, or carry expensive overhead that typically accompanies such efforts.
We outsource most of the steps in our manufacturing process in order to deliver high quality products in very large volumes to meet the demands of our customers. Our outsourced supply chain strategy matches supply and demand, while providing the lowest total installed cost to our customers. We utilize our Grass Valley, California facility to perform design, product development and specialty manufacturing and assembly functions.
3. We intend to offer financed solutions to the residential market through long-term power purchase agreements that will contribute to increased product sales and generate recurring revenues from the sale of energy.
In general, homeowners, commercial tenants and industrial operations do not buy power generating systems. They pay for power through their monthly utility bills. Although state rebates, federal tax incentives and other programs have reduced the costs of solar generation systems, they remain expensive to purchase. We have developed a plan we believe will provide a financial solution that monetizes the full array of tax incentives for the ultimate benefit of the residential energy consumer. Together with a tax equity partner, we will install solar generation systems in “solar communities.” We will coordinate the engineering, equipment procurement and construction of each project. We will contract with third parties to maintain the rooftop systems, to read the meters, and to bill the customers. The tax equity partner will receive a secure internal rate of return and the benefits of the 30% investment tax credit and 5-year accelerated depreciation under the 2005 U.S. Energy Bill. The builders will reduce their construction costs and, hopefully, sell their homes more quickly. The residential consumer will be guaranteed a reduced monthly utility bill and receive the benefits of incremental home value at no additional expense or tax impact. We believe we will sell more products and participate in the long term revenue streams associated with the sale of energy.
We are currently evaluating the possibility of licensing the intellectual property associated with our tile and membrane products. A license of one or both of these products to one or more parties on either a geographically limited or worldwide basis could have the effect of driving substantially greater sales volumes at substantially reduced overhead costs. We believe that a license strategy would
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exchange revenue growth for greater operational profitability. We anticipate that our channel distribution strategy would remain intact in a licensing scenario, and we would continue to provide pre- and post-sale services to our channel partners and end users.
Our Products
SolarSave® Roofing Tiles
SolarSave® PV Roofing Tiles are primarily targeted for residential housing projects, where the use of slate or ceramic tiles is prevalent. We have developed a line of PV tiles that blend seamlessly with the colors and edge profiles of the most commonly used cement tiles. SolarSave® Roofing Tiles are waterproof, fire-rated building materials that require no external framing or roof penetration. They can be safely and easily installed by professional roofing contractors. SolarSave® Tiles have the following features and benefits:
· Easily installed using Roof Tile Institute standards
· Class A Fire Rated, Certified to UL 1703 standards
· 25-year warranty to produce 80% power output
· Available in colors that match traditional cement tiles
· Edge profiles naturally shed water
· Modular, expandable system
· 200 pound/foot snow load capacity
· 125 mph wind load rating with clips installed
We have recently introduced the first generation of brown and terra cotta tiles to match brown and red tile roofs, which we believe significantly enhances the aesthetic potential of rooftop solar applications. Based on considerable feedback from our channel partners, we will soon be introducing brown and terra cotta tiles using colored solar cells into the market. Finally, we are presently designing and will soon be introducing an asphalt shingle product that is designed to provide a solar solution for the substantial majority of rooftops in the U.S. that are asphalt shingle-based.
SolarSave® Roofing Membranes
SolarSave® Roofing Membranes are a frameless, weather tight, fire rated, low maintenance product with superior aesthetics and power performance, generating between 400 and 450 watts per panel. Our membrane product is designed for flat or low slope commercial, industrial and institutional roofing applications. Our pre-sale market feedback has indicated that there is robust demand for the membrane product both in the U.S. and European markets. The membrane product has been UL approved for use with Duro-last, IB, Fibertite, Sarnafil, Carlisle and Cooley roofing membranes.
We are developing our next generation commercial membrane product. We have temporarily suspended shipments of our current membrane product due to a product corrosion issue. The membrane product is exhibiting random corrosion post-installation. The corrosion occurrence and rate of development may be exacerbated by heat, humidity, sunlight, and electrical current.
We have engaged Bodycote Testing Laboratories (a worldwide testing agency with multiple facilities in Toronto and surrounding areas) to determine the metallurgical and chemical composition of the corrosion as well as conduct a polymer layer analysis, so that we can: (1) determine the cause; (2) implement appropriate changes to the manufacturing and distribution processes to prevent future occurrences; (3) determine appropriate corrective action if corrosion is detected on a module; (4) initiate quality assurance procedures to evaluate our product including: work in process laminates in our plant; finished goods on hand in our plant; finished goods on hand in our customers’ warehouses; and membranes that have been installed on end user roofs.
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SolarSave® Architectural Glass
We also design and manufacture custom PV glass laminates to meet the aesthetic, performance and structural requirements of designers and architects. Sizes, shapes and configurations can be built to match virtually any specification available today, allowing for a direct substitution for monolithic, laminated or insulated glass panels. This product is ideally suited for LEED certification on green building projects.
SolarSave® Architectural Glass, or “Glass,” offers both shading and electrical power generation, and is geared towards glass canopies, skylights, atriums, vertical glass curtain walls, and other architectural applications. It is often desirable to achieve translucency in PV skylight applications. While a standard PV cell is an opaque 125 mm or 156 mm square, our cells can be arranged within clear glass panels to provide appropriate light levels and shading coefficients. A wide variety of colors, thickness, patterns, and shapes can be produced.
Our first major architectural glass project was installed at the California Academy of Sciences Museum in Golden Gate Park, California in the fourth calendar quarter of 2007. The PV glass laminates for this project were certified to UL 1703 standards using Sunpower cells.
Manufacturing
In May 2007, we outsourced production of our tile laminate to Suntech, who produced the tile laminate in China. In addition, the assembly of the laminate into the frame was outsourced to a company in California. We have also obtained UL 1703 certification with an alternate supplier.
SolarSave® Architectural PV Glass is specified by architects and designers seeking to incorporate PV directly into skylights, glass canopies, or vertical glass curtain walls. Currently, we manufacture Glass at our Grass Valley facility, which provides us flexibility for short run production.
Historically, we manufactured SolarSave® Membranes in Aurora, Ontario, Canada. We have temporarily suspended shipments of our membrane product due to a corrosion issue that we are currently working to resolve. Concurrently, we are working on a combination of product enhancements and incorporating PV cells from alternate manufacturers. In addition, we are evaluating additional alternatives in an effort to optimize our manufacturing processes on a company-wide basis. Our plan is to outsource the production of the membrane product once UL certification of alternate PV cells is obtained.
There is currently an industry-wide shortage of semi-conductor grade silicon, an essential raw material in the production of certain of our primary products. Continued shortages of silicon used in the manufacture of our products may result in significant price increases in PV cells or our inability to obtain needed raw materials on a timely basis, which could result in delays in manufacturing and adversely affect gross margins and results of operations.
Sales and Marketing Strategy
Market Segmentation
We divide our marketing and sales strategy into two separate, yet complimentary components. The first is product sales of SolarSave® Tiles, Membrane and Glass, as well as balance of system (BOS) components such as inverters and SolarEye monitoring software. The second component is our Solar Communities business. The Solar Communities business represents the sale of both products and electricity under long term power purchase agreements (PPAs) or leases wherein we develop, install, own and operate systems in residential multifamily developments. Both product sales and our Solar Communities businesses are aligned through the building products channel.
Product Sales
Product sales are segmented by channel within the building products industry. For example, SolarSave® Tiles are predominantly sold through Eagle Roofing under a master distribution agreement. Eagle is the largest manufacturer of residential concrete tiles in North America, providing us with access to customers through Eagle’s relationships with national home builders and roofing contractors. We are developing a similar business model for SolarSave® Membranes which, in addition to being sold directly to large solar
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integrators, will be marketed and distributed through relationships with several of the leading manufacturers of traditional PVC roofing membrane. Our SolarSave® Architectural PV Glass products are sold directly to architectural and design firms, or construction contractors.
Solar Communities
We have developed an innovative strategy geared to builders and owners of condominium and town home communities. These developers are under increasing regulatory pressure to increase energy efficiency and incorporate renewable energy alternatives in their properties. Utilizing a traditional project finance model and the legal structures of existing homeowners associations, we plan to provide an opportunity for the installation of solar systems at no or limited additional cost to the builder or the homeowner, and to finance these installations from the revenue streams generated under long term power purchase agreements for the electricity generated by the solar systems.
We will benefit from a development fee for each project, increased sales of our solar tiles, and participation in the long term revenue streams. The builder is anticipated to experience reduced construction costs, an accelerated permitting process, and increased sales velocity of new homes, particularly in this challenging housing market. The homeowner will benefit from a reduced utility bill and an increase in the resale value of their property at no additional cost. We believe it is a compelling value proposition.
Several members of our management team have previous experience successfully developing and financing distributed generation projects, with related power purchase agreements, engineering procurement and construction contracts, and operation and maintenance agreements. This knowledge base is currently being deployed in the development of similar frameworks for project financing solar systems on multi-family dwellings. Over the next five years, we anticipate entering into agreements with major residential builders and homeowners associations to provide our unique “Solar Communities” package in a number of locations.
Market Criteria
We currently focus our domestic marketing and sales efforts in territories that meet the following criteria:
· Strong solar incentives;
· High retail electricity rates;
· High electrical consumption; and
· Significant service volatility.
California is the dominant market in the United States for PV, and is the Company’s primary market. Arizona, Nevada, New Mexico and Florida are also significant potential markets for our PV products.
Customer Profiles
We have identified a number of potential customers by industry, sector, and application. We focus on high-profile opportunities within correlative industries and with the following sector application demographics:
· Building products companies;
· Residential developers;
· Architects and interior designers;
· Public administrators, city planners;
· Hotel and resort developers;
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· Educational institutions; and
· Government purchasing officers.
Current market opportunities are being realized in the new residential home building market, where solar has recently become a competitive advantage for the sale of new homes by major national home builders. As an example, companies such as Lennar, Centex, and others are beginning to offer solar rooftops as a standard feature in many California communities.
Product Promotion
SolarSave® Tiles, Membranes and Glass are sold on the basis of their features and associated benefits. They are lighter, stronger, easier to install and maintain, and aesthetically superior to most PV products available in the market today. Through our web presence, public relations activities, industry advertising and trade show attendance, we have established a strong brand within a very competitive market environment. Open Energy and its SolarSave® products have appeared in a number of industrial trade publications, in ads, articles, and product reviews. This publicity generates sales leads, which are entered into a database and circulated to our network of distributors and integrators.
We have developed a sophisticated web site that includes corporate information and company profile, a complete product information section, a list of our distributors and sales relationships, pictures of our installations, as well as investor and public relations sections. We have invested in Website and Search Engine Optimization through RenewableEnergyAccess.com, SolarBuzz.com, and links to numerous industry sites and information sources. Our website address is www.openenergycorp.com. Information on our website is not incorporated into this report by reference.
Research & Development
A core competency of ours is innovative design, engineering and development of market-focused and next generation solar energy BIPV products. We employ a team of mechanical, electrical and software engineers in Grass Valley, California who are responsible for this development effort. A number of initiatives are currently under way to develop and extend our product lines to cover:
· Asphalt/composition roofs;
· Colored tile roofs;
· Tile and membrane enhancements and certification for European markets; and
· Selected additional residential and commercial roofing materials.
The Competition
We face competition from domestic and international companies actively engaged in the manufacturing and distribution of solar PV systems, as well as from emerging solar technology companies that may become viable in the near future. The best funded and most powerful of these multi-national corporations are vertically integrated, producing PV cells as well as PV modules. These standard PV modules (framed arrays of PV cells) must be rack-mounted externally to the building, creating penetrations in the roof, generating maintenance problems, and detracting from their visual appearance. The manufacturers of these modules include: Sharp, Kyocera, Suntech, Sanyo, REC, Mitsubishi Electric and many others.
While the standard PV modules could be considered competition to our products, Open Energy targets the building-integrated marketplace. In the residential arena, we compete with BIPV tile manufacturers that include Sharp, Kyocera, BP Solar, GE Solar and Sunpower Corporation. In the commercial arena, we compete with PV membrane manufacturer Solar Integrated Technologies, which utilizes less efficient flexible thin film PV products.
With the influx of capital, the expansion of global PV capacity, and the launch of new traditional and thin film manufacturers in Europe, Asia and here in the U.S., we expect to face increased competition, which may result in price reductions or reduced margins. The solar power market in general competes with other sources of renewable energy (such as wind turbines), as well as conventional electrical power generation from coal and natural gas combustion. We may also face competition from some of our customers who
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may develop products or technologies internally, or who may enter into strategic relationships to acquire existing solar power product providers.
Our current and future competitors may have longer operating histories, greater name recognition and greater financial, technical and human resources than us, or may develop technologies superior to ours. Many of our competitors have well-established relationships with our current and potential dealers and their customers and have extensive knowledge of our target markets. As a result, our competitors may be able to devote greater resources to the research, development, promotion and sale of their products and respond more quickly to evolving industry standards and changing customer requirements than we can. Consolidation or strategic alliances among our competitors may strengthen these advantages and may provide them greater access to customers or new technologies.
SolarSave® Roofing Tile Competition
Our primary competitors for the SolarSave™ Tile product are BP Solar, Sharp, Kyocera, GE Solar, and Sunpower Corporation/Powerlight, each of which has a version of a building-integrated tile product. However, we believe that SolarSave® Tiles have a number of important advantages. Because they are made from injection molded composites, they can be made to match the colors and edge profiles of the most commonly used cement tiles used in the domestic market today. Thus, their visual appearance is superior to our competitors. They are a light weight, Class A fire rated, UL certified roofing product that is safer and easier to install than the competition. They can support a snow load up to 200 pounds per square foot, and winds up to 120 mph with clips. The SolarSave® Tile is a true roof tile, designed to be installed by roofers with traditional roofing tools and methods. The BIPV products offered by our competition must generally be installed by an electrician which increases installation costs.
SolarSave® Architectural PV Glass Competition
In the United States, our primary competitors for manufacturing solar glass products are Atlantis Energy and Spire Solar. Companies that market to the architectural community could be considered competitors from the standpoint that they may market solely competing manufacturers’ products; however, they could potentially become Open Energy dealers as well. Internationally, we compete with solar glass manufacturers such as: GSS Solar (Germany), Schuko (Germany), Solar Nova (Germany), Swiss Sustainable Systems (“3S” in Switzerland), and MSK (a subsidiary of Suntech, in Japan). Our current intention is to outsource a substantial portion of the manufacture of our architectural glass products.
SolarSave® Roofing Membrane Competition
Our primary competitors for the SolarSave® membrane product are: Solar Integrated Technologies (SIT) which integrates Uni-solar’s (United Solar Ovonic) thin-film technology with a Sarnafil commercial roofing membrane; and Nanosolar SolarPly™, a building-integrated CIGS (Copper Indium Gallium Diselenide) thin film product that is integrated with commercial roofing membranes. The SolarSave® roofing membrane product has significantly higher energy production per square foot of roof space (i.e. higher efficiency), primarily due to our use of high-efficiency crystalline PV cells rather than thin-film technology. SIT’s product currently generates approximately 6 watts per square foot, as compared to approximately 14 watts per square foot for our membrane product. In addition, the SolarSave® membrane has been UL approved for use with Duro-last, IB, Fibertite, Sarnafil, Carlisle and Cooley roofing membranes.
For commercial installations, we also compete with a number of companies that manufacture standard PV modules, as discussed above. In addition, solar integrators and/or installers that market commercial solar products could be considered competitors to the extent that they market solely competing manufacturers’ products, such as: Powerlight (Sunpower), Conergy Inc., Dome-Tech Group, Eastwood Energy, GE Energy (a subsidiary of General Electric Corporation), Global Solar Energy, Inc. (a subsidiary of Solon AG), SPG Solar, Inc., and Sun Edison LLC.
Intellectual Property
We rely on a combination of patent, copyright, trade secret, trademark and contractual protection to establish and protect our intellectual property. We have filed trademark registration applications in the U.S. for SolarSave® and for other trademarks. We require our customers to enter into confidentiality and nondisclosure agreements before we disclose any sensitive aspects of our solar technologies or strategic plans, and we typically enter into proprietary information agreements with employees and consultants. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our technology. It is difficult to monitor unauthorized use of technology, particularly in foreign countries where the laws may not protect
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our proprietary rights as fully as laws in the United States. In addition, our competitors may independently develop products similar to ours. Our precautions may not prevent misappropriation or infringement of our intellectual property.
In the United States we have three issued patents, seven U.S. patent applications pending, and three foreign patent applications pending relating to our title, membrane and remote water monitoring products. Pursuant to an agreement with Dr. Melvin Prueitt, we are the exclusive licensee of a U.S. patent application for the first version of Suncone that consisted of an inexpensive lightweight reflected film that is formed into one or more cones that concentrate the sun’s rays to the base, and the collected energy can be used to heat a fluid. We have redesigned Suncone™ CSP to achieve a cost effective design with a more wind-resistant cone and have submitted our own patent application. Our issued patents will begin to expire in 2018. We intend to continue assessing appropriate opportunities for patent protection of those aspects of our technology that we believe provide significant competitive advantages to us, and for licensing opportunities of new technologies relevant to our business.
Although we apply for patents to protect our technology, our revenue is not dependent on any one patent we own, and we currently rely on trade secret rights to protect our proprietary information and know-how. We also employ proprietary processes and customized equipment in manufacturing facilities. We do not know if our current or future patent applications will result in patents being issued with the scope of the claims we seek, if at all, or whether any patents we may receive will be challenged, invalidated or declared unenforceable.
Environmental Regulations
We are subject to a variety of foreign, federal, state and local governmental laws and regulations related to the purchase, storage, use and disposal of hazardous materials. If we fail to comply with present or future environmental laws and regulations, we could be subject to fines, suspension of production or a cessation of operations. In addition, under some foreign, federal, state and local statutes and regulations, a governmental agency may seek recovery and response costs from operators of property where releases of hazardous substances have occurred or are ongoing, even if the operator was not responsible for the release or otherwise was not at fault.
We believe that we have all environmental permits necessary to conduct our business. We believe that we have properly handled our hazardous materials and wastes and have appropriately remediated any contamination at any of our premises. We are not aware of any pending or threatened environmental investigation, proceeding or action by foreign, federal, state or local agencies, or third parties involving our current facilities. Any failure by us to control the use of or to restrict adequately the discharge of, hazardous substances could subject us to substantial financial liabilities, operational interruptions and adverse publicity, any of which could materially and adversely affect our business, results of operations and financial condition.
Employees
Our current full-time headcount is 37 employees. Of that number, 5 are in production-related positions in Grass Valley; 22 are in corporate, marketing, and administrative; 4 are in product development; and 4 are in sales.
Investors should carefully consider the risks described below before deciding whether to invest in our common stock. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently believe are immaterial may also impair our business operations and financial results. If any of the following risks actually occurs, our business, financial condition or results of operations could be adversely affected. In such case, the trading price of our common stock could decline and you could lose all or part of your investment. Our other filings with the Securities and Exchange Commission also contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks we face described below. See “Special Note Regarding Forward-Looking Statements.”
The execution of our business plan will require substantial funds. If we are unable to acquire additional financing, we may be forced to discontinue our operations.
We will need to raise additional funds in order to execute our business plan and continue operations. No assurance can be given that this additional financing will be available on terms satisfactory to us. Any such financing will likely result in substantial additional dilution to our current stockholders.
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If we are unable to raise substantial funds, we may be unable to pay our debts as they mature and we may be forced to discontinue our operations and liquidate. In such event, holders of our common stock would likely lose all or substantially all of their investment in our shares.
Depending on our method of raising funds, now and in the future, your shares may be diluted.
If we raise additional funds by selling additional shares of our capital stock, or securities convertible into or exercisable for shares of our capital stock, the ownership interest of our stockholders may be diluted. It is likely that any financing will result in substantial dilution to our existing stockholders. For example, the financing described in Note 22 - Subsequent Events - Securities Purchase Agreement, which has not closed as of the date of this report, would result in substantial dilution to existing stockholders.
New home construction in the U.S. is currently slowing, and doing so fairly dramatically in several areas where the Company’s products are offered. This building slow-down could negatively impact our sales.
California, our most important market, represents a majority of all PV installations in North America, and new home construction in California has slowed significantly. Arizona, Nevada, New Mexico and Florida are also significant potential markets for our PV products and they too are experiencing a decline in new home construction activity. In addition, these regions also have a high volume of unsold new home inventory. If the residential home industry continues to have a high volume of unsold inventory, the new home construction market is likely to continue to decline. This could adversely affect solar installations, particularly for our residential PV roofing tiles.
Our auditors have expressed substantial doubt regarding our ability to continue as a going concern.
As of the date of our most recent audit, which included the fiscal years ended May 31, 2008 and May 31, 2007, we had not generated sufficient revenues to meet our cash flow needs. As a result, our auditors have expressed substantial doubt about our ability to continue as a going concern. Although we have generated revenue, we are still operating at a net loss, and may continue to incur losses for a period of time. We incurred a net loss of $34.9 million for the year ended May 31, 2008, a net loss of $39.6 million for the year ended May 31, 2007, and a net loss of $12.2 million for the year ended May 31, 2006. We cannot assure you that we will be able to obtain sufficient funds from our operating or financing activities to support our continued operations. If we cannot continue as a going concern, we may need to substantially revise our business plan or cease operations, which may reduce or negate the value of your investment.
We expect our operating results to fluctuate on a quarterly and annual basis, which could cause our stock price to fluctuate or decline.
We believe that our operating results may fluctuate substantially from quarter-to-quarter and year-to-year for a variety of reasons, many of which are beyond our control. Factors that could affect our quarterly and annual operating results include those listed below as well as others listed in this “Risk Factors” section:
· our current reliance on large-volume orders from only a few customers;
· the receipt and shipment of large orders or reductions in these orders;
· variability between customer and product mix;
· changes in our pricing policies or those of our competitors;
· the introduction of new products or product enhancements by us or our competitors;
· changes in the terms of our arrangements with customers or suppliers;
· the ability of our customers to accurately forecast demand for our products by their end users;
· the impact of changes in government regulation and rebate and similar incentive programs affecting our products;
· delays or failures to fulfill orders for our products on a timely basis;
· delays in the introduction of new or enhanced products by us or market acceptance of these products;
· our ability to finance our working capital needs;
· the availability and cost of raw materials and components for our products;
· an increase in product warranty returns or in our allowance for doubtful accounts; and
· operational disruptions, such as transportation delays or failures of our order processing system.
A substantial portion of our sales in a given quarter may depend on obtaining orders for products to be manufactured and shipped in the same quarter in which those orders are received. As a result of these factors, period-to-period comparisons of our operating results
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may not be meaningful, and you should not rely on them as an indication of our future performance. In addition, our operating results may fall below the expectations of public market analysts or investors. In this event, our stock price could decline significantly.
Evaluating our business and future prospects may be difficult due to the rapidly changing technological and market landscape.
There is limited historical information available about our company upon which you can base your evaluation of our business and prospects. We first shipped renewable energy commercial products in December 2005. Relative to the entire solar industry, we have shipped only a very small number of products.
The market we are addressing is rapidly evolving and is experiencing technological advances and new market entrants. We have recently begun to outsource substantially all of our manufacturing, and there is no guarantee we can do this at a price that is competitive with our competition, or that we can gain access to new, more cost effective solar technologies that may be developed by our competitors. Moreover, the SunCone™ CSP system is only in the early stages of development and we have limited experience upon which to predict whether it can be successfully commercialized and limited capital to fund such development.
We face intense competition from other companies producing solar power and other energy generation products. If we fail to compete effectively, we may be unable to increase our market share and sales.
The solar power market is intensely competitive and rapidly evolving. Our competitors are better capitalized, have established market positions more prominent than ours, and if we fail to attract and retain customers and establish a successful distribution network for our solar products, we may be unable to achieve adequate sales and market share. There are a number of major multi-national corporations that produce solar power products, including BP Solar, Kyocera, Sharp, GE, Mitsubishi, Solar World AG and Sanyo. We also expect that future competition will include new entrants to the solar power market offering new technological solutions. Further, many of our competitors are developing and currently producing products based on new solar power technologies that may have costs similar to, or lower than, our projected costs.
Most of our competitors are substantially larger than we are, have longer operating histories, and have substantially greater financial, technical, manufacturing and other resources than we do. Our competitors’ greater sizes in some cases provides them with competitive advantages with respect to manufacturing costs due to their ability to allocate fixed costs across a greater volume of production and purchase raw materials at lower prices. Many also have far greater name recognition, an established distribution network and an installed base of customers. In addition, many of our competitors have well-established relationships with current and potential resellers, which have extensive knowledge of our target markets. As a result, our competitors will be able to devote greater resources to research, development, promotion and sale of their products and may be able to respond more quickly to evolving industry standards and changing customer requirements than we can.
There is a shortage of semi-conductor grade silicon and the PV cells made from this material, upon which our products depend, that may constrain our revenue growth. Additionally, we may not have sufficient financial resources to take advantage of supply opportunities as they may arise.
Silicon is an essential raw material in the production of PV cells. There is currently an industry-wide shortage of silicon ingots, which has resulted in significant price increases. Increases in silicon prices may impact our manufacturing costs in the future. As demand for PV cells has increased, a number of manufacturers have announced plans to add additional capacity. As this manufacturing capacity becomes operational, it will increase the demand for silicon. Polysilicon is also used in the semiconductor industry generally, and any increase in demand from that sector will compound the shortage. The production of silicon is capital intensive and adding additional capacity requires significant lead time. We expect that silicon demand will continue to outstrip supply in the near term.
We depend on a limited number of suppliers for the laminates and cells necessary to manufacture our products, and the loss or interruption of supply would negatively impact sales and damage our reputation with our customers.
We currently purchase laminate and cells from a small number of major solar suppliers. There has been an industry wide shortage of laminate which has resulted in shipment delays and price increases. Unlike some of our competitors, we are not vertically integrated and do not control our supply chain. We are evaluating alternate suppliers for the critical parts of all of our products. Any interruption or slow down in supply, or increase in product costs, could cause a disruption or a complete stoppage of our manufacturing operations and a corresponding loss of revenue.
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In addition, we have entered into agreements with our significant customers that require that we provide them with certain volume commitments. Any inability on our part to meet the requirements of those customers would damage our reputation with those customers and negatively impact our operations.
Our products may not gain market acceptance, which would prevent us from achieving sales and market share.
The development of a successful market for our products may be adversely affected by a number of factors, some of which are beyond our control, including:
· our failure to produce products that compete favorably against other solar power products on the basis of cost, quality and performance;
· our failure to produce products that compete favorably against conventional energy sources and alternative distributed-generation technologies, such as wind, biomass and solar thermal, on the basis of cost, quality and performance;
· whether customers will accept our new designs under development; and
· our failure to develop and maintain successful relationships with distributors, systems integrators and other resellers, as well as strategic partners.
If our products fail to gain market acceptance, we will be unable to achieve sales and market share.
Technological changes in the solar power industry could render our products uncompetitive or obsolete, which could prevent us from achieving market share and sales.
Our failure to refine our technology and to develop and introduce new products could cause our products to become uncompetitive or obsolete, which could prevent us from achieving market share and sales. The solar power industry is rapidly evolving and highly competitive. We will need to invest significant financial resources in research and development to keep pace with technological advances in the solar power industry and to compete in the future and we may be unable to secure such financing. We believe that a variety of competing solar power technologies may be under development by other companies that could result in lower manufacturing costs or higher product performance than those expected for our products. Our development efforts may be rendered obsolete by the technological advances of others, and other technologies may prove more advantageous for the commercialization of solar power products.
The reduction or elimination of government economic incentives could prevent us from achieving sales and market share.
We believe that the near-term growth of the market for “on-grid” applications, where solar power is used to supplement a customer’s electricity purchased from the utility network, depends in large part on the availability and size of federal and state government economic incentives. The reduction or elimination of government economic incentives may adversely affect the growth of this market or result in increased price competition, which could prevent us from achieving sales and market share. In the United States, the 30% federal investment tax credit is currently scheduled to expire on December 31, 2008. If Congress does not extend the investment tax credit, the Company and the industry in general will be severely and negatively affected. In December 2007, the Senate failed to get enough votes to pass the proposed clean energy bill and its associated renewable electricity standard which would have extended the investment tax credit. Similar attempts in Congress during 2008 to extend the investment tax credit have failed.
Today, the cost of solar power exceeds the cost of power furnished by the electric utility grid in many locations. As a result, federal, state and local government bodies in many countries, most notably Germany and Japan, have provided incentives in the form of feed-in tariffs, cash rebates, tax credits, permitting preferences and other incentives to promote the use of solar energy and to reduce dependency on fossil fuels. These government economic incentives could be reduced or eliminated altogether, which would significantly harm our business and future prospects.
Existing regulations and changes to such regulations may present technical, regulatory and economic barriers to the purchase and use of solar power products, which may significantly reduce demand for our products.
The traditional energy and electrical utility industries are heavily regulated by foreign, federal, state and local governments. These regulations and policies often relate to electricity pricing and technical interconnection of customer-owned power generation systems. In the United States and in a number of other countries, these regulations and policies are being modified and may continue to be
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modified. Customer purchases of, or further investment in the research and development of, alternative energy sources, including solar power technology, could be deterred by these regulations and policies, which could result in a significant reduction in the potential demand for our solar power products. For example, utility companies commonly charge fees to larger, industrial customers for having the capacity to use power from the electric grid for back-up purposes. These fees could increase the cost to our customers of using our solar power products and make them less desirable, which would harm our business, prospects, results of operations and financial condition.
We anticipate that our solar power products and their installation will be subject to oversight and regulation in accordance with national and local ordinances relating to building codes, health and safety standards, environmental regulations, utility interconnection and metering and related matters. There is also a burden in having to track the requirements of individual states and design equipment to comply with the varying standards. Any new government regulations or utility policies pertaining to our solar power products may result in significant additional expenses to us and our resellers and their customers and, as a result, could cause a significant reduction in demand for our solar power products.
Problems with product quality or product performance may cause us to incur warranty expenses and prevent us from achieving sales and market share, particularly if we introduce new technologies.
As is consistent with standard practice in our industry, the duration of our product warranties is lengthy. Our current roofing tile product warranty is for 25 years, and our roofing membrane product warranty is for 20 years. Due to the long warranty period, we bear the risk of extensive warranty claims long after we have shipped product and recognized revenues. Our products have not been installed long enough to allow us to evaluate their performance over a 20 to 25-year period. We experienced a warranty claim with our first tile installation. Although we believe the initial problem has been resolved, other warranty issues could develop. We also experienced warranty claims with some of our initial membrane installations, causing us to temporarily discontinue product shipments. There is no assurance that the membrane product warranty issues can be resolved. Failure to resolve these product warranty issues could force us to permanently discontinue product shipments, which would materially and negatively affect the Company’s revenues. Please see “Description of Business — Our Products — SolarSave® Roofing Membranes.”
If solar power technology is not suitable for widespread adoption or sufficient demand for solar power products does not develop or takes longer to develop than we anticipate, we would be unable to achieve sales and market share.
The market for solar power products is emerging and rapidly evolving, and its future success is uncertain. If solar power technology proves unsuitable for widespread commercial deployment or if demand for solar power products fails to develop sufficiently, we would be unable to achieve sales and market share. In addition, demand for solar power products in the markets and geographic regions we target may not develop or may develop more slowly than we anticipate. Many factors will influence the widespread adoption of solar power technology and demand for solar power products, including:
· cost-effectiveness of solar technologies as compared with conventional and competitive alternative energy technologies;
· performance and reliability of solar products as compared with conventional and non-solar alternative energy products;
· success of alternative distributed generation technologies such as hydrogen fuel cells, wind turbines, bio-diesel generators and solar thermal technologies;
· public concern regarding energy security, the potential risks associated with global warming, the environmental and social impacts of fossil fuel extraction and use;
· fluctuations in economic and market conditions that impact the viability of conventional and competitive alternative energy sources;
· increases or decreases in the prices of oil, coal and natural gas;
· capital expenditures by customers, which tend to decrease when the domestic or foreign economies slow;
· continued deregulation of the electric power industry and broader energy industry; and
· availability of government subsidies and incentives.
If we are unable to protect our intellectual property adequately, we could lose our competitive advantage in the solar power market.
Our ability to compete effectively against other solar power technologies will depend, in part, on our ability to protect our current and future proprietary technology, product designs and manufacturing processes through a combination of patent, copyright, trademark,
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trade secret and unfair competition laws. We may not be able to protect our intellectual property and may need to defend our products and services against infringement claims, either of which could result in the loss of our competitive advantage in the solar power market and materially harm our business and profitability. We face the following risks in protecting our intellectual property and in developing, manufacturing, marketing and selling our products and services:
· we cannot be certain that our pending patent applications will result in issued patents or that the claims allowed are or will be sufficiently broad to protect our technology or processes;
· given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important;
· third parties may design around our patented technologies or seek to challenge or invalidate our intellectual property rights and there is no assurance that our intellectual property rights will deter infringement or misappropriation of our intellectual property;
· we may incur significant costs and diversion of management resources in prosecuting or defending intellectual property infringement suits;
· we may not be successful in prosecuting or defending intellectual property infringement suits and, as a result, may need to seek to obtain a license of the third party’s intellectual property rights, which may not be available to us, whether on reasonable terms or at all; and
· the contractual provisions we rely on to protect our trade secrets and proprietary information, such as our confidentiality and non-disclosure agreements with our employees, consultants and other third parties, may be breached and our trade secrets and proprietary information may be disclosed to competitors, strategic partners and the public.
Failure to adequately protect our trademark rights could cause us to lose market share and cause our sales to decline.
We sell our solar roofing, architectural glass and balance-of-system products under our brand names SolarSave® and we have branded our solar concentrating technology under the brand name SunConeTM CSP. We are also branding our company with the name Open EnergyTM. We expect to expend significant resources promoting these brand names, and we have applied for registered trademarks in the United States for SunConeTM CSP, the OE Logo, Open EnergyTM and other trademarks. However, registration of our brand name trademarks could be denied, and if granted, such registration will not necessarily deter or prevent unauthorized use by others. If other companies, including our competitors, use our brand names, consumers may not recognize us as the source of our products. This would reduce the value of goodwill associated with our brand names. This consumer confusion and the resulting reduction in goodwill could cause us to lose market share and cause our sales to decline.
Material weaknesses in our disclosure controls and procedures and our internal control over financial reporting, if not remedied effectively, could prevent us from reporting our financial results on a timely and accurate basis and result in a decrease in the trading price of our common stock and otherwise seriously harm our business.
Management has concluded that our disclosure controls and procedures and our internal control over financial reporting had material weaknesses as of May 31, 2008. We have not remedied all weaknesses at this time. In addition, because of our limited financial resources and operating challenges, we have not been able to complete the design, documentation and implementation of an internal control system that meets the standards prescribed by Section 404 of the Sarbanes-Oxley Act of 2002, as amended. These controls and procedures are designed to provide reasonable assurance that we can provide timely and accurate financial reporting of our results of operations.
Failure to achieve and maintain an effective internal control environment could prevent us from reporting our financial results on a timely and accurate basis or cause investors to lose confidence in our reported financial information. These effects could in turn result in a decrease in the trading price of our common stock.
There are a large number of shares underlying our convertible debentures and warrants that may be available for future sale. Our existing stockholders may experience immediate and substantial dilution resulting from the issuance of these shares and the sale of these shares may depress the future market price of our common stock.
As of August 22, 2008, we had (i) 127,952,397 shares of common stock issued and outstanding; (ii) debentures outstanding that, including accrued interest, are convertible into 42,000,000 additional shares of common stock; and (iii) warrants outstanding to purchase up to 74,973,656 additional shares of our common stock. The number of shares of common stock issuable upon conversion
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or exercise of the foregoing securities may increase if we issue shares of common stock or securities convertible into common stock at an effective price per share less than the conversion and/or exercise prices of the foregoing securities. See “Management’s Discussion and Analysis - Liquidity and Capital Resources – Debt Financings.” If and when our outstanding debentures, notes and warrants are converted or exercised for shares of our common stock, our existing stockholders will be diluted. In addition, the sale of a significant number of such shares of common stock may depress the market price of our common stock.
Our senior lender has a general security interest in our inventory, specified accounts receivable and our cash accounts, which collectively represent substantially all of our liquid assets. If we were to default under the terms of our loan agreement, our lender would have the right to foreclose on these assets.
In April 2008, we entered into a loan and security agreement with The Quercus Trust pursuant to which Quercus loaned us $3.5 million based upon the availability of specified collateral. The loan and security agreement is collateralized by a general security interest in all of our inventory, specified accounts receivable and our cash accounts. If we were to default under the terms and conditions of the loan and security agreement, or if our collateral ratios fall below specified levels, Quercus would have the right to accelerate the outstanding indebtedness under the loan and security agreement and foreclose on the collateral. Such a foreclosure would have a material adverse effect on our business, liquidity, results of operations and financial position.
Our failure to withhold for or pay federal and state employment and income taxes associated with the vesting or issuance of shares of restricted stock granted to our employees may result in significant liabilities for which we may not have sufficient cash to satisfy.
In the past, we issued shares of restricted stock to certain employees. We failed to withhold and pay taxes on such restricted shares upon vesting, which resulted in tax liability to the Company. We are obligated to pay all employee federal and state withholding taxes as well as the employer’s portion of FICA. As of August 29, 2008, we have a remaining obligation to pay $207,000 in employment taxes incurred in connection with the vesting of restricted stock.
Our obligation to withhold for and pay federal and state employment and income taxes associated with these restricted shares granted to employees is ongoing with each new vesting date, and the level of tax obligation would be significant if any of the vesting schedules were to accelerate in accordance with the terms of the employment agreements upon a termination by the Company without cause or by the employee for good reason or upon a change of control of the Company. We could therefore incur significant additional liabilities for which we may not have sufficient cash to satisfy, requiring us to raise additional funds or curtail or cease operations.
Nevada law may have the effect of deterring hostile takeovers or delaying changes in control of our management, which could depress the market price of our common stock.
Business Combinations Act. We will become subject to Sections 78.411 and 78.444 of the NGCL if we ever have 200 or more stockholders of record. Such statutes prohibit an “interested stockholder” from entering into a “combination” with the corporation, unless certain conditions are met. An “interested stockholder” is a person who:
· Directly or indirectly beneficially owns 10% or more of the voting power of the outstanding voting shares of the corporation, or
· Is an affiliate or associate of the corporation and at any time within three years before the date in question was the beneficial owner, directly or indirectly, of 10% or more of the voting power of the then outstanding shares of the corporation.
Under certain circumstances, a corporation may not engage in a combination within three years after the interested stockholder first became an interested stockholder, unless the combination or the transaction by which the person became an interested stockholder was approved by the board of directors before the date the interested stockholder first became an interested stockholder. If this approval was not obtained, then after the three year period expires, the combination may be consummated if all the requirements in the corporation’s articles of incorporation are met and either the approval of the non-interested stockholders is obtained or certain minimum price and other Nevada law requirements are met.
Business combinations encompass a wide variety of transactions with or caused by an interested stockholder, including mergers, asset sales and other transactions in which the interested stockholder receives or could receive a benefit on other than a pro rata basis with
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other stockholders. Provisions of this law have an anti-takeover effect on transactions not approved in advance by the board of directors.
Control Shares Act. Nevada law provides that, in certain circumstances, a stockholder who acquires a controlling interest in a corporation, defined in the statute as an interest in excess of a 1/5, 1/3, or 1/2 interest in the voting power of the corporation in the election of directors, has only such voting rights in the shares acquired that caused the stockholder to exceed any such threshold as are conferred by a majority vote of the corporation’s stockholders at an annual or special stockholders’ meeting.
The control shares provision applies to Nevada corporations with at least 200 stockholders, including at least 100 stockholders who have addresses in Nevada appearing on the stock ledger of the corporation, and which do business directly or indirectly in Nevada. We do not have at least 200 stockholders and do not have at least 100 stockholders who have addresses in Nevada; therefore the control shares provision does not currently apply to us. If the control shares provision became applicable to us in the future, acquisition of us could become more difficult.
Our success depends on our ability to retain our key personnel.
Our success is dependent upon the efforts of key members of our management, including our president and chief operating officer, David Field, our executive vice president of worldwide operations, Christopher Gopal, our chief financial officer, Aidan Shields and our general counsel and senior vice president, Dalton W. Sprinkle. The loss of these persons, or other key employees, could have a material adverse effect on us. Our future success is likely to depend substantially on our continued ability to attract and retain highly qualified personnel. The competition for such personnel is intense, and our inability to attract and retain such personnel could have a material adverse effect on us. We do not maintain life insurance on any of our personnel.
Our growth may not be manageable and our business could suffer as a result.
Even if we are successful in obtaining new business, failure to manage the growth could adversely affect our operations. We may experience extended periods of very rapid growth, which could place a significant strain on our management, operating, financial and other resources. Our future performance will depend in part on our ability to manage growth effectively. We must develop management information systems, including operating, financial, and accounting systems, improve project management systems and expand, train, and manage employees to keep pace with growth. Our inability to manage growth effectively could negatively affect results of operations and the ability to meet obligations as they come due.
We may not address successfully the problems encountered in connection with any recent and potential future acquisitions.
In March and April, 2006, we completed the acquisitions of Solar Roofing Systems, Inc. and Connect Renewable Energy, Inc. In December of 2006 we acquired WaterEye Corporation. In addition, we expect to consider future opportunities to acquire or make investments in other technologies, products and businesses that could enhance our capabilities, complement our products, or expand the breadth of our markets or customer base. We have limited experience in acquiring other businesses and technologies. Potential and completed acquisitions and strategic investments involve numerous risks, including:
· problems assimilating the purchased technologies, products or business operations;
· problems maintaining uniform standards, procedures, controls and policies;
· unanticipated costs associated with the acquisition;
· diversion of management’s attention from our core business;
· adverse effects on existing business relationships with suppliers and customers;
· risks associated with entering new markets in which we have no or limited prior experience;
· potential loss of key employees of acquired businesses; and
18
· increased legal and accounting costs as a result of the newly adopted rules and regulations related to the Sarbanes-Oxley Act of 2002.
We have not paid dividends on our common stock in the past and do not anticipate paying dividends on our common stock in the foreseeable future.
We have not paid common stock dividends since our inception and do not anticipate paying dividends in the foreseeable future. Our current business plan provides for the reinvestment of earnings in an effort to complete development of our technologies and products, with the goal of increasing sales and long-term profitability and value. In addition, several of our financing agreements currently restrict, and any other credit or borrowing arrangements that we may enter into may restrict or limit, our ability to pay common stock dividends to our stockholders.
We are subject to significant corporate governance and internal control reporting requirements, and our costs related to compliance with, or our failure to comply with existing and future requirements, could adversely affect our business.
We face significant corporate governance requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations subsequently adopted by the SEC and the Public Company Accounting Oversight Board. These laws, rules and regulations continue to evolve and may become increasingly stringent in the future. In particular, under rules adopted by the SEC, we are required to include management’s report on internal controls as part of this annual report pursuant to Section 404 of the Sarbanes-Oxley Act. Furthermore, an attestation report on our internal controls from our independent registered public accounting firm will be required as part of our annual report for the fiscal year ending May 31, 2010. We are in the process of evaluating our control structure to help ensure that we will be able to comply with Section 404 of the Sarbanes-Oxley Act, but we have not completed such evaluation as of the date of this annual report and we cannot assure you that we will be able to fully comply with these laws, rules and regulations that address corporate governance, internal control reporting and similar matters. The financial cost of compliance with these laws, rules and regulations is substantial and our financial resources are limited. Failure to comply with these laws, rules and regulations could materially adversely affect our reputation, financial condition and the value of our securities.
Our common stock is subject to penny stock rules.
Our common stock is subject to Rule 15g-1 through 15g-9 under the Exchange Act, which imposes certain sales practice requirements on broker-dealers which sell our common stock to persons other than established customers and “accredited investors” (generally, individuals with net worths in excess of $1,000,000 or annual incomes exceeding $200,000 (or $300,000 together with their spouses)). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to the sale. This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of such common stock. Additionally, our common stock is subject to the SEC regulations for “penny stock.” Penny stock includes any equity security that is not listed on a national exchange and has a market price of less than $5.00 per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/sell transaction in a penny stock; a disclosure schedule set forth by the SEC relating to the penny stock market must be delivered to the purchaser of such penny stock. This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for the common stock. The regulations also require that monthly statements be sent to holders of penny stock which disclose recent price information for the penny stock and information of the limited market for penny stocks. These requirements adversely affect the market liquidity of our common stock.
If a letter agreement with one of our investors were held to be in violation of Section 5 of the Securities Act of 1933, we could be required to repurchase certain securities sold in a previous offering.
On March 30, 2006, we entered into a securities purchase agreement pursuant to which we issued convertible debentures and warrants to Cornell Capital Partners, L.P. In May of 2007, we entered into a letter agreement, or the May Letter, whereby Cornell elected to waive a condition of the convertible debentures then held by Cornell that stated that Cornell could own no more than 4.99% of the Company. The May Letter also stated that the Company elected to waive a provision of the convertible debentures relating to the conversion limitation in any thirty (30) day period.
While we do not believe it to be the case, the May Letter may have resulted in a violation of Section 5 of the Securities Act of 1933. However, if the May Letter was held by a court to be in violation of the Securities Act of 1933, we could be required to repurchase any shares held by Cornell and the shares sold by Cornell in such offering at the original purchase price, less any amounts previously
19
paid by us to Cornell in partial redemption of the convertible debentures or received by Cornell from the sale of shares of our common stock into which the convertible debentures were converted in part, plus statutory interest from the date of purchase. We sold an aggregate of $15 million in principal amount of convertible debentures to Cornell pursuant to the March 30, 2006 securities purchase agreement and we previously redeemed approximately $1.9 million in principal amount of such convertible debentures, and paid approximately $864,000 in interest on such convertible debentures. In the event that we were required to repurchase shares our cash position would be reduced by the amount of shares we were required to repurchase. There can be no assurance that we would have sufficient cash available to meet such obligation as well as our continuing operating requirements or that, if additional financing were required, that such financing could be obtained on terms acceptable to us, if at all. We would contest vigorously any claim that a violation of the Securities Act of 1933 occurred.
We own no real property. We lease facilities in Solana Beach, California totaling approximately 4,300 square feet for our corporate headquarters. We lease an approximately 8,000 square foot manufacturing facility in Grass Valley, California. Additionally, we lease 2,400 square feet related to warehouse space in Grass Valley for tile and glass related inventory.
Each of our facilities is covered by insurance and we believe them to be suitable for their respective uses and adequate for our present needs. We believe that suitable additional or substitute space will be available to accommodate the foreseeable expansion of our operations.
We are not involved in any material pending legal proceeding against us, nor are we involved as a plaintiff in any material pending litigation. From time to time, we are a party to other claims and legal proceedings arising in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 16, 2008, we entered into an amendment of our 9/19/2007 Note and our 12/7/07 Notes (which collectively comprise our Series B Convertible Notes) with the holders thereof, which amendment:
· Permits us to issue shares of our common stock that are not registered pursuant to the Securities Act of 1933, as amended, in lieu of cash interest payments on the Series B Convertible Notes;
· Permits us to issue warrants to acquire shares of our common stock, in lieu of cash interest payments on the Series B Convertible Notes, which warrants will have an exercise price per share equal to the greater of $0.506 per share or 5-day weighted average price per share of our common stock and;
· Waives any prior defaults or trigger events caused by our previous failure to pay interest on our Series B Convertible Notes when due, upon the issuance of warrants in lieu of such accrued interest.
In connection with the above amendment, we issued warrants to the holders of our Series B Convertible Notes to acquire a total of 3,092,704 shares of our common stock with an exercise price of $0.506 per share in lieu of accrued and unpaid interest that was in arrearage. The other terms of such warrants are substantially the same as the 9/19/07 Warrants described in “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—Financings—9/19/07 Note.”
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ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our common stock is traded on the National Association of Securities Dealers, Inc. Over-the-Counter Bulletin Board, or the OTCBB. It has been quoted under the symbol “OEGY.OB” since April 21, 2006. Before that, it was quoted under the symbol “BBSE.OB.” The following is a summary of the high and low closing prices of our common stock on the OTCBB during the periods presented. Such prices represent inter-dealer prices, without retail mark-up, mark down or commissions, and may not necessarily represent actual transactions. Trading in our common stock has not been extensive in all the periods presented below, and such trades may not constitute an active trading market in all the periods presented below.
|
| High |
| Low |
| ||
Year Ended May 31, 2008 |
|
|
|
|
| ||
First Quarter |
| $ | 0.77 |
| $ | 0.41 |
|
Second Quarter |
| 0.63 |
| 0.45 |
| ||
Third Quarter |
| 0.46 |
| 0.24 |
| ||
Fourth Quarter |
| 0.34 |
| 0.24 |
| ||
Year Ended May 31, 2007 |
|
|
|
|
| ||
First Quarter |
| $ | 1.59 |
| $ | 0.60 |
|
Second Quarter |
| 0.95 |
| 0.48 |
| ||
Third Quarter |
| 0.66 |
| 0.30 |
| ||
Fourth Quarter |
| 0.59 |
| 0.30 |
| ||
On August 22, 2008, the closing sales price for our common stock was $0.125, as reported on the website of the OTCBB. As of August 22, 2008, there were 59 stockholders of record of the common stock (which does not include the number of persons or entities holding stock in nominee or street name through various brokerage firms).
Dividends
Since inception, we have not declared or paid any dividend on our common stock. We do not anticipate that any dividends will be declared or paid in the foreseeable future on our common stock. In addition, our security agreements with certain of our lenders currently restrict or limit our ability to enter into other credit or borrowing arrangements and restrict or limit our ability to pay common stock dividends to our stockholders.
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Securities authorized for issuance under equity compensation plans
Equity Compensation Plan Information
Plan Category |
| Number of securities |
| Weighted-average |
| Number of securities |
|
Equity compensation plans approved by security holders |
| 15,470,386 |
| 0.50 |
| 1,029,614 |
|
Equity compensation plans not approved by security holders |
| 2,100,000 |
| 0.44 |
| 9,432,017 | (1) |
Total |
| 17,570,386 |
| 0.50 |
| 10,461,631 |
|
(1) Reflects securities issuable under the Company’s 2004 Consultant Compensation Plan (the “Plan”). Under the Plan, the Company’s Board of Directors, or a designated committee of two or more members of the Board, is authorized to issue up to 9,771,000 shares of our common stock to consultants or advisors of the Company or its subsidiaries. Stock grants under the Plan are restricted to consultant or advisors who, in the discretion of the Board of Directors or designated committee have provided or will provide significant bona fide services to the Company or an affiliated entity (other than services in connection with a capital raising transaction, investor relations or market making services) pursuant to the terms of a written contract. The Board of Directors or designated committee, in its sole discretion, is empowered to make all decisions with respect to stock grants under the Plan, including when to make a grant, the number of shares, vesting of the grant or restrictions on future transferability of the shares issued pursuant to a grant under the Plan. The Company has issued 338,983 shares of common stock under the Plan and as of May 31, 2008, a total of 9,432,017 shares issued pursuant to the plan were outstanding.
ITEM 6. |
Disclosure not required as a result of the Company’s status as a smaller reporting company.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Company Description and Overview
Open Energy Corporation is a renewable energy company focused on the development and commercialization of a portfolio of solar electric technologies for residential, commercial and industrial applications. The Company currently designs, manufactures and distributes building-integrated photovoltaic (BIPV) roofing tiles, roofing membranes and architectural photovoltaic glass products under the SolarSave® trade name. The company maintains two facilities: A corporate office in Solana Beach for senior management, marketing, sales, customer service, legal and finance and an engineering facility in Grass Valley, California for product design, project engineering, prototyping, custom glass manufacturing, and materials management.
The following three strategic initiatives distinguish our approach from others in an industry that is increasingly becoming commoditized and price-driven:
1. |
| We utilize the roofing products industry as our primary channel partner, co-designing, co-marketing and distributing our solar products through this well established industry. |
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During the fiscal year ended May 31, 2008, we participated with our channel partners in the training of over 350 roofers and sales personnel to sell and install our proprietary products. In April 2008, we amended our joint marketing and distribution agreement with Eagle Roofing Products whereby Eagle has agreed to purchase at least 82,500 tiles in monthly increments from April 2008 through December 2008. In November 2007 we signed a distribution agreement with Petersen-Dean Roofing systems to distribute SolarSave® products across the country.
2. |
| We outsource production in order to lower our costs, increase our capacity and better balance demand and supply of our proprietary best-in-class building integrated PV products. |
During the year ended May 31, 2008, we implemented a new supply chain strategy, pursuant to which we transitioned our manufacturing model to a multi-source, outsourcing model resulting in the expansion of our supply of tiles from 2,000 to 20,000 tiles per month. Our outsourced supply chain strategy provides flexibility, allowing us to match supply and demand, while providing the lowest total installed cost to our customers. In January 2008, we completed the shutdown of operations at our Aurora, Ontario, manufacturing facility in Canada. We continue to utilize the resources in our Grass Valley, California facility to perform design and supplemental manufacturing and assembly functions.
3. |
| We intend to offer financed solutions to the residential market through long-term power purchase agreements that will contribute to increased product sales and generate recurring revenues from the sale of energy. |
In February 2008, we signed a development agreement for our first “solar community” project, a 47-unit condominium project co-sited with a Whole Foods store and other mixed retail outlets in San Diego, California. The project is a LEED certified “green” development and construction commenced during the summer of 2008.
Critical Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.
Management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. The Company has identified the following accounting policies, described below, as the most important to an understanding of the Company’s current financial condition and results of operations.
Revenue Recognition
The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”). The Company generates revenue from the sale of photovoltaic roofing tiles, photovoltaic roofing membranes, balance of system products, water monitoring equipment and subscriptions and management system products to dealers and other parties. The Company does not perform any installations of photovoltaic products. The Company does, however, install water monitoring systems and recognizes corresponding license/subscription revenue consistent with AICPA Statement of Position (SOP) 97-2, Software Revenue Recognition requirements.
SAB 104 requires that four basic criteria be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the seller’s price to the buyer is fixed and determinable; and (4) collectability is reasonably assured. Amounts billed or received from customers in advance of performance are recorded as deferred revenue. In addition, the Company records deferred revenue in connection with sales to certain customers of products that qualify for state rebates that have been assigned to the Company by the customer. Based on the assignment of the rebate to the Company, the Company bills the customer net of the anticipated rebate and assumes the responsibility for collection of the rebate. The rebate processing cycle involves a multi-step process in which the Company accumulates and submits information required by the state agency necessary for
23
the collection of the rebate. The entire process can take up to 120 days or more to complete. Although title to the products sold have transferred to the customer, due to uncertainty relating to the collection of the rebate and the determination of the ultimate price to be received, the Company defers revenue on the portion of the selling price related to the rebate, until such time that the rebate claim is submitted to the state agency.
Cost of sales related to revenue that has been deferred in connection with rebate collection process is recorded as deferred charges until such time as the related revenue is recognized.
Accounts Receivable
The Company regularly evaluates the collectability of its accounts receivable. An allowance for doubtful accounts is maintained for estimated credit losses, and such losses have been minimal and within management’s expectations. When estimating credit losses, the Company considers a number of factors including the aging of a customer’s account, creditworthiness of specific customers, historical trends and other information. Accounts receivable consist of trade receivables and amounts due from state agencies or utilities for rebates on state-approved solar systems installed. These rebate amounts are passed on to the customer at the time the customer is billed and the rebate is assigned to the Company. Generally, state agencies or utilities can take 120 days or more to remit the rebate amounts to the Company.
Inventories
Inventories are valued at lower of cost (first in, first out) or market. Management provides a reserve, as necessary, to reduce inventory to its net realizable value. Certain factors could impact the realizable value of inventory so management continually evaluates the recoverability based on assumptions about customer demand and market conditions. The evaluation may take into consideration expected demand, new product development, the effect new products might have on the sale of existing products, product obsolescence and other factors. The reserve or write down is equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory reserves or write downs may be required. If actual market conditions are more favorable, reserves or write-downs may be reversed.
Goodwill and Intangible Assets
Goodwill represents the excess of costs over fair value of assets of businesses acquired. Per Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No.142”), goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead must be tested for impairment annually or more frequently if circumstances indicate that indicators of impairment may be present. Management assesses goodwill for impairment at the reporting unit level on an annual basis at fiscal year-end or more frequently under certain circumstances. Such circumstances include (i) significant adverse change in legal factors or in the business climate, (ii) an adverse action or assessment by a regulator, (iii) unanticipated competition, (iv) a loss of key personnel, (v) a more-likely-than-not expectation that a reporting unit or a significant portion of that unit will be sold or otherwise disposed of, and (vi) recognition of an impairment loss in a subsidiary that is a component of a reporting unit. Management must make assumptions regarding estimating the fair value of the Company reporting unit. If these estimates or related assumptions change in the future, the Company may be required to record an impairment charge.
Evaluation of Long-lived Assets
The Company’s policy is to assess potential impairments to its long-lived assets when there is evidence that events or changes in circumstances have made recovery of the assets carrying value unlikely and the carrying amount on the asset exceeds the estimated undiscounted future cash flows. If such evaluation were to indicate a material non-recoverability of these long-lived assets, such impairment would be recognized by a write down of the applicable asset to its estimated fair value under SFAS No. 144, Accounting for the Impairment of Disposal of Long-Lived Assets.
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Income Taxes
Income taxes are computed using the asset and liability method. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and the tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized.
Beneficial Conversion and Warrant Valuation
In accordance with EITF No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, the Company records a beneficial conversion feature (“BCF”) related to the issuance of convertible debt instruments that have conversion features at fixed rates that are in the money when issued, and the fair value of warrants issued in connection with those instruments. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds to warrants, based on their relative fair value, and as a reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the conversion feature. The discounts recorded in connection with the BCF and warrant valuation are recognized as non-cash interest expense over the term of the convertible debt, using the effective interest method.
Limited Operating History
There is limited historical financial information about our company upon which to base an evaluation of our future performance. Our company has generated limited revenues from operations. We cannot guarantee that we will be successful in our business. We are subject to risks inherent in a fast growing company, including limited capital resources, possible delays in product development and manufacturing, and possible cost overruns due to price and cost increases. There is no assurance that future financing will be available to our company on acceptable terms. Additional equity financing will likely result in substantial dilution to existing stockholders.
Results of Operations – Fiscal Year Ended May 31, 2008 compared to Fiscal Year Ended May 31, 2007
The following table sets forth the Company’s consolidated statement of operations data for the years ended May 31, 2008 and 2007.
Summary Statement of Operations (in thousands):
|
| Twelve Months Ended May 31, |
| ||||||||
|
| 2008 |
| 2007 |
| ||||||
Revenues, net |
| $ | 6,938 |
| 100.0 | % | $ | 4,292 |
| 100.0 | % |
Gross profit (loss) |
| (4,162 | ) | (60.0 | ) | (4,788 | ) | (111.6 | ) | ||
Operating expenses: |
|
|
|
|
|
|
|
|
| ||
Selling, general and administrative |
| 18,747 |
| 270.2 |
| 17,084 |
| 398.0 |
| ||
Research and development |
| 290 |
| 4.2 |
| 513 |
| 12.0 |
| ||
Restructuring Costs |
| 849 |
| 12.2 |
| — |
| — |
| ||
Impairment of intangibles and goodwill |
| — |
| — |
| 10,540 |
| 245.6 |
| ||
Impairment of note receivable |
| — |
| — |
| 683 |
| 15.9 |
| ||
Total operating expenses |
| 19,886 |
| 286.6 |
| 28,820 |
| 671.5 |
| ||
Loss from operations |
| (24,048 | ) | (346.6 | ) | (33,608 | ) | (783.0 | ) | ||
Total other income (expense) |
| (12,339 | ) | (177.8 | ) | (9,206 | ) | 214.5 | ) | ||
Loss from operations before income tax benefit |
| (36,387 | ) | (524.5 | ) | (42,814 | ) | (997.5 | ) | ||
Income tax benefit |
| 1,452 |
| 20.9 |
| 3,262 |
| 76.0 |
| ||
Net loss |
| $ | (34,935 | ) | (503.5 | )% | $ | (39,552 | ) | (921.5 | )% |
Revenues
For the years ended May 31, 2008 and 2007, revenues were $6,938,000 and $4,292,000, respectively.
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During the year ended May 31, 2008, revenues of $6,938,000 primarily consisted of $4,448,000 in sales of SolarSave® Tiles for residential projects and $1,250,000 in sales of SolarSave® PV Glass for the remainder of the California Academy of Sciences Museum installation in Golden Gate Park, San Francisco, California, and to another PV Glass customer. SolarSave® Tile revenues have increased by 280% from 2007 primarily as a result of our change in distribution strategy to utilization of the Eagle Roofing Products sales channel.
At May 31, 2008, we deferred revenue in the amount of $2,822,000, which was primarily related to rebate claims submitted to state and federal agencies. The amount of deferred revenue was determined by assigning a declining factor to the rebate, based on the progress of the rebate application through the rebate processing cycle.
For the year ended May 31, 2007, revenues for SolarSave® Tile and SolarSave® Membrane products and WaterEye water monitoring subscriptions totaled $4,292,000. Revenues were significantly below our initial financial projections primarily due to a manufacturing and cell procurement cost structure that was too high relative to the competition and which caused us to price our products at a premium. In addition, our initial sales strategy for our SolarSave® Tile of selling through solar integrators resulted in a sales cost structure that compounded the price disadvantage.
Cost of Sales
For the years ended May 31, 2008 and 2007, cost of sales was $11,100,000 and $9,080,000, respectively. Gross loss for the years ended May 31, 2008 and 2007, was $4,162,000 and $4,788,000, respectively.
The gross loss for the year ended May 31, 2008 of $4,162,000 reflects: the high cost of laminates for the SolarSave® Tile for low volume purchase quantities, higher than expected freight and manufacturing costs incurred as a result of our need to satisfy tight delivery schedules, a $996,000 increase to warranty reserve related to diode failures of SolarSave® Membrane product shipments and a $372,000 increase to warranty reserve related to tile delamination on a small percentage of early production Solar Save® Tiles.
For the year ended May 31, 2007, cost of sales was $9,080,000, resulting in a gross loss of $4,788,000. The cost of sales includes charges for $1,370,000 of inventory reserves for our membrane product, a $547,000 charge to adjust tile inventory to the lower of cost or market and a charge for membrane product warranty reserves totaling $1,520,000. The remaining $5,643,000 of cost of sales exceeded revenues due to an underutilization of manufacturing capacity and the resulting under-absorption of labor and overhead expenses due to lower than anticipated sales volume. The inventory and warranty reserves for the membrane product are primarily related to the estimated costs to correct the corrosion issues with the membrane product for both on-hand inventories and existing installations.
Our industry is still developing and the highly competitive environment continues to put pressure on pricing. In addition, scarce resources of silicon have increased costs of sales. The combination of these factors is putting pressure on gross margins.
We have undertaken a number of initiatives to improve gross margin, the most significant of which is moving from a 3 foot tile to a 4 foot standard tile, which is expected to be commercially available in the calendar-quarter ended December 31, 2008. We believe that the redesign of our SolarSave® Membrane product scheduled for release to market early in 2009 will address the previous product failure issues. We are negotiating with outsourced manufacturers on product pricing for our current and next generation SolarSave® roofing tiles and are also evaluating other cost effective supply options for our laminates and products. As we mature in our relationship with our suppliers and customers and improve forecasting, we expect to reduce costs. In addition, we are currently evaluating the potential of licensing the intellectual property associated with our tile and membrane products. We believe that such a licensing strategy would result in greater operational profitability.
Operating Expenses
Selling, general and administrative
For the years ended May 31, 2008 and 2007, selling, general and administrative expenses (“SG&A”) were $18,747,000 and $17,084,000, respectively.
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For the year ended May 31, 2008, SG&A expenses of $18,747,000 included $9,645,000 in stock-based compensation, $1,006,000 of depreciation expense and intangible asset amortization expense, and $1,707,000 of legal and professional fees associated primarily with SEC reporting, contractual matters, and efforts to protect the Company’s intellectual property.
SG&A expenses for the year ended May 31, 2007 were $17,084,000. SG&A expenses included $7,421,000 in non-cash compensation for stock grants to key management, directors, and consultants. Cash-based management fees, wages and salaries were approximately $3,536,000 for fiscal 2007. Legal, professional and consulting fees were approximately $2,249,000 for fiscal 2007. The legal and professional fees were primarily related to our financing activities, our registration statement that went effective in October 2006, the acquisition of WaterEye, and SEC reporting. Depreciation and amortization were $151,000 and $1,350,000, respectively. General administrative, insurance, facilities, and travel for fiscal 2007 were $1,752,000. Advertising expenses, which include investor relations expenses, were $626,000 for fiscal 2007. These expenses were related to the branding of the Open Energy name, participation in trade shows, and the marketing of the SolarSave ® Tiles, Membranes, and Glass.
Research and Development
For the years ended May 31, 2008 and 2007, research and development expenses were $290,000 and $513,000, respectively.
The research and development expenses incurred in both years were related to the ongoing development of the SolarSave® Tiles, SolarSave® Membranes, SolarSave® Glass and future product development. Future research and development efforts will be focused on improvements to our SolarSave® Tiles and Membranes, as well as a suite of asphalt shingle products which we believe will contribute to increasing and retaining market share.
Restructuring costs
For the year ended May 31, 2008, restructuring costs were $849,000. The Company did not incur restructuring costs in 2007.
In December 2007, we adopted a plan to shut down operations at our Aurora, Ontario facility in Canada. The plan was substantially complete as of January 31, 2008. In connection with the plan, we terminated 28 of our 30 full-time employees at the Aurora facility. Existing operations and specified assets at the Aurora facility were transferred to our Grass Valley, California facility and we sold certain of the other assets located at the Aurora facility. We recorded total costs associated with the plan of $849,000, of which $272,000 related to employee termination costs, $210,000 related to asset impairment and relocation costs, $171,000 pertained to lease and lease settlement costs and $196,000 was incurred for legal and administrative costs. At May 31, 2008, $68,000 of lease settlement costs remained outstanding.
Impairment of intangibles and goodwill
The Company has performed annual impairment tests of the carrying value of goodwill and intangibles of its SRS and CRE acquisitions as required under SFAS NO. 142 and SFAS NO. 144, respectively. The tests determined that indications of impairment did not exist for certain purchased intangible assets and goodwill associated with the acquisitions. Based on these assessments, there were no write-offs for the year ended May 31, 2008.
During the year ended May 31, 2007, the Company recorded an impairment charge of $10,540,000 that was related to the impairment of intangibles and goodwill in SRS of $3,500,000 and $2,731,000, respectively, and an impairment of goodwill in WaterEye of $2,525,000. In addition, the Company wrote-off the unamortized amount of $1,694,000 of the SunCone TM CSP license agreement.
Impairment of note receivable
In 2007, the Company wrote off a note receivable of $683,000, including accrued interest totaling $33,000, relating to the divestiture of its oil and gas interests.
There were no such write-offs for the year ended May 31, 2008.
Other income (expense)
Other expenses for year ended May 31, 2008 and 2007 were $12,339,000 and $9,206,000, respectively.
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For the year ended May 31, 2008, other expenses totaling $12,339,000 included $10,833,000 in non-cash interest from the amortization of the discounts recorded in connection with warrants, beneficial conversion features and original issue discounts, and non-cash deferred financing fees associated with convertible debentures and notes payable.
In fiscal 2007, other expense was $9,206,000. Interest expense was $8,924,000 in fiscal 2007, of which $8,211,000 was due to warrant repricings and non-cash interest expense related to amortization of the warrants, beneficial conversion feature and original issue discount associated with various debentures.
Net Loss
Our net loss for the year ended May 31, 2008 and 2007 was $34,935,000 and $39,552,000, respectively.
For the year ended May 31, 2008, the net loss of $34,935,000 included $9,645,000 in stock-based compensation, $1,006,000 in depreciation and amortization expense, and $10,833,000 in non-cash interest from the amortization of the discounts recorded in connection with warrants, beneficial conversion features and original issue discounts, and non-cash deferred financing fees associated with convertible debentures and notes payable.
Our net loss was $39,552,000 for fiscal 2007, of which $10,540,000 was the write-off and impairment of intangibles and goodwill, $7,418,000 was stock-based compensation, $1,594,000 was depreciation and amortization expense, and $8,211,000 was non-cash interest expense.
Liquidity and Capital Resources
The Company has incurred losses since its inception totaling approximately $87,388,000 through May 31, 2008. The Company has been selling its products at a negative margin to gain market share and is unsure if or when it will become profitable.
During the year ended May 31, 2008, we funded our operations primarily from private sales of equity and debt securities. We have no unused sources of liquidity. Thus, additional equity or debt financing will need to be raised in the near future to continue operations and implement our business strategy. As discussed below, in April 2008, we entered into a loan and security agreement with The Quercus Trust pursuant to which Quercus agreed to loan us up to $3,500,000 based upon the availability of specified collateral. As of May 31, 2008, we had borrowed $1,550,000 under this agreement and by June 10, 2008 the remaining $1,950,000 had been funded. The loan and security agreement is collateralized by a general security interest in all of our inventory, specified accounts receivable and our cash accounts. If we were to default under the terms and conditions of the loan and security agreement, or if our specified collateral ratios fall below certain levels, Quercus would have the right to accelerate the outstanding indebtedness under the loan and security agreement and foreclose on the collateral. Such a foreclosure would have a material adverse effect on our business, liquidity, results of operations and financial position.
As of May 31, 2008, we had cash and cash equivalents of $327,000 and negative working capital of $4,796,000. For the year ended May 31, 2008, we used $15,099,000 of cash in operations. Investment activities used $145,000 of cash during the year, which was related to the acquisition of property and equipment. Financing activities provided $15,252,000 of cash during the year, with $24,500,000 in gross proceeds resulting from the sale of promissory notes and convertible debentures with warrants.
During the year ended May 31, 2008, we took steps to improve our debt structure in an effort to increase our ability to secure additional financing. We repaid our 8/31/2007 Note for $1,000,000 which matured on February 29, 2008. On February 25, 2008, the Company redeemed all remaining amounts outstanding pursuant to the 5% Debentures (defined below) issued by the Company in 2006 to YA Global Investments, L.P., and its affiliates (formerly known as Cornell Capital Partners, L.P.). The redemption payment, which included principal, accrued interest and a redemption premium, totaled approximately $3,100,000. The Company recognized an immaterial gain on the early extinguishment. While the scheduled maturity date of the 2006 Debentures was in March 2009, the 5% Debentures permitted the holder to demand redemption and a redemption premium for so long as the Company’s common stock was trading below $.50 per share. The 2006 Debentures were the only remaining variably-priced convertible securities in the Company’s capital structure. YA Global Investments held one additional 10% Debenture (defined below) in the principal amount of $3,000,000, which was scheduled to mature in March 2008. YA Global Investments agreed to extend the maturity date and on April 30, 2008, the Company repaid all remaining principal amounts outstanding pursuant to the series 10% Debenture. The payment, which included principal and accrued interest, totaled approximately $3,300,000. The 10% Debenture was the only remaining convertible debenture held by YA Global Investments in the Company’s capital structure.
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On September 12, 2008, we entered into a definitive securities purchase agreement with The Quercus Trust. The securities purchase agreement provides for the purchase by Quercus of warrants to acquire 235,000,000 shares of the Company’s common stock at a purchase price of $.02 per warrant share for a total of $4.2 million of cash, $300,000 of forgiveness of accrued interest on the Series B Convertible Notes held by Quercus and a $200,000 restructuring fee for the amendment of certain terms of the $3.5 million secured loan previously extended to the Company by Quercus. The warrants would have an exercise price equal to $0.067 per share. The $3.5 million secured loan would be amended to (1) extend the maturity date of the secured loan from October 2008 to March 2009, (2) reduce the borrowing base collateral requirement to 100% of the outstanding loan amount, and (3) eliminate the requirement that the Company make prepayments of the secured loan with the proceeds of California state solar rebates received by the Company. The warrants would have an exercise price equal to $0.067 per share. The closing of the financing under the securities purchase agreement is subject to customary conditions precedent that have not been satisfied as of the date of this report.
On September 12, 2008, we entered into a forbearance and repayment agreement with Suntech, our largest supplier. The forbearance agreement provides for a payment plan for the approximately $3 million of payables currently due from us to Suntech with interest at 12% per annum. Pursuant to the forbearance agreement, we agreed to pay $1 million on or prior to September 19, 2008, $500,000 on or prior to January 15, 2009, and six payments of $297,558 on a monthly basis beginning on March 15, 2009 until the entire amount is paid in full.
As of May 31, 2007, we had cash and cash equivalents of $319,000 and negative working capital of $8,492,000. For the year ended May 31, 2007, we used $9,239,000 of cash in operations. Investment activities used $832,000 of cash during the year, which was primarily related to acquisition of property and equipment. Financing activities provided $7,639,000 of cash during the year, with $8,000,000 in gross proceeds from convertible debentures with warrants and $500,000 in proceeds from warrants that were exercised.
To date, the Company has been unable to meet forecasted sales and margin projections and as a result has experienced significant negative cash flow for an extended period of time. Based on its current cash usage rate, the Company estimates that it currently has adequate cash to fund operations only through the end of September 2008. The ability of the Company to continue as a going concern is dependent on obtaining additional financing to support its production and working capital requirements. Management is pursuing a number of possible debt and equity financing opportunities in an effort to address these requirements. However, the Company cannot currently predict the likelihood of being able to raise additional debt or equity financing in an amount, nature or on terms that would be acceptable to the Company and the Company currently does not have any commitments for future debt and/or equity financing. If the Company is unable to obtain additional financing prior to the end of September 2008, the Company may not have sufficient cash to satisfy all ongoing capital requirements and previously incurred liabilities and will have to substantially curtail or cease operations.
Significant Capital Expenditures
We anticipate that we will make limited capital expenditures over the next twelve months for manufacturing equipment and leasehold improvements.
Contractual obligations
The maturities of our long-term debt and future payments relating to our operating leases and other purchase commitments as of May 31, 2008 are as follows (in thousands):
|
| Payments Due by Period |
| |||||||||||||
Contractual Obligation |
| Total |
| Less than |
| 1-3 years |
| 4-5 years |
| More than |
| |||||
Long-Term Debt |
| $ | 21,000 |
| $ | — |
| $ | 21,000 |
| $ | — |
| $ | — |
|
Operating Leases |
| 476 |
| 294 |
| 169 |
| 13 |
| — |
| |||||
Purchase Commitments |
| 3,024 |
| 3,024 |
| — |
| — |
| — |
| |||||
|
| $ | 24,500 |
| $ | 3,318 |
| $ | 21,169 |
| $ | 13 |
| $ | — |
|
Financings
4/30/2008 Note
On April 30, 2008, the Company entered into a Loan and Security Agreement and issued a promissory note for a loan of up to $3,500,000 (the “4/30/2008 Note”). Pursuant to the Loan Agreement, the Company may borrow an amount equal to the lesser of 50% of the Company’s combined inventory, accounts receivable and cash balances, and 100% of its qualified accounts receivable (as defined in the Loan Agreement) (the “Borrowing Base”), up to a maximum of $3.5 million.
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On April 30, 2008, the Company borrowed $1,550,000 under the Loan Agreement. From April 30, 2008 through June 30, 2008, the Company was permitted to request additional advances under the Loan Agreement in minimum amounts of at least $200,000, as the Company generated additional qualified accounts receivable and assuming the Borrowing Base was satisfied. All unpaid principal under the 4/30/2008 Note is due in full on October 30, 2008, and the 4/30/2008 Note may be prepaid in full at any time. The Company is required to make partial prepayments on the 4/30/2008 Note upon receipt of any rebates included in the accounts receivable portion of the Collateral (defined below), and upon determination that the Borrowing Base is not satisfied at specified intervals during the term of the 4/30/2008 Note.
Interest on the 4/30/2008 Note is payable in warrants to acquire shares of the Company’s common stock at an exercise price of $.506 per share. The total number of warrants that may be issued, assuming the maximum loan amount of $3.5 million is funded is 1,389,096, which the parties agreed equates to an 18% per annum interest rate on the 4/30/2008 Note. The warrants have a seven-year term. On April 30, 2008, the Company issued warrants to acquire 615,171 shares of the Company’s common stock upon the receipt of the $1,550,000 described above. The Company recorded prepaid interest of $137,589 in payment of interest in warrant shares.
The 4/30/2008 Note is secured by a first priority security interest in all of the Company’s inventory, accounts receivable and money and deposit accounts (the “Collateral”). If any event of default occurs under the Loan Agreement, the lender may: (1) declare null and void its obligation to make any additional advances under the 4/30/2008 Note, (2) require the Company to immediately repay the 4/30/2008 Note in full, (3) foreclose on the Collateral, and (4) assert all other rights and remedies of a lender under applicable law.
12/7/2007 Notes
On December 7, 2007, the Company entered into an amendment of a certain Securities Purchase Agreement, dated as of September 19, 2007 between the Company and an accredited investor pursuant to which amendment the Company issued (i) convertible notes (the “12/7/07 Notes”) in the aggregate principal amount of $1,000,000 and (ii) warrants (the “12/7/07 Warrants”) to acquire up to 2,000,000 shares of the Company’s common stock for an aggregate purchase price of $1,000,000. The transaction resulted in net proceeds to the Company of $913,000, which was used for the repayment of debt and general corporate and working capital purposes.
The maturity date of the 12/7/07 Notes is three years from December 7, 2007, which may be accelerated at the option of the investors if (i) a trigger event (as defined in the 12/7/07 Notes) has occurred and is continuing, and (ii) through the date that is ten business days after the consummation of a change of control in the event that a change of control is publicly announced. The Company does not have the right to prepay the 12/7/07 Notes in whole or in part without penalty prior to the maturity date. The 12/7/07 Notes are convertible into shares of the Company’s common stock at an initial price of $0.50 per share, subject to adjustment, including anti-dilution protection, on the terms set forth in the 12/7/07 Notes. The 12/7/07 Notes accrue interest at a rate of 6% per annum, with accrued interest due and payable quarterly in arrears.
The 12/7/07 Warrants are exercisable for up to 2,000,000 shares of the Company’s common stock at an exercise price of $0.506 per share, subject to adjustment, including anti-dilution protection, on the terms set forth in the 12/7/07 Warrants.
In connection with the December 7, 2007 amendment and related transactions, the Company paid approximately $86,437 in placement agent fees and expenses and agreed to issue warrants to acquire 80,000 shares of common stock to its placement agents.
In connection with the 12/7/07 Notes and 12/7/07 Warrants, the Company recorded debt discount in the aggregate amount of $487,500 in accordance with EITF 98-05, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05 to Certain Convertible Instruments. As a result of the debt discounts recorded in connection with the 12/7/07 Notes, the effective interest rate on the date of issuance was estimated to be approximately 22%.
As discussed above, the 12/7/07 Notes accrue interest at a rate of 6% per annum, with accrued interest due and payable quarterly in arrears on each January 1, April 1, July 1 and October 1 beginning on the first such date after December 7, 2007. The Company had not made the interest payments due on the following dates: January 1, 2008 and April 1, 2008. The total past due interest owed through March 31, 2008 was approximately $19,000. The Company entered into an amendment of its 12/7/07 Notes effective as of April 17, 2008, which are more fully described below under “9/19/07 Note.” In connection with the amendment of the 12/7/07 Notes, we issued warrants to acquire a total of 89,334 shares of our common stock with an exercise price of $0.506 per share to the holders of
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the 12/7/07 Notes in lieu of accrued and unpaid interest that was in arrearage (44,667 of such warrants were issued after May 31, 2008). The other terms of such warrants are substantially the same as the warrants issued to the holders of the 12/7/07 Note.
9/19/2007 Note
On September 19, 2007, the Company issued to an accredited investor (i) a convertible note in the principal amount of $20,000,000 (the “9/19/07 Note”) and (ii) a warrant to acquire up to 40,000,000 shares of common stock (the “9/19/07 Warrant”) for an aggregate purchase price of $20,000,000.
The maturity date of the 9/19/07 Note is three years from September 19, 2007, which may be accelerated at the option of the holder if (i) a trigger event (as defined in the 9/19/07 Note) has occurred and is continuing on the maturity date, and (ii) through the date that is ten business days after the consummation of a change of control in the event that a change of control is publicly announced. The Company does not have the right to prepay the 9/19/07 Note in whole or part without penalty prior to the maturity date. The Company may not declare or pay any cash dividend or distribution on its capital stock while the 9/19/07 Note is outstanding without the prior express written consent of the holder. The 9/19/07 Note is convertible at the option of the holder into shares of the Company’s common stock at an initial price of $0.50 per share, subject to adjustment as specified in the 9/19/07 Note. The 9/19/07 Note accrues interest at a rate of 6% per annum with accrued interest due and payable quarterly in arrears.
The 9/19/07 Warrant is exercisable for up to 40,000,000 shares of common stock at an exercise price of $0.506, which is subject to adjustment as described in the 9/19/07 Warrant. The 9/19/07 Warrant expires 84 months after the initial closing date of September 19, 2007. In addition, warrants to purchase 1,600,000 shares at $0.50 per share were issued to an investment banker for services rendered in connection with the financing.
In connection with the 9/17/07 Note and 9/17/07 Warrant, the Company recorded debt discount in the aggregate amount of $16,910,000 in accordance with EITF 98-05, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05 to Certain Convertible Instruments. As a result of the debt discounts recorded in connection with the 9/17/07 Note, the effective interest rate on the date of issuance was estimated to be approximately 64%.
As discussed above, the 9/19/07 Note accrues interest at a rate of 6% per annum, with accrued interest due and payable quarterly in arrears on each January 1, April 1, July 1 and October 1 beginning on the first such date after September 17, 2007. The Company had not made the interest payments due on the following dates: October 1, 2007, January 1, 2008 and April 1, 2008. The total past due interest owed through March 31, 2008 was approximately $641,000. On April 16, 2008, we entered into amendments of our 9/19/2007 Note and our 12/7/07 Notes (collectively, our “Series B Convertible Notes”) with the holders thereof, which amendments:
· Permit us to issue shares of our common stock that are not registered pursuant to the Securities Act of 1933, as amended, in lieu of cash interest payments on the Series B Convertible Notes;
· Permit us to issue warrants to acquire shares of our common stock, in lieu of cash interest payments on the Series B Convertible Notes, which warrants will have an exercise price per share equal to the greater of $0.506 per share or 5-day weighted average price per share of our common stock and ; and
· Waive any prior defaults or trigger events caused by our previous failure to pay interest on our Series B Convertible Notes when due, upon the issuance of warrants in lieu of such accrued interest.
On April 17, 2008, we issued warrants to acquire a total of 3,003,390 shares of our common stock with an exercise price of $0.506 per share to the holder of our 9/19/2007 Note in lieu of accrued and unpaid interest that was in arrearage. The other terms of such warrants are substantially the same as the 9/19/07 Warrants.
8/31/07 Note
On August 31, 2007, the Company entered into a Securities Purchase Agreement with an accredited investor for the private placement of (i) a convertible note in the principal amount of $1,000,000 (the “8/31/07 Note”) and (ii) a warrant to acquire up to 1,200,000 shares of common stock (the “8/31/07 Warrant”) for an aggregate purchase price of $950,000. The maturity date of the 8/31/07 Note was February 29, 2008, at which time the Company repaid the 8/31/07 Note in full. The 8/31/07 Note accrued interest at a rate of 10% per annum, with accrued interest due and payable February 29, 2008. The 8/31/07 Note was convertible into shares of the
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Company’s common stock at the option of the holder at an initial price of $0.50 per share, subject to adjustment as specified in the 8/31/07 Note.
The 8/31/07 Warrant is exercisable for up to 1,200,000 shares of common stock at an exercise price of $0.709, subject to adjustment according to the anti-dilution provisions in the 8/31/07 Warrant, provided that, in no event shall the exercise price be reduced to less than five cents ($0.05) per share (such floor price to be adjusted in the same manner that the exercise price is adjusted), and is exercisable through August 31, 2012. In addition, a warrant to purchase 72,000 shares at $0.709 per share and expiring on August 31, 2012 was issued to an investment banker for services rendered in connection with the financing.
The Company and the investor also executed a Registration Rights Agreement pursuant to which the Company has agreed to provide certain registration rights with respect to the 8/31/07 Note and the 8/31/07 Warrant.
In connection with the 8/31/07 Note and 8/31/07 Warrant, the Company recorded debt discount in the aggregate amount of $1,000,000 in accordance with EITF 98-05, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05 to Certain Convertible Instruments.
The carrying value of the 8/31/07 Note will accrete to the face value over the life of the debt, as the value of the discounts is expensed. As a result of the debt discounts recorded in connection with the 8/31/07 Note, the effective interest rate on the date of issuance was estimated to be approximately 147%.
6/15/2007 Note
On June 15, 2007, the Company entered into a Note and Warrant Purchase Agreement with an accredited investor for the private placement of a $950,000 promissory note (the “6/15/07 Note”) and a related warrant to acquire up to 4,000,000 shares of common stock (the “6/15/07 Warrant”) for a purchase price of $750,000. The maturity date of the 6/15/07 Note was October 15, 2007, and it was paid in full on October 5, 2007. The 6/15/07 Warrant is exercisable for three years, and is subject to anti-dilution provisions and a floor exercise price of $0.05 per share.
In addition to the purchase discount of $200,000, debt discount in the amount of $590,000 was recorded based on the estimated fair value of the 6/15/07 Warrant. In addition, a warrant to purchase 400,000 shares of common stock at the rate of $0.50 per share that expires on June 15, 2012, was issued to an investment banker for services rendered in connection with the financing.
5% Secured Convertible Debentures and Related Warrants
On February 25, 2008, the Company redeemed all remaining principal amounts outstanding pursuant to the 5% Debentures issued by the Company in 2006 to YA Global Investments, L.P., and its affiliates (formerly known as Cornell Capital Partners, L.P.) (the “5% Debenture”). The total redemption payment, which included principal, accrued interest and a redemption premium, amounted to approximately $3.1 million and the Company recognized an immaterial gain on the early extinguishment.
0% Convertible Debentures and Related Warrants
As of May 31, 2008 all of the 0% Debentures, originally issued in February 2006, have been converted and are no longer outstanding.
As of February 29, 2008, 1,475,010 warrants issued in connection with the 0% Debentures were outstanding at an exercise price of $0.2419 per share. The exercise price is subject to further adjustment upon the occurrence of certain specified events including, but not limited to, the issuance of securities at a deemed price below the current exercise price, stock dividends, stock splits, mergers or reorganizations, and our failure to meet certain revenue milestones.
10% Secured Convertible Debentures and Related Warrants
On March 30, 2007, we issued to YA Global Investments (formerly Cornell Capital Partners, L.P.): (i) a Convertible Secured Debenture in the original principal amount of $3,000,000 (the “10% Debenture”) and (b) a Warrant to purchase up to 6,000,000 shares of our common stock, which were issued and sold for an aggregate purchase price of $3,000,000. The 2007 Debenture accrued interest at a rate of 10% per annum and was originally scheduled to mature on March 30, 2008. The maturity date was extended to April 30, 2008. No payments of interest or principal were due under the 10% Debenture until maturity. Subject to specified
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limitations, the 10% Debenture was convertible at any time at Cornell’s option into shares of our common stock at a conversion price of $0.50 per share, subject to adjustment as set forth in the 10% Debenture. The warrant issued to Cornell has an initial exercise price of $0.50 per share, subject to adjustment, and a term of five years from the issuance date. On April 30, 2008, the Company repaid all remaining principal amounts outstanding pursuant to the 10% Debenture. The total payment, which included principal and accrued interest, totaled approximately $3,300,000. The 10% Debenture was the only remaining convertible debenture held by YA Global Investments in the Company’s capital structure.
Payroll Withholding Taxes
As discussed in Note 13 of the Consolidated Financial Statements, during the fiscal years ended May 31, 2006 and 2007, we did not withhold for or pay federal or state employment or income taxes associated with the vesting dates for restricted stock set forth in certain officers’ and employees’ employment agreements, or associated with the grants of shares to officers and employees during their employment periods for consulting and/or director services. We also did not withhold or pay employment or income taxes for shares of common stock issued to a non-executive employee during the fiscal year ended May 31, 2006, and another employee during the fiscal year ended May 31, 2007.
The shares of stock subject to all of these awards were registered for the first time with the registration statement that went effective October 27, 2006. At this time, we cannot predict when shares may be sold by the employees as a means of generating funds to satisfy withholding obligations. Market conditions and SEC regulations may also limit the number of shares that may be sold and the proceeds to the employees from such sales. We may be obligated to pay such tax liabilities before the employees have been able to sell their shares, and the sales prices the employees receive may be less than the tax liability.
Total accrued liabilities at May 31, 2008 and 2007 associated with the employees’ and employer’s combined portion of required withholding, which is an obligation of our company to the extent not satisfied by the employees, are $190,000 and $2,417,000, respectively. We also may be subject to penalties and interest, estimated to be approximately $9,000 and $324,000 for the fiscal years ended May 31, 2008 and 2007, respectively, which has been recorded as other expense. In January 2008, the Company paid past-due taxes related to these restricted stock grants, as well as related estimated interest and penalties associated with previously unpaid taxes.
The Company has recorded corresponding amounts due from the officers and employees at May 31, 2008 and 2007 totaling $397,000 and $1,993,000, respectively. These amounts are classified as due from related parties on the accompanying balance sheets and represent the amount of the liability that is owed by the individuals to the Company for the required withholdings not made on their behalf. In December 2007, the Company received $1,498,770 from its chairman and chief executive officer to satisfy the employee portion of the required withholding taxes on his restricted stock grants. The May 31, 2008 balance represents the remaining obligation for one employee and one former employee to repay the Company for taxes to be paid on their behalf.
On March 30, 2008, we entered into an amendment to the employment agreement between us and David Saltman, our chairman and chief executive officer, which provides that all restricted shares granted to Mr. Saltman that were scheduled to vest on March 31, 2008 would vest on April 20, 2008. On April 18, 2008, we entered into an additional amendment to Mr. Saltman’s employment agreement which provides that all restricted shares granted to Mr. Saltman that were scheduled to vest on: (1) April 20, 2008 would vest on May 20, 2009; (2) June 30, 2008 would vest on August 20, 2009, and (3) September 30, 2008 would vest on November 20, 2009.
Recent Accounting Pronouncements
Adoption of New Accounting Pronouncement
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FIN 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB No. 109 (“FIN 48”) which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on recognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The Company adopted FIN 48 at the beginning of fiscal year 2007. The adoption of FIN 48 did not impact our consolidated financial position, results of operations and cash flows (see Note 20).
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Recent Accounting Pronouncements
In September 2006, the FASB issued Statements of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”). SFAS No. 157 defines fair value, established a framework for measuring fair value under generally accepted accounting principles (“GAAP”) and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. On November 14, 2007, the FASB provided a one-year deferral for implementation of SFAS No. 157 for other nonfinancial assets and liabilities. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
In December 2006, the FASB issued FASB Staff Position (“FSP”) on Emerging Issues Task Force (“EITF”) 00-19-2 Accounting for Registration Payment Arrangements (“FSP EITF 00-19-2”) which specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement should be separately recognized and measured in accordance with SFAS No. 5, Accounting for Contingencies. Adoption of FSP EITF 00-19-02 is required for fiscal years beginning after December 15, 2006. The adoption of FSP EITF 00-19-2 did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other items at fair value. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Adoption is required for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or after November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
In March 2007, the FASB issued FASB Staff Position EITF 07-03 (“FSP 07-03”), Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. FSP 07-03 addresses whether nonrefundable advance payments for goods or services that will be used or rendered for research and development activities should be expensed when the advance payment is made or when the research and development activity has been performed. FSP 07-03 will be effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS No. 141R”). SFAS 141R retains the fundamental requirements in SFAS 141 that the acquisition method of accounting (which SFAS 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141R also establishes principles and requirements for how the acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree; (b) improves the completeness of the information reported about a business combination by changing the requirements for recognizing assets acquired and liabilities assumed arising from contingencies; (c) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (d) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early application is not permitted. The Company has not yet determined the impact, if any, SFAS No. 141R will have on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements (“SFAS No. 160”). SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the non-controlling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company has not yet determined the impact, if any, that SFAS No. 160 will have on its consolidated financial statements.
In December 2007, the FASB ratified the Emerging Issues Task Force consensus on EITF Issue No. 07-1, Accounting for Collaborative Arrangements that discusses how parties to a collaborative arrangement (which does not establish a legal entity within such arrangement) should account for various activities. The consensus indicates that costs incurred and revenues generated from transactions with third parties (i.e., parties outside of the collaborative arrangement) should be reported by the collaborators on the respective line items in their income statements pursuant to EITF Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent. Additionally, the consensus provides that income statement characterization of payments between the participants in a
34
collaborative arrangement should be based upon existing authoritative pronouncements; analogy to such pronouncements if not within their scope; or a reasonable, rational, and consistently applied accounting policy election. EITF Issue No. 07-1 is effective beginning January 1, 2009 and is to be applied retrospectively to all periods presented for collaborative arrangements existing as of the date of adoption. The Company is currently evaluating the impacts and disclosures of this standard, but would not expect EITF Issue No. 07-1 to have a material impact on the Company’s consolidated results of operations or financial condition.
In March, 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The new standard also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under SFAS No. 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company does not believe that the adoption of the disclosure provisions required under SFAS No. 161 will have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, Determining the Useful Life of Intangible Assets (“FSP 142-3”). FSP 142-3 amends the factors to be considered in determining the useful life of intangible assets. Its intent is to improve the consistency between the useful life of an intangible asset and the period of expected cash flows used to measure its fair value. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
On May 9, 2008, the FASB issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement (“FSP APB 14-1”). FSP APB 14-1 requires issuers of convertible debt that may be settled wholly or partly in cash when converted to account for the debt and equity components separately. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 and must be applied retrospectively to all periods presented. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Policies” (“SFAS No. 162”), which reorganizes the GAAP hierarchy. The purpose of the new standard is to improve financial reporting by providing a consistent framework for determining what accounting principles should be used when preparing the U.S. GAAP financial statements. The standard is effective 60 days after the SEC’s approval of the PCAOB’s amendments to AU Section 411. The adoption of SFAS No. 162 is not expected to have an impact on our consolidated financial statements.
In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60” (“SFAS No. 163”). SFAS 163 interprets Statement 60 and amends existing accounting pronouncements to clarify their application to the financial guarantee insurance contracts included within the scope of that Statement. SFAS No. 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. The Company does not expect that SFAS No. 163 will have a material impact on its consolidated financial statements.
In June 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”), which requires entities to apply the two-class method of computing basic and diluted earnings per share for participating securities that include awards that accrue cash dividends (whether paid or unpaid) any time common shareholders receive dividends and those dividends do not need to be returned to the entity if the employee forfeits the award. FSP EITF 03-6-1 will be effective for the Company on January 1, 2009 and will require retroactive disclosure. The Company is currently evaluating the impact of adopting FSP EITF 03-6-1 on its financial position, cash flows, and results of operations.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated under the Securities Act of 1933.
35
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Disclosure not required as a result of the Company’s status as a smaller reporting company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of May 31, 2008 and 2007
Consolidated Statements of Operations for the years ended May 31, 2008 and 2007
Consolidated Statements of Changes in Stockholders’ Equity for the years ended May 31, 2008 and 2007
Consolidated Statements of Cash Flows for the years ended May 31, 2008 and 2007
Notes to the Consolidated Financial Statements
36
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Open Energy Corporation
Solana Beach, California
We have audited the accompanying consolidated balance sheets of Open Energy Corporation and its subsidiaries as of May 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company was not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that were 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 Open Energy Corporation as of May 31, 2008 and 2007, 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 financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company’s recurring losses from operations and working capital deficiency raise substantial doubt about its ability to continue as a going concern. Management’s plans as to these matters are described in Note 2. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Squar, Milner, Peterson, Miranda & Williamson, LLP |
|
|
|
San Diego, California |
|
September 15, 2008 |
|
37
OPEN ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
|
| May 31, 2008 |
| May 31, 2007 |
| ||
ASSETS |
|
|
|
|
| ||
Current assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 327 |
| $ | 319 |
|
Accounts receivable, net of allowance for doubtful accounts of $232 and $138 at May 31, 2008 and 2007, respectively |
| 3,834 |
| 415 |
| ||
Inventories |
| 2,221 |
| 1,857 |
| ||
Deferred charges |
| 2,617 |
| — |
| ||
Prepaid expenses and other current assets |
| 367 |
| 380 |
| ||
Total current assets |
| 9,366 |
| 2,971 |
| ||
|
|
|
|
|
| ||
Fixed assets, net |
| 757 |
| 1,298 |
| ||
Due from related parties |
| 397 |
| 1,993 |
| ||
Deferred financing costs, net |
| 1,644 |
| 93 |
| ||
Intangible assets, net |
| 4,196 |
| 4,889 |
| ||
Goodwill |
| 10,221 |
| 10,221 |
| ||
Total assets |
| $ | 26,581 |
| $ | 21,465 |
|
|
|
|
|
|
| ||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
| ||
Accounts payable |
| $ | 5,283 |
| $ | 1,687 |
|
Notes payable, current maturities |
| 1,516 |
| 325 |
| ||
Current portion of convertible debentures, net |
| — |
| 1,778 |
| ||
Advances from related parties |
| 67 |
| 312 |
| ||
Other accrued liabilities |
| 4,474 |
| 6,164 |
| ||
Deferred revenue |
| 2,822 |
| 1,197 |
| ||
Total current liabilities |
| 14,162 |
| 11,463 |
| ||
|
|
|
|
|
| ||
Notes payable, net of current maturities |
| — |
| 14 |
| ||
Long-term portion of convertible debentures, net |
| 5,351 |
| 4,178 |
| ||
Deferred tax liability |
| 3,943 |
| 1,752 |
| ||
Total liabilities |
| 23,456 |
| 17,407 |
| ||
|
|
|
|
|
| ||
Commitments and contingencies (Note 17) |
|
|
|
|
| ||
|
|
|
|
|
| ||
Stockholders’ equity |
|
|
|
|
| ||
Common stock, $0.001 par value; 1,125,000,000 shares authorized; 127,952,400 and 103,801,854 shares issued and outstanding at May 31, 2008 and 2007, respectively |
| 128 |
| 104 |
| ||
Additional paid—in capital |
| 90,385 |
| 56,407 |
| ||
Accumulated deficit |
| (87,388 | ) | (52,453 | ) | ||
Total stockholders’ equity |
| 3,125 |
| 4,058 |
| ||
|
|
|
|
|
| ||
Total liabilities and stockholders’ equity |
| $ | 26,581 |
| $ | 21,465 |
|
The accompanying notes are an integral part of these consolidated financial statements.
38
OPEN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
|
| Twelve Months Ended May 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
Revenues, net |
| $ | 6,938 |
| $ | 4,292 |
|
Cost of sales |
| 11,100 |
| 9,080 |
| ||
Gross profit (loss) |
| (4,162 | ) | (4,788 | ) | ||
|
|
|
|
|
| ||
Operating expenses: |
|
|
|
|
| ||
Selling, general and administrative |
| 18,747 |
| 17,084 |
| ||
Research and development |
| 290 |
| 513 |
| ||
Restructuring Costs |
| 849 |
| — |
| ||
Impairment of intangibles and goodwill |
| — |
| 10,540 |
| ||
Impairment of note receivable |
| — |
| 683 |
| ||
Total operating expenses |
| 19,886 |
| 28,820 |
| ||
|
|
|
|
|
| ||
Loss from operations |
| (24,048 | ) | (33,608 | ) | ||
|
|
|
|
|
| ||
Other income (expense): |
|
|
|
|
| ||
Interest income |
| 314 |
| 70 |
| ||
Interest expense |
| (12,391 | ) | (8,924 | ) | ||
Other income (expense) |
| (188 | ) | (237 | ) | ||
Loss on foreign exchange |
| (74 | ) | (115 | ) | ||
Total other income (expense) |
| (12,339 | ) | (9,206 | ) | ||
|
|
|
|
|
| ||
Loss before income tax benefit |
| (36,387 | ) | (42,814 | ) | ||
Income tax benefit |
| 1,452 |
| 3,262 |
| ||
Net loss |
| $ | (34,935 | ) | $ | (39,552 | ) |
|
|
|
|
|
| ||
Net loss per share – basic and diluted |
| $ | (0.29 | ) | $ | (0.49 | ) |
|
|
|
|
|
| ||
Weighted average shares outstanding - basic and diluted |
| 121,527,253 |
| 81,085,056 |
|
The accompanying notes are an integral part of these consolidated financial statements.
39
OPEN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended May 31, 2008 and 2007
(In thousands, except stock shares)
|
| Common |
| Common |
| Additional |
| Accumulated |
| Other |
| Total |
| |||||
Balance, May 31, 2006 |
| 69,131,663 |
| 69 |
| 30,589 |
| (12,901 | ) | 7 |
| 17,764 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Restricted stock amortization |
| — |
| — |
| 6,420 |
| — |
| — |
| 6,420 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock for services |
| 421,483 |
| 1 |
| 233 |
| — |
| — |
| 234 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock and warrants for licensing rights |
| 100,000 |
| — |
| 1,787 |
| — |
| — |
| 1,787 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Cancellation of stock issued for licensing rights |
| (100,000 | ) | — |
| — |
| — |
| — |
| — |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of warrants in connection with debt financing |
| — |
| — |
| 1,801 |
| — |
| — |
| 1,801 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Beneficial conversion feature - convertible debt, net of income tax |
| — |
| — |
| 229 |
| — |
| — |
| 229 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Conversion of convertible debentures |
| 26,261,997 |
| 26 |
| 10,029 |
| — |
| — |
| 10,055 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock in legal settlement |
| 75,000 |
| — |
| 70 |
| — |
| — |
| 70 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock in connection with acquisitions |
| 6,911,711 |
| 7 |
| 2,905 |
| — |
| — |
| 2,912 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Stock based compensation expense |
| — |
| — |
| 765 |
| — |
| — |
| 765 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock upon warrant exercise |
| 1,000,000 |
| 1 |
| 499 |
| — |
| — |
| 500 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Foreign currency translation adjustments |
| — |
| — |
| — |
| — |
| (7 | ) | (7 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Warrant repricing |
| — |
| — |
| 1,080 |
| — |
| — |
| 1,080 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net loss |
| — |
| — |
| — |
| (39,552 | ) | — |
| (39,552 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance, May 31, 2007 |
| 103,801,854 |
| $ | 104 |
| $ | 56,407 |
| $ | (52,453 | ) | $ | — |
| $ | 4,058 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Restricted stock amortization |
| — |
| — |
| 5,489 |
| — |
| — |
| 5,489 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock for services |
| 6,250 |
| — |
| 3 |
| — |
| — |
| 3 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of warrants in connection with debt financing |
| — |
| — |
| 10,577 |
| — |
| — |
| 10,577 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Beneficial conversion feature - convertible debt, net of income tax |
| — |
| — |
| 7,975 |
| — |
| — |
| 7,975 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Tax benefit on beneficial conversion feature |
| — |
| — |
| (3,643 | ) | — |
| — |
| (3,643 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Conversion of convertible debentures |
| 22,897,003 |
| 23 |
| 8,273 |
| — |
| — |
| 8,296 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock in connection with SRS settlement |
| 368,040 |
| 0 |
| 110 |
| — |
| — |
| 110 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Stock based compensation expense |
| — |
| — |
| 4,154 |
| — |
| — |
| 4,154 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Issuance of stock upon warrant exercise |
| 879,251 |
| 1 |
| 252 |
| — |
| — |
| 253 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Warrants issued in payment of interest |
| — |
| — |
| 788 |
| — |
| — |
| 788 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net loss |
| — |
| — |
| — |
| (34,935 | ) | — |
| (34,935 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance, May 31, 2008 |
| 127,952,398 |
| $ | 128 |
| $ | 90,385 |
| $ | (87,388 | ) | $ | — |
| $ | 3,125 |
|
The accompanying notes are an integral part of these consolidated financial statements.
40
OPEN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
| Twelve Months Ended May 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
CASH FLOWS FROM OPERATING ACTIVITIES |
|
|
|
|
| ||
Net loss |
| $ | (34,935 | ) | $ | (39,552 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
| ||
Depreciation and amortization |
| 1,005 |
| 1,593 |
| ||
Interest from amortization of warrants and beneficial conversion feature, net of tax |
| 8,800 |
| 6,507 |
| ||
Amortization of deferred financing costs |
| 820 |
| 51 |
| ||
Amortization of original issue discount |
| 1,189 |
| 573 |
| ||
Warrant repricing |
| — |
| 1,080 |
| ||
Stock issued in SRS settlement |
| 110 |
| — |
| ||
Stock issued in legal settlement |
| — |
| 70 |
| ||
Stock based compensation |
| 9,646 |
| 7,418 |
| ||
Increase in allowance for doubtful accounts |
| 94 |
| 138 |
| ||
Reduction to inventory reserves |
| (1,232 | ) | 1,917 |
| ||
Loss on disposition of fixed assets |
| 297 |
| — |
| ||
Impairment of fixed assets |
| 119 |
| — |
| ||
Impairment of intangibles and goodwill |
| — |
| 10,541 |
| ||
Reserve for note receivable and accrued interest receivable |
| — |
| 683 |
| ||
Deferred taxes |
| (1,452 | ) | (3,236 | ) | ||
Change in operating assets and liabilities, net of effects of acquisitions: |
|
|
|
|
| ||
Accounts receivable |
| (3,513 | ) | (228 | ) | ||
Due from related parties |
| 1,596 |
| (853 | ) | ||
Inventories |
| 825 |
| (842 | ) | ||
Deferred Charges |
| (2,617 | ) | — |
| ||
Other current assets |
| 13 |
| 124 |
| ||
Accounts payable |
| 3,596 |
| 545 |
| ||
Advances from related parties |
| (245 | ) | — |
| ||
Other accrued liabilities |
| (840 | ) | 3,177 |
| ||
Deferred revenue |
| 1,625 |
| 1,055 |
| ||
Net cash used in operating activities |
| (15,099 | ) | (9,239 | ) | ||
|
|
|
|
|
| ||
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
|
| ||
Purchases of property and equipment |
| (145 | ) | (852 | ) | ||
Additions to intangible assets |
| — |
| (2 | ) | ||
Acquisitions, net of cash acquired |
| — |
| 22 |
| ||
Net cash used in investing activities |
| (145 | ) | (832 | ) | ||
|
|
|
|
|
| ||
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
|
| ||
Proceeds from issuance of notes payable |
| 2,500 |
| — |
| ||
Proceeds from issuance of convertible debt |
| 22,000 |
| 8,000 |
| ||
Proceeds from warrant exercise |
| — |
| 500 |
| ||
Payments on convertible debt |
| (6,279 | ) | — |
| ||
Payments on notes payable |
| (1,133 | ) | (149 | ) | ||
Payments on advances from related parties |
| — |
| (2 | ) | ||
Payment of debt issuance costs |
| (1,836 | ) | (710 | ) | ||
Net cash provided by financing activities |
| 15,252 |
| 7,639 |
| ||
|
|
|
|
|
| ||
Effect of foreign currency translation |
| — |
| (7 | ) | ||
|
|
|
|
|
| ||
Net increase (decrease) in cash and cash equivalents |
| 8 |
| (2,439 | ) | ||
|
|
|
|
|
| ||
Cash and cash equivalents at beginning of period |
| 319 |
| 2,758 |
| ||
|
|
|
|
|
| ||
CASH AND CASH EQUIVALENTS AT END OF PERIOD |
| $ | 327 |
| $ | 319 |
|
|
|
|
|
|
| ||
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION |
|
|
|
|
| ||
|
|
|
|
|
| ||
Cash paid during the year for: |
|
|
|
|
| ||
Interest |
| $ | 33 |
| $ | 13 |
|
Income taxes |
| $ | — |
| $ | — |
|
|
|
|
|
|
| ||
Non-cash investing and financing activities: |
|
|
|
|
| ||
Stock issued and to be issued in connection with acquisition |
| $ | 110 |
| $ | 3,643 |
|
Liabilities assumed in connection with acquisition |
| $ | — |
| $ | 24 |
|
Assets acquired in connection with acquisition |
| $ | — |
| $ | 2,873 |
|
Payment of convertible note and accrued interest with warrant exercise |
| $ | (253 | ) | $ | — |
|
Stock issued upon exercise of warrants |
| $ | 253 |
| $ | 1,801 |
|
Warrants issued in payment of interest |
| $ | 788 |
| — |
| |
Warrants issued in connection with debt financing |
| $ | 10,579 |
| $ | 229 |
|
Beneficial conversion feature associated with convertible debt |
| $ | 9,145 |
| $ | — |
|
Stock issued upon conversion of debt |
| $ | 8.296 |
| $ | 10,055 |
|
Stock and warrants issued for technology license |
| $ | — |
| $ | 1,787 |
|
Acquisition of fixed assets pursuant to notes payable agreement |
| $ | — |
| $ | 91 |
|
Acquisition of fixed assets pursuant to capital lease |
| $ | — |
| $ | 16 |
|
The accompanying notes are an integral part of these consolidated financial statements.
41
Open Energy Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended May 31, 2008 and 2007
Note 1 – Description of Business
Open Energy Corporation, a Nevada corporation (the “Company” or “OEC”), is a renewable energy company focused on the development and commercialization of a portfolio of solar electric technologies for residential, commercial and industrial applications. The Company currently designs, manufactures and distributes building-integrated photovoltaic (BIPV) roofing tiles, roofing membranes and architectural photovoltaic glass products under the SolarSave® trade name. The company currently maintains two facilities: a corporate office in Solana Beach, California for senior management, marketing, sales, customer service, legal and finance; an engineering facility in Grass Valley, California for product design, project engineering, prototyping, customer glass manufacturing, and materials management. In addition, the Company is planning to open a sales and logistics office in Sacramento, adjacent to one of OEC’s major channel partner facilities.
Shares of the Company’s common stock currently trade on the OTC Bulletin Board under the symbol “OEGY.OB” (formerly BBSE.OB). In April 2006, the Company effected a corporate name change from Barnabus Energy, Inc. to Open Energy Corporation. (In May 2005, the Company had effected a corporate name change from Barnabus Enterprises, Ltd. to Barnabus Energy, Inc).
Note 2 – Going Concern
The accompanying financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has incurred losses since its inception totaling approximately $87,388,000 through May 31, 2008. As of May 31, 2008, we had cash and cash equivalents of $327,000, and negative working capital of $4,796,000. During the year ended May 31, 2008, we funded our operations from private sales of equity and debt securities and as of May 31, 2008, have no unused sources of liquidity. We believe our current cash will only provide sufficient working capital to fund our operations through September 2008. Our current cash requirements are significant due to significant inventory purchases; the need to bring in additional personnel to support our sales efforts; delays in product shipments as a result of the shift to outsourcing and the suspension of membrane product shipments; research and development expenses; and other operational expenses. We expect to continue to use significant sources of cash to fund our operations during fiscal 2009. Thus, additional equity or debt financing will need to be raised in the near future to implement our business strategy.
The ability of the Company to continue as a going concern is dependent on the Company obtaining adequate capital or it could be forced to cease operations. In order to continue as a going concern, the Company will also need to develop and grow its customer base and revenues and achieve a profitable level of operations. Management’s plans to obtain such resources for the Company include raising additional capital through sales of debt and equity, the proceeds of which will be used to support its production and working capital requirements. In September 2008 the Company entered into a securities purchase agreement pursuant to which it expects to receive initial gross cash proceeds of $4.2 million (see Note 22). The financial statements included herein do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Note 3 - Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated.
Reclassification
Certain amounts in the prior periods presented have been reclassified to conform to the current period financial statement presentation.
42
Foreign Currency
The functional currency for the Company’s Canadian subsidiary is the United States dollar. Gains and losses from foreign exchange transactions are included in the consolidated statements of operations and have not been significant. Translation adjustments resulting from the process of translating the Company’s former oil and gas operations into U.S. dollars are included in determining comprehensive loss and have not been significant.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and also requires disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made by management include revenue recognition estimates, the viability of recognizing deferred tax assets, valuation of intangibles and goodwill, valuation of equity instruments, reserves for inventory, allowance for uncollectible amounts due from related parties and the allowance for doubtful accounts receivable. Significant changes in these estimates may have a material impact on the financial statements.
Revenue Recognition
The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). The Company generates revenue from the sale of PV roofing tiles, PV roofing membranes, balance of system products, and management system products to our dealers or other parties. The Company does not perform any installations of PV products. The Company does, however, install water monitoring systems and recognizes corresponding license/subscription revenue consistent with the requirements of AICPA Statement of Position (SOP) 97-2, Software Revenue Recognition . SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the seller’s price to the buyer is fixed and determinable; and (4) collectability is reasonably assured. Amounts billed or received from customers in advance of performance are recorded as deferred revenue.
Deferred Revenue and Deferred Charges - Sales Subject to State Rebates
The Company records deferred revenue in connection with sales to certain customers of products that qualify for state rebates that have been assigned to the Company by the customer. Based on the assignment of the rebate to the Company, the Company bills the customer net of the anticipated rebate and assumes the responsibility for collection of the rebate. The rebate processing cycle involves a multi-step process in which the Company accumulates and submits information required by the state agency necessary for the collection of the rebate. The entire process can take up to 120 days or more to complete. Although title to the products sold have transferred to the customer, due to uncertainty relating to the collection of the rebate and the determination of the ultimate price to be received, the Company defers revenue on the portion of the selling price related to the rebate, until such time that the rebate claim is submitted to the state agency.
Cost of sales related to revenue that has been deferred in connection with rebate collection process is recorded as deferred charges until such time as the related revenue is recognized.
Cash and Cash Equivalents
Cash and cash equivalents consist primarily of cash on deposit, certificates of deposit with original maturities of three months or less and money market accounts that are readily convertible into cash.
Fair Value of Financial Instruments
Cash, accounts receivable and accounts payable are stated at their respective carrying values, which approximate their fair values. The carrying value of notes payable approximates their estimated fair values as these obligations bear interest at rates which approximate current market rates.
43
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade accounts receivable. The Company maintains cash balances at various financial institutions primarily located in California. Accounts at these institutions are secured by the Federal Deposit Insurance Corporation up to $100,000. At times, balances may exceed federally insured limits. The Company has not experienced any losses in such accounts. Management believes that the Company is not exposed to any significant credit risk with respect to its cash and cash equivalents.
Accounts Receivable
The Company carries its accounts receivable at their face amounts less an allowance for doubtful accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts based on a combination of specific customer circumstances and credit conditions and based on a history of write-offs and collections. The Company evaluates items on an individual basis when determining accounts receivable write-offs. The Company’s policy is generally to not charge interest on trade receivables after the invoice becomes past due.
Inventories
Inventories consist of PV cells and other component material for specific customer orders and spare parts, and are valued at lower of cost (first-in, first-out) or market. Management provides a reserve to reduce inventory to its net realizable value. Certain factors could impact the realizable value of inventory, so management continually evaluates its recoverability based on assumptions about customer demand and market conditions. The evaluation may take into consideration expected demand, new product development, the effect new products might have on the sale of existing products, product obsolescence, and other factors. The reserve or write-down is equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory reserves or write-downs may be required. If actual market conditions are more favorable, reserves or write-downs may be reversed.
Warranty Reserves
It is customary in the Company’s business and industry to warrant or guarantee the performance of PV roofing products at certain levels of conversion efficiency for extended periods, often as long as 25 years. It is also customary to warrant or guarantee the functionality of inverters and balance of systems for 10 years. The Company therefore maintains warranty reserves based on an estimated percentage of revenues upon shipment of products to customers as a component of cost of sales to cover the potential liability that could arise from these guarantees. The Company’s potential liability is generally in the form of product replacement. As necessary, the Company’s warranty reserve will also include specific accruals for known product issues and an accrual for an estimate of incurred but not reported product issues based on industry loss information.
Property and Equipment
Property and equipment is recorded at cost and depreciated using the straight-line method over estimated useful lives of the assets, generally ranging from three to seven years. Leasehold improvements are amortized over the lesser of the lease term or useful life of the asset. Expenditures for ordinary repairs and maintenance are expensed as incurred while major additions and improvements are capitalized.
Goodwill and Intangible Assets
Goodwill represents the excess of costs over fair value of assets of businesses acquired. Per Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead must be tested for impairment annually or more frequently if circumstances indicate that indicators of impairment may be present. Management assesses goodwill for impairment at the reporting unit level on an annual basis at fiscal year-end or more frequently under certain circumstances. Such circumstances include (i) significant adverse change in legal factors or in the business climate, (ii) an adverse action or assessment by a regulator, (iii) unanticipated competition, (iv) a loss of key personnel, (v) a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of, and (vi) recognition of an impairment loss in a subsidiary that is a component of a reporting unit. Management must make assumptions regarding estimating the fair value of the company
44
reporting unit. If these estimates or related assumptions change in the future, the Company may be required to record an impairment charge. For the year ended May 31, 2007, the Company tested its goodwill for impairment under the provisions of SFAS No. 142, and recorded the charges described in Note 5.
Intangible assets with finite lives are amortized over their estimated useful lives, which range from five to ten years. Intangible assets are reviewed for impairment whenever events or circumstances indicate impairment might exist in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. The projected undiscounted net cash flows expected to be derived from the use of those assets are compared to the respective net carrying amounts to determine whether any impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.
Factors the Company considers important which could trigger an impairment review include:
· Significant underperformance relative to historical or projected future operating results;
· Significant changes in the manner of use of the acquired assets or the strategy for the Company’s overall business; and
· Significant negative industry or economic trends.
Deferred Financing Costs
Costs related to the issuance of debt are capitalized and amortized to interest expense over the life of the related debt on a straight line basis which is not materially different from the results obtained using the effective interest method.
Income Taxes
Income taxes are computed using the asset and liability method. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized.
Derivative Financial Instruments
The Company accounts for derivative instruments in accordance with the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), and its related interpretations, and complies with SFAS No. 138, Accounting for Certain Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS No. 133”) .. SFAS No. 133 and SFAS No. 138 establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities.
The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risk. Terms of convertible debt and equity instruments are reviewed to determine whether or not they contain embedded derivative instruments that are required under SFAS No. 133 to be accounted for separately from the host contract, and recorded on the balance sheet at fair value. The fair value of derivative liabilities is required to be revalued at each reporting date, with corresponding changes in fair value recorded in current period operating results.
Freestanding warrants issued by the Company in connection with the issuance or sale of debt and equity instruments are considered to be derivative instruments, and are evaluated and accounted for in accordance with the provisions of the Emerging Issues Task Force Issue (“EITF”) No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF No. 00-19”). Pursuant to EITF No. 00-19, an evaluation of specifically identified conditions is made to determine whether the fair value of warrants issued is required to be classified as equity or as a derivative liability.
Beneficial Conversion and Warrant Valuation
In accordance with EITF No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, the Company records a beneficial conversion feature (“BCF”) related to the issuance of convertible debt instruments that have conversion features at fixed rates that are in-the-money when issued, and the fair value of warrants issued in connection with those instruments. The BCF for
45
the convertible instruments is recognized and measured by allocating a portion of the proceeds to warrants, based on their relative fair value, and as a reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the conversion feature. The discounts recorded in connection with the BCF and warrant valuation are recognized as non-cash interest expense over the term of the convertible debt, using the effective interest method.
Stock-Based Compensation
Beginning in fiscal year 2007, the Company accounts for share-based compensation arrangements in accordance with the provisions of Statement of Financial Accounting Standards No. 123R (“SFAS 123R”) Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on estimated fair values. The Company uses the Black-Scholes option valuation model to estimate the fair value of its stock options at the date of grant. The Black-Scholes option valuation model requires the input of subjective assumptions to calculate the value of stock options. The Company uses historical data among other information to estimate the expected price volatility, the expected option life and the expected forfeiture rate.
In accordance with SFAS 123R, the Company records compensation expense for Restricted Stock Awards based on the estimated fair value of the award on the date of grant. The estimated fair value is determined based on the closing price of the Company’s Common Stock on the award date multiplied by the number of awards expected to vest. The number of awards expected to vest is based on the number of awards granted adjusted by estimated forfeiture rates. The total compensation cost is then recognized ratably over the vesting period.
Litigation
From time to time, the Company is involved in disputes, litigation and other legal actions. The Company estimates the range of liability related to pending litigation where the amount and range of loss can be estimated. The Company records its best estimate of a loss when the loss is considered probable. Where a liability is probable and there is a range of estimated loss with no best estimate in the range, the Company records a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated.
Basic and Diluted Net Loss per Share
Basic net loss per share is computed by dividing the loss for the period by the weighted average number of common shares outstanding for the period. Fully diluted loss per share reflects the potential dilution of securities by including other potential issuances of common stock, including shares to be issued upon exercise of stock options and warrants, in the weighted average number of shares of common stock outstanding for a period and is not presented where the effect is anti-dilutive.
For the year ended May 31, 2008, a total of 42,000,000 shares underlying convertible debt, 74,973,656 shares underlying warrants and 17,570,386 outstanding stock options to purchase shares of our common stock have been excluded from the calculation because they are deemed to be anti-dilutive.
Segment Reporting
The Company has determined it operates in one operating segment. Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker assesses the Company’s performance, and allocates its resources as a single operating segment.
46
Note 4 – Recent Accounting Pronouncements
Adoption of New Accounting Pronouncement
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FIN 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB No. 109 (“FIN 48”) which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on recognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The Company adopted FIN 48 at the beginning of fiscal year 2007. The adoption of FIN 48 did not impact our consolidated financial position, results of operations and cash flows (see Note 11).
Recent Accounting Pronouncements
In September 2006, the FASB issued Statements of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”). SFAS No. 157 defines fair value, established a framework for measuring fair value under generally accepted accounting principles (“GAAP”) and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. On November 14, 2007, the FASB provided a one-year deferral for implementation of SFAS No. 157 for other nonfinancial assets and liabilities. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
In December 2006, the FASB issued FASB Staff Position (“FSP”) on Emerging Issues Task Force (“EITF”) 00-19-2 Accounting for Registration Payment Arrangements (“FSP EITF 00-19-2”) which specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement should be separately recognized and measured in accordance with SFAS No. 5, Accounting for Contingencies. Adoption of FSP EITF 00-19-02 is required for fiscal years beginning after December 15, 2006. The adoption of FSP EITF 00-19-2 did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other items at fair value. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Adoption is required for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
In March 2007, the FASB issued FASB Staff Position EITF 07-03 (“FSP 07-03”), Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. FSP 07-03 addresses whether nonrefundable advance payments for goods or services that will be used or rendered for research and development activities should be expensed when the advance payment is made or when the research and development activity has been performed. FSP 07-03 will be effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS No. 141R”). SFAS 141R retains the fundamental requirements in SFAS 141 that the acquisition method of accounting (which SFAS 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141R also establishes principles and requirements for how the acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree; (b) improves the completeness of the information reported about a business combination by changing the requirements for recognizing assets acquired and liabilities assumed arising from contingencies; (c) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (d) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early application is not permitted. The Company has not yet determined the impact, if any, SFAS No. 141R will have on its consolidated financial statements.
47
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements (“SFAS No. 160”). SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the non-controlling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company has not yet determined the impact, if any, that SFAS No. 160 will have on its consolidated financial statements.
In December 2007, the FASB ratified the Emerging Issues Task Force consensus on EITF Issue No. 07-1, Accounting for Collaborative Arrangements that discusses how parties to a collaborative arrangement (which does not establish a legal entity within such arrangement) should account for various activities. The consensus indicates that costs incurred and revenues generated from transactions with third parties (i.e., parties outside of the collaborative arrangement) should be reported by the collaborators on the respective line items in their income statements pursuant to EITF Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent. Additionally, the consensus provides that income statement characterization of payments between the participants in a collaborative arrangement should be based upon existing authoritative pronouncements; analogy to such pronouncements if not within their scope; or a reasonable, rational, and consistently applied accounting policy election. EITF Issue No. 07-1 is effective beginning January 1, 2009 and is to be applied retrospectively to all periods presented for collaborative arrangements existing as of the date of adoption. The Company is currently evaluating the impacts and disclosures of this standard, but would not expect EITF Issue No. 07-1 to have a material impact on the Company’s consolidated results of operations or financial condition.
In March, 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The new standard also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under SFAS No. 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company does not believe that the adoption of the disclosure provisions required under SFAS No. 161 will have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
In April 2008, the FASB issued Staff Position No. 142-3, Determining the Useful Life of Intangible Assets (“FSP 142-3”). FSP 142-3 amends the factors to be considered in determining the useful life of intangible assets. Its intent is to improve the consistency between the useful life of an intangible asset and the period of expected cash flows used to measure its fair value. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is evaluating the effect the implementation will have on its consolidated financial statements.
In May, 2008, the FASB issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (“FSP APB 14-1”). FSP APB 14-1 requires issuers of convertible debt that may be settled wholly or partly in cash when converted to account for the debt and equity components separately. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 and must be applied retrospectively to all periods presented. The Company is evaluating the effect the implementation will have on its consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Policies” (“SFAS No. 162”), which reorganizes the GAAP hierarchy. The purpose of the new standard is to improve financial reporting by providing a consistent framework for determining what accounting principles should be used when preparing the U.S. GAAP financial statements. The standard is effective 60 days after the SEC’s approval of the PCAOB’s amendments to AU Section 411. The adoption of SFAS No. 162 is not expected to have an impact on our consolidated financial statements.
In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60” (“SFAS No. 163”). SFAS 163 interprets Statement 60 and amends existing accounting pronouncements to clarify their application to the financial guarantee insurance contracts included within the scope of that Statement. SFAS No. 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. The Company does not expect that SFAS No. 163 will have a material impact on its consolidated financial statements.
In June 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”), which requires entities to apply the two-class method of computing
48
basic and diluted earnings per share for participating securities that include awards that accrue cash dividends (whether paid or unpaid) any time common shareholders receive dividends and those dividends do not need to be returned to the entity if the employee forfeits the award. FSP EITF 03-6-1 will be effective for the Company on January 1, 2009 and will require retroactive disclosure. The Company is currently evaluating the impact of adopting FSP EITF 03-6-1 on its financial position, cash flows, and results of operations.
Note 5 – Accounts Receivable
Accounts receivable consisted of the following (in thousands):
|
| May 31, |
| May 31, |
| ||
Assigned rebates |
| $ | 2,734 |
| $ | 106 |
|
Trade accounts |
| 1,332 |
| 447 |
| ||
Less: Allowance for doubtful accounts |
| (232 | ) | (138 | ) | ||
Total |
| $ | 3,834 |
| $ | 415 |
|
Assigned rebates represent uncollected rebates from the California Energy Commission that have been assigned to the Company from its customers. The Company records deferred revenue in connection with sales to certain customers of products that qualify for state rebates that have been assigned to the Company by the customer. Based on the assignment of the rebate to the Company, the Company bills the customer net of the anticipated rebate and assumes the responsibility for collection of the rebate. The rebate processing cycle involves a multi-step process in which the Company accumulates and submits information required by the state agency necessary for the collection of the rebate. The entire process can take up to 120 days or more to complete.
49
Note 6 – Inventories
Inventories consisted of the following (in thousands):
|
| May 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
Raw materials |
| $ | 2,181 |
| $ | 2,532 |
|
Work-in-process |
| — |
| 540 |
| ||
Finished goods |
| 724 |
| 702 |
| ||
Less reserves |
| (684 | ) | (1,917 | ) | ||
Total |
| $ | 2,221 |
| $ | 1,857 |
|
Note 7 – Deferred Charges
At May 31, 2008, the Company had deferred charges of $2,617,000. These charges represent the cost of sales related to revenue that has been deferred in connection with the rebate collection process.
Note 8 –Fixed Assets
Fixed assets are stated at cost less accumulated depreciation and amortization. Depreciation and amortization of fixed assets are provided over the estimated useful lives of the assets, or the related lease terms if shorter, by the straight-line method. Useful lives range as follows:
Computers and networks |
| 3 years |
|
Machinery and equipment |
| 5-7 years |
|
Furniture and fixtures |
| 5-7 years |
|
Leasehold improvements |
| Lesser of lease term or useful life of the improvement |
|
Fixed assets consisted of the following (in thousands):
|
| May 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
Computers and Networks |
| $ | 336 |
| $ | 310 |
|
Machinery and Equipment |
| 683 |
| 735 |
| ||
Furniture and fixtures |
| 137 |
| 89 |
| ||
Leasehold improvement |
| 13 |
| 59 |
| ||
Construction in progress |
| 0 |
| 369 |
| ||
Subtotal |
| 1,169 |
| 1,562 |
| ||
Less: accumulated depreciation |
| (412 | ) | (264 | ) | ||
Fixed assets, net |
| $ | 757 |
| $ | 1,298 |
|
Depreciation expense was $312,000 and $243,000 for the years ending May 31, 2008 and 2007, respectively.
Note 9 – Due from Related Parties
Amounts due from related parties as of May 31, 2008 and 2007 of $397,000 and $1,993,000, respectively, consist of estimated balances owed by certain officers and other employees to the Company for income tax withholding in connection with previously issued restricted stock grants (see Notes 12 and 13). In December 2007, the Company received $1,498,770 from its Chairman and Chief Executive Officer to satisfy the employee portion of the required withholding taxes on restricted stock grants to him that have vested to date. In January 2008, the Company paid past-due federal and state employment taxes, as well as related estimated interest
50
and penalties associated with previously unpaid taxes. The May 31, 2008 balance represents the remaining obligation for one employee and one former employee to repay the Company for taxes paid and to be paid on their behalf.
Note 10 – Deferred Financing Costs, net
The Company capitalizes costs directly related to financing agreements and certain qualified debt restructuring costs, and amortizes these costs as additional interest expense over the terms of the related debt.
Net deferred financing costs are comprised of the following (in thousands):
|
| May 31, 2008 |
| May 31, 2007 |
| ||
Deferred financing costs |
| $ | 2,159 |
| $ | 152 |
|
Accumulated amortization |
| (515 | ) | (59 | ) | ||
Deferred financing costs, net |
| $ | 1,644 |
| $ | 93 |
|
For the year ended May 31, 2008 and 2007, the Company recognized amortization expense of $820,000 and $51,000, respectively, related to deferred financing fees.
Note 11 – Goodwill and Intangible Assets
As of May 31, 2008 and 2007, goodwill and intangible assets consisted of the following (in thousands):
|
| May 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
Goodwill: |
|
|
|
|
| ||
|
|
|
|
|
| ||
CRE |
| $ | 6,097 |
| $ | 6,097 |
|
SRS |
| 3,846 |
| 3,846 |
| ||
WaterEye |
| 278 |
| 278 |
| ||
|
| $ | 10,221 |
| $ | 10,221 |
|
|
| Weighted |
|
|
|
|
| ||
|
| average |
|
|
|
|
| ||
|
| amortization |
| May 31, |
| ||||
|
| (years) |
| 2008 |
| 2007 |
| ||
Amortized intangible assets: |
|
|
|
|
|
|
| ||
|
|
|
|
|
|
|
| ||
Patented technologies |
| (8 | ) | $ | 5,699 |
| $ | 5,699 |
|
Customer relationships |
| (8 | ) | 462 |
| 462 |
| ||
Backlog |
| (0.5 | ) | — |
| 300 |
| ||
Subtotal |
|
|
| 6,161 |
| 6,461 |
| ||
Less: accumulated amortization |
|
|
| (2,075 | ) | (1,682 | ) | ||
Total amortized intangibles |
|
|
| 4,086 |
| 4,779 |
| ||
|
|
|
|
|
|
|
| ||
Unamortized intangible assets: |
|
|
|
|
|
|
| ||
Trademarks |
|
|
| 110 |
| 110 |
| ||
Total unamortized intangibles |
|
|
| 110 |
| 110 |
| ||
|
|
|
|
|
|
|
| ||
Total intangibles |
|
|
| $ | 4,196 |
| $ | 4,889 |
|
51
Aggregate amortization expense for all intangible assets for the years ended May 31, 2008 and 2007 totaled $694,000 and $1,350,000, respectively. Estimated amortization of intangible assets is $699,000 annually for fiscal 2009 through 2012 and $1,290,000 thereafter.
Note 12 – Advances from Related Parties
The Company assumed advances from various related parties, including shareholders, in connection with the acquisition of SRS. These advances are due on demand and bear interest as of May 31, 2008 and 2007, at 18% and 6% per annum respectively.
On March 7, 2008, the Company entered into a settlement and general release agreement (the “Settlement Agreement”) with the former stockholders (the “SRS Stockholders”) of Solar Roofing Systems, Inc. The Settlement Agreement was entered into to settle certain disagreements related to the rights and liabilities of the Company and the SRS Stockholders under the terms of the stock purchase agreement the Company entered with Solar Roofing Systems, Inc. and the SRS Stockholders in February 2006. Under the terms of the Settlement Agreement, among other things, in exchange for mutual releases given by the Company and the SRS Stockholders in favor of the other, the Company agreed to pay off principal and interest of approximately $436,000 for certain loans owed to the SRS Stockholders.
As of May 31, 2008 and 2007, balances due to related parties totaled $67,000 and $312,000, respectively, and related accrued interest totaled $3,000 and $81,000, respectively.
Note 13 – Other Accrued Liabilities
Other accrued liabilities consisted of the following (in thousands):
|
| May 31, |
| May 31, |
| ||
|
| 2008 |
| 2007 |
| ||
Accrued warranty |
| $ | 2,403 |
| $ | 1,520 |
|
Payroll liabilities |
| 406 |
| 2,533 |
| ||
Accrued interest |
| 351 |
| 879 |
| ||
Common stock issuable |
| 746 |
| 734 |
| ||
Accrued legal fees |
| 74 |
| — |
| ||
Accrued restructuring costs |
| 68 |
| — |
| ||
Other |
| 426 |
| 498 |
| ||
Total |
| $ | 4,474 |
| $ | 6,164 |
|
Accrued warranty. Changes in the warranty reserve for the year ended were the following (in thousands):
|
| May 31, 2008 |
| May 31, 2007 |
| ||
Beginning balance |
| $ | 1,520 |
| $ | 16 |
|
Provisions |
| 1,578 |
| 1,504 |
| ||
Warranty settlements |
| (695 | ) | — |
| ||
Ending balance |
| $ | 2,403 |
| $ | 1,520 |
|
Included in the accrued warranty reserve is $943,000 related to warranty work to repair diodes on the Company’s SolarSave® membrane product that was shipped in prior quarters, $987,000 related to a product corrosion issue on the Company’s SolarSave® membrane product shipped in prior quarters, $277,000 related to tile delamination, and $196,000 related to a general reserve on products sold to date.
Payroll liabilities. Included in payroll liabilities at May 31, 2008 and 2007 are liabilities totaling $190,000 and $2,417,000, respectively, representing estimated employer and employee taxes, employee withholding, interest and penalties related to stock-based compensation resulting from the vesting through February 29, 2008 and May 31, 2007 of previous issuances of restricted common stock to certain officers and employees of the Company. In connection with the issuance of these shares, the Company failed to withhold the required amounts related to the individuals’ federal and state income and payroll tax liabilities, pay the related employer tax liabilities associated with the issuances, and did not remit the amounts to the appropriate federal and state government agencies associated with amounts vested at the times required by law. In January 2008, the Company paid past-due taxes related to these restricted stock grants, as well as related estimated interest and penalties associated with previously unpaid taxes. The Company has
52
recorded corresponding amounts due from the officers and employees at May 31, 2008 and 2007 totaling $397,000 and $1,993,000, respectively. These amounts are classified as due from related parties on the accompanying balance sheets and represent the amount of the liability that is owed by the individuals to the Company for the required withholdings not made on their behalf. In December 2007, the Company received $1,498,770 from its Company’s Chairman and Chief Executive Officer to satisfy the employee portion of the required withholding taxes on his restricted stock grants. The May 31, 2008 balance represents the remaining obligation for one employee and one former employee to repay the Company for taxes to be paid on their behalf.
Common stock issuable. Common stock issuable represented the liability to former shareholders of Solar Roofing Systems, Inc. (“SRS”) under the terms of the stock purchase agreement the Company entered into with SRS and SRS stockholders in February 2006. On March 7, 2008, the Company entered into a settlement and general release agreement with the former stockholders of SRS to settle certain disagreements related to the rights and liabilities of the Company and the SRS Stockholders. The Company agreed to issue an aggregate of 2,202,594 shares of common stock under the terms of the settlement agreement, of which 1,834,554 shares remain to be issued.
Accrued restructuring costs. The Company has remaining accrued restructuring costs related to the settlement of its Canadian facility lease of $68,000 (see Note 21).
Note 14 – Deferred Revenue
Deferred revenue consisted of the following (in thousands):
|
| May 31, |
| May 31, |
| ||
Rebate processing |
| $ | 2,617 |
| $ | — |
|
Other |
| 205 |
| 1,197 |
| ||
|
|
|
|
|
| ||
Total |
| $ | 2,822 |
| $ | 1,197 |
|
The Company records deferred revenue in connection with sales to certain customers of products that qualify for state rebates that have been assigned to the Company by the customer. Although title to the products sold have transferred to the customer, due to uncertainty relating to the collection of the rebate, the Company defers revenue on a portion of the selling price related to the rebate. As the rebate processing advances through the various stages of the processing cycle, revenue is deferred until such time that the rebate claim is submitted to the state agency, at which point, any deferred revenue relating to that specific transaction is recognized.
Note 15 – Notes Payable
Notes payable consisted of the following (in thousands):
|
| May 31, |
| May 31, |
| ||
|
| 2008 |
| 2007 |
| ||
Secured loan agreement for borrowings up to $3,500,000, bearing interest at 18% payable at funding in warrant shares, matures October 30, 2008, secured by accounts, including but not limited to qualified accounts receivable, all inventory, money and deposit accounts, cash and non-cash proceeds of any and all of the foregoing |
| $ | 1,511 |
| $ | — |
|
Unsecured demand promissory note payable to an unrelated party, bearing interest at 18% per annum calculated annually with no fixed term of repayment |
| — |
| 190 |
| ||
Promissory note in connection with the purchase of computer software bearing interest at 8%, due in six monthly installments of $15,000 through April 2007 |
| — |
| 77 |
| ||
Secured credit facility agreement for borrowings up to CDN $250,000, bearing interest at prime plus 3% (11.5% at May 31, 2007), matured March 2008, secured by equipment and personally guaranteed by certain shareholders of the Company |
| — |
| 62 |
| ||
Other |
| 5 |
| 10 |
| ||
Total |
| 1,516 |
| 339 |
| ||
Notes payable, current maturities |
| 1,516 |
| 325 |
| ||
Notes payable, long term maturities |
| $ | — |
| $ | 14 |
|
53
On April 30, 2008, the Company entered into a Loan and Security Agreement and issued a promissory note for a loan of up to $3,500,000 (the “4/30/2008 Note”). Pursuant to the Loan Agreement, the Company may borrow an amount equal to the lesser of 50% of the Company’s combined inventory, accounts receivable and cash balances, and 100% of its qualified accounts receivable (as defined in the Loan Agreement) (the “Borrowing Base”), up to a maximum of $3,500,000. On April 30, 2008, the Company was funded $1,550,000 under the Loan. From April 30, 2008 through June 30, 2008, the Company was entitled to make additional advances under the Loan Agreements in minimum amounts of at least $200,000, as the Company generates additional qualified accounts receivable and assuming the Borrowing Base is satisfied. All unpaid principal under the Loan is due in full on October 30, 2008, and the Loan may be prepaid in full at any time. The Company is required to make partial prepayments on the Loan upon receipt of any rebates included in the accounts receivable portion of the Collateral (defined below), and upon determination that the Borrowing Base is not satisfied at specified intervals during the term of the Loan. Through June 30, 2008, the Company borrowed a total of $3,500,000 under this facility.
Interest on the Loan is payable in warrants to acquire shares of the Company’s common stock at an exercise price of $.506 per share. The total number of warrants that may be issued, assuming the maximum Loan amount of $3.5 million is funded is 1,389,096, which the parties agreed equates to an 18% per annum interest rate on the Loan. The warrants have a seven-year term. On April 30, 2008, the Company issued warrants to acquire 615,171 shares of the Company’s common stock upon the receipt of the $1,550,000 described above. The Company recorded prepaid interest of $137,589 in payment of interest in warrant shares.
The Loan is secured by a first priority security interest in all of the Company’s inventory, accounts receivable and money and deposit accounts (the “Collateral”). If any event of default occurs under the Loan Agreements, the lender may: (1) declare null and void its obligation to make any additional advances under the Loan, (2) require the Company to immediately repay the Loan in full, (3) foreclose on the Collateral, and (4) assert all other rights and remedies of a lender under applicable law.
On September 14, 2007, the Company agreed to apply the principal and interest due under the 18% unsecured demand promissory notes to Coach Capital, LLC (for the three Demand Notes dated August 4, November 9, and December 2, 2005) to the exercise price of certain warrants held by them as payment in full of the Company’s obligations under the 18% unsecured demand promissory notes. The Company applied an aggregate amount of $252,785 to the exercise price pursuant to the Warrant Exercise Notices received from Coach Capital. The amount of $193,386 at $0.2875 per warrant share for a total of 672,646 common shares was applied to the Coach Capital exercise, and $59,399 at $0.2875 per warrant share for a total of 206,605 common shares was applied to the Nadelson Internacional S.A. exercise. After this exercise, Coach Capital has no further warrants outstanding and Nadelson has 129,718 warrants still outstanding at May 31, 2008.
On June 15, 2007, the Company entered into a Note and Warrant Purchase Agreement with an accredited investor for the private placement of a $950,000 promissory note (the “6/15/07 Note”) and a related warrant to acquire up to 4,000,000 shares of common stock for a purchase price of $750,000. The maturity date of the 6/15/07 Note was October 15, 2007, and it was paid in full on October 5, 2007. The warrant is exercisable for three years, and was subject to anti-dilution provisions and a floor exercise price of $0.05 per share. In addition to the purchase discount of $200,000, debt discount in the amount of $590,000 was recorded based on the estimated fair value of the warrants. In addition, a warrant to purchase 400,000 shares of common stock at the rate of $0.50 per share that expires on June 15, 2012, was issued to an investment banker for services rendered in connection with the financing.
Accrued interest related to notes payable at May 31, 2008 and 2007 totaled $0 and $55,000, respectively.
Note 16 – Convertible Debentures and Warrants
12/7/2007 Notes
On December 7, 2007, the Company entered into an amendment of a certain Securities Purchase Agreement, dated as of September 19, 2007 between the Company and an accredited investor pursuant to which amendment the Company issued (i) convertible notes (the “12/7/07 Notes”) in the aggregate principal amount of $1,000,000 and (ii) warrants (the “12/7/07 Warrants”) to acquire up to 2,000,000 shares of the Company’s common stock for an aggregate purchase price of $1,000,000. The transaction
54
resulted in net proceeds to the Company of $913,000, which was used for the repayment of debt and general corporate and working capital purposes.
The maturity date of the 12/7/07 Notes is three years from December 7, 2007, which may be accelerated at the option of the investors if (i) a trigger event (as defined in the 12/7/07 Notes) has occurred and is continuing, and (ii) through the date that is ten business days after the consummation of a change of control in the event that a change of control is publicly announced. The Company does not have the right to prepay the 12/7/07 Notes in whole or in part without penalty prior to the maturity date. The 12/7/07 Notes are convertible into shares of the Company’s common stock at an initial price of $0.50 per share, subject to adjustment, including anti-dilution protection, on the terms set forth in the 12/7/07 Notes. The 12/7/07 Notes accrue interest at a rate of 6% per annum, with accrued interest due and payable quarterly in arrears.
The 12/7/07 Warrants are exercisable for up to 2,000,000 shares of the Company’s common stock at an exercise price of $0.506 per share, subject to adjustment, including anti-dilution protection, on the terms set forth in the 12/7/07 Warrants.
In connection with the December 7, 2007 amendment and related transactions, the Company paid approximately $86,437 in placement agent fees and expenses and agreed to issue warrants to acquire 80,000 shares of common stock to its placement agents.
In connection with the 12/7/07 Notes and 12/7/07 Warrants, the Company recorded debt discount in the aggregate amount of $487,500 in accordance with EITF 98-05, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05 to Certain Convertible Instruments . As a result of the debt discounts recorded in connection with the note, the effective interest rate on the date of issuance was estimated to be approximately 22%.
As discussed above, the 12/7/07 Notes accrue interest at a rate of 6% per annum, with accrued interest due and payable quarterly in arrears on each January 1, April 1, July 1 and October 1 beginning on the first such date after December 7, 2007. The Company had not made the interest payments due on the following dates: January 1, 2008 and April 1, 2008. The total past due interest owed through March 31, 2008 was approximately $19,000. The Company entered into an amendment of its Series B Convertible Notes issued on September 19, 2007, the (“9/19/07” Note) and the 12/7/07 Notes, which notes collectively constitute the Series B Convertible Notes. In connection with the amendment of the Series B Convertible Notes, we issued warrants to acquire a total of 89,334 shares of our common stock with an exercise price of $0.506 per share to the holders in lieu of accrued and unpaid interest that was in arrearage (see Note 22). The other terms of such warrants are substantially the same as the warrants issued to the holders of the 12/7/07 Note.
9/19/2007 Note
On September 19, 2007, the Company issued to an accredited investor (i) a convertible note in the principal amount of $20,000,000 (the “9/19/07 Note”) and (ii) a warrant to acquire up to 40,000,000 shares of common stock (the “9/19/07 Warrant”) for an aggregate purchase price of $20,000,000.
The maturity date of the 9/19/07 Note is three years from September 19, 2007, which may be accelerated at the option of the holder if (i) a trigger event (as defined in the 9/19/07 Note) has occurred and is continuing on the maturity date, and (ii) through the date that is ten business days after the consummation of a change of control in the event that a change of control is publicly announced. The Company does not have the right to prepay the 9/19/07 Note in whole or part without penalty prior to the maturity date. The Company may not declare or pay any cash dividend or distribution on its capital stock while the 9/19/07 Note is outstanding without the prior express written consent of the holder. The 9/19/07 Note is convertible at the option of the holder into shares of the Company’s common stock at an initial price of $0.50 per share, subject to adjustment as specified in the 9/19/07 Note. The 9/19/07 Note accrues interest at a rate of 6% per annum with accrued interest due and payable quarterly in arrears.
The 9/19/07 Warrant is exercisable for up to 40,000,000 shares of common stock at an exercise price of $0.506, which is subject to adjustment as described in the 9/19/07 Warrant. The 9/19/07 Warrant expires 84 months after the initial closing date of September 19, 2007. In addition, a separate warrant to purchase 1,600,000 shares at $0.50 per share was issued to an investment banker for services rendered in connection with the financing.
In connection with the 9/19/07 Note and 9/19/07 Warrant, the Company recorded debt discount in the aggregate amount of $16,910,000 in accordance with EITF 98-05, Accounting for Convertible Securities with Beneficial Conversion Features or
55
Contingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05 to Certain Convertible Instruments . As a result of the debt discounts recorded in connection with the note, the effective interest rate on the date of issuance was estimated to be approximately 64%.
As discussed above, the 9/19/07 Note accrues interest at a rate of 6% per annum, with accrued interest due and payable quarterly in arrears on each January 1, April 1, July 1 and October 1 beginning on the first such date after September 17, 2007. The Company had not made the interest payments due on the following dates: October 1, 2007, January 1, 2008 and April 1, 2008. The total past due interest owed through March 31, 2008 was approximately $641,000. On April 16, 2008, we entered into amendments of our 9/19/2007 Note with the holder thereof, which amendments:
· Permit us to issue shares of our common stock that are not registered pursuant to the Securities Act of 1933, as amended, in lieu of cash interest payments on the 9/19/2007 Note;
· Permit us to issue warrants to acquire shares of our common stock, in lieu of cash interest payments on the 9/19/2007 Note, which warrants will have an exercise price per share equal to the greater of $0.506 per share or 5-day weighted average price per share of our common stock; and
· Waive any prior defaults or trigger events caused by our previous failure to pay interest on our 9/19/2007 Note when due, upon the issuance of warrants in lieu of such accrued interest.
On April 17, 2008, we issued warrants to acquire a total of 3,003,370 shares of our common stock with an exercise price of $0.506 per share to the holder of our 9/19/2007 Note in lieu of accrued and unpaid interest that was in arrearage. The other terms of such warrants are substantially the same as the 9/19/07 Warrants.
8/31/07 Note
On August 31, 2007, the Company entered into a Securities Purchase Agreement with an accredited investor for the private placement of (i) a convertible note in the principal amount of $1,000,000 (the “8/31/07 Note”) and (ii) a warrant to acquire up to 1,200,000 shares of common stock (the “8/31/07 Warrant”) for an aggregate purchase price of $950,000. The maturity date of the 8/31/07 Note was February 29, 2008, at which time the Company repaid the 8/31/07 Note in full. The 8/31/07 Note accrued interest at a rate of 10% per annum, with accrued interest due and payable February 29, 2008. The 8/31/07 Note was convertible into shares of the Company’s common stock at the option of the holder at an initial price of $0.50 per share, subject to adjustment as specified in the 8/31/07 Note.
The 8/31/07 Warrant is exercisable for up to 1,200,000 shares of common stock at an exercise price of $0.709, subject to adjustment according to the anti-dilution provisions in the 8/31/07 Warrant, provided that, in no event shall the exercise price be reduced to less than five cents ($0.05) per share (such floor price to be adjusted in the same manner that the exercise price is adjusted), and is exercisable through August 31, 2012. In addition, a warrant to purchase 72,000 shares at $0.709 per share and expiring on August 31, 2012 was issued to an investment banker for services rendered in connection with the financing.
The Company and the investor also executed a Registration Rights Agreement pursuant to which the Company has agreed to provide certain registration rights with respect to the 8/31/07 Note and the 8/31/07 Warrant.
In connection with the 8/31/07 Note and 8/31/07 Warrant, the Company recorded debt discount in the aggregate amount of $1,000,000 in accordance with EITF 98-05, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05 to Certain Convertible Instruments. As a result of the debt discounts recorded in connection with the note, the effective interest rate on the date of issuance was estimated to be approximately 147%.
0% Subordinated Convertible Debentures
In February and March 2006, the Company completed a private placement pursuant to which it issued five-year warrants and $5.25 million 0% subordinated convertible debentures due July 31, 2008 (“0% Debentures”) at par to Coach Capital LLC, Eversource Group Limited, Bank Sal. Oppenheim jr. & Cie. (Schweiz) AG and Nadelson Internacional S.A. The warrants are exercisable into 2,354,261 shares of the Company’s common stock. The warrant exercise price and 0% Debenture conversion price, which were initially set at $2.23 per share and $1.46, respectively, both became $0.2875 per share on December 22, 2006, and are subject to further adjustment upon the occurrence of certain specified events including, but not limited to, the issuance of securities at a deemed price below the
56
current exercise price, stock dividends, stock splits, mergers or reorganizations, and the Company’s failure to meet certain revenue milestones. A previous reduction in the warrant exercise price from $2.23 to $0.5833 per share on August 22, 2006 resulted in a non-cash interest charge of $447,000 for the year ended May 31, 2007 due to the change in the estimated fair value of the warrants before and after the exercise price reduction as determined by the Black Scholes option pricing model using the following assumptions: estimated volatility of 87%; risk free interest rate of 4.82%; an estimated life of 4.58 years and no dividend yield. A reduction in the warrant exercise price from $0.5833 to $0.2875 per share on December 22, 2006 resulted in a non-cash interest charge of $104,000 for the year ended May 31, 2007 due to the change in the estimated fair value of the warrants before and after the exercise price reduction as determined by the Black Scholes option pricing model using the following assumptions: estimated volatility of 94%; risk free interest rate of 4.53%; an estimated life of 4.25 years and no dividend yield.
As of March 30, 2006, the 0% Debentures and warrants were amended and restated to provide that the anti-dilution adjustments will occur only upon a future exercise or conversion of a convertible security, rather than upon the issuance of a convertible security, and will be calculated based upon the actual price used for the exercise or conversion. In July 2006, the 0% Debentures and warrants were further amended to provide for a minimum conversion price and exercise price, respectively, of $0.05 per share. The warrants were also amended to fix the aggregate number of warrant shares that are issuable to the number of shares of common stock for which the warrants were exercisable at the time the warrants were originally granted, or 2,354,261 shares.
On September 25, 2006, Coach Capital LLC, Eversource Group Limited and Nadelson Internacional S.A. converted an aggregate of $3,750,000 principal amount of 0% Debentures, representing the entire principal amount of 0% Debentures that were issued to them at $0.5833 per share, and the Company correspondingly issued 2,571,576 shares of its common stock to Coach Capital LLC, 2,571,576 shares of its common stock to Eversource Group Limited and 1,285,788 shares of its common stock to Nadelson Internacional S.A. On February 22, 2007, Bank Sal. Oppenheim jr. & Cie. (Schweiz) AG converted the remaining $1,500,000 principal amount of 0% Debentures into 5,217,391 shares of common stock at $0.2875 per share.
5% Convertible Debentures
In March 2006, the Company entered into a securities purchase agreement with Cornell Capital Partners, L.P. (“Cornell”), pursuant to which, as subsequently amended, the Company agreed to issue and sell to Cornell up to an aggregate of $15.0 million of secured convertible debentures (“5% Debentures) and warrants to purchase up to an aggregate of 13,250,000 shares of the Company’s common stock. On March 31, 2006, Cornell purchased $10,000,000 of the 5% Debentures and the Company issued to Cornell warrants to purchase up to an aggregate of 7,000,000 shares of common stock. Cornell also agreed to purchase an additional $5,000,000 of 5% Debentures and warrants to purchase up to 3,000,000 shares of common stock on the date the Company’s registration statement covering the shares issuable upon conversion of the 5% Debentures and exercise of the warrants was declared effective. Initially, the warrants were to have an exercise price of $1.50 per share and a term of five years. Each 5% Debenture matures three years from its date of issuance and bears interest at five percent (5%) per annum.
The conversion price of the 5% Debentures is the lower of (i) a fixed conversion price (initially $1.50) or (ii) 95% of the lowest volume weighted average price of the common stock during the 30 trading days immediately preceding the conversion date. The 5% Debentures are secured pursuant to the terms of (1) a pledge and escrow agreement among the Company, Cornell and David Gonzalez, Esq., as escrow agent, and (2) security agreements among the Company, Cornell and two of the Company’s subsidiaries. In accordance with the pledge and escrow agreement, the Company deposited 44,117,647 newly issued shares of the Company’s common stock into escrow, and granted to Cornell a security interest in those shares to secure the Company’s obligations to Cornell under the 5% Debentures and related agreements.
Under the security agreements, the Company and its subsidiaries granted to Cornell a blanket security interest in the Company’s consolidated assets. The 5% Debentures holders agreed to subordinate their security interests for certain transactions occurring in the normal course of business.
The Company agreed to file with the SEC by May 15, 2006, which date the Company refers to as the filing date, a registration statement including the shares underlying the 5% Debentures and warrants, and to use its best efforts to have such registration statement declared effective by July 29, 2006, which date the Company refers to as the effectiveness date. If a registration statement was not filed by the filing date or declared effective by the effectiveness date, as applicable, the Company would have become obligated to pay to Cornell, either in cash or in shares of common stock, liquidated damages equal to 1% of the liquidated value of the 5% Debentures outstanding for each 30 day period (pro-rated for partial periods) that the registration statement was not filed or declared effective, as applicable. The Company is obligated to keep the registration statement effective until all the shares have been sold or are eligible for sale without volume restrictions pursuant to Rule 144(k) promulgated under the Securities Act of 1933.
57
In July 2006, the Company and Cornell agreed to amend the investment agreements described above, effective as of their original date, as follows:
· Provide for a floor price of $0.05 per share on the adjustable conversion price of the 5% Debentures;
· Provide for a floor price of $0.05 per share on the exercise price of the warrants applicable to adjustments with respect to certain future issuances of securities by the Company, and upon certain distributions of assets and similar recapitalization events;
· Extend the deadline for having a registration statement declared effective until August 12, 2006; and
· Cap liquidated damages payable in respect of failure to have an effective registration statement at 15% of the liquidated value of the debentures outstanding.
In addition, on August 17, 2006 the Company and Cornell agreed to further amend the investment agreements described above, as follows:
· Provide for the purchase by Cornell of $1,500,000 of the remaining 5% Debentures as of the date of the amendment, with the remaining $3,500,000 to be purchased by Cornell upon the effectiveness of the registration statement;
· Waive any breaches of the investment agreements with Cornell related to the Company’s tax withholding liabilities as described in Note 8 to the financial statements;
· Further extend the deadline for having a registration statement declared effective until September 5, 2006; and
· Reduce the exercise price of the warrant to be issued in connection with Cornell’s purchase of the remaining $5,000,000 of 5% Debentures to $0.80 from $1.50 per share and increase the total number of warrant shares underlying such warrants to 6,250,000 from 3,000,000. These warrants were issued on the date of the amendment.
In addition, Cornell granted the Company a waiver of certain of the restrictive covenants contained in the investment agreements to permit the Company to take certain remedial actions relative to the Company’s tax withholding liabilities described in Note 8, including the following with respect to any officer or employee: repurchasing vested shares, canceling any unvested shares, granting substitute equity awards, or permitting such persons to sell, pledge or transfer their shares.
Effective as of September 15, 2006, Cornell agreed to further extend the deadline for having the registration statement declared effective until October 31, 2006, and waived the event of default set forth in each of the 5% Debentures, provided that the registration statement was declared effective on or before October 31, 2006. On October 25, 2006, Cornell agreed to reduce the aggregate number of shares of common stock that the Company was required to register on Cornell’s behalf from 54,117,647 to 18,730,000 shares.
On August 30, 2006, the Company filed a registration statement on Form SB-2 covering, among others, the shares issuable upon conversion of the debentures and exercise of the warrants, which was declared effective on October 27, 2006 (the “SB-2 registration statement”). On October 30, 2006, the Company completed the sale of the 5% $3,500,000 debenture to Cornell. We evaluated the embedded conversion feature in the March 2006, August 2006 and October 2006 debentures in accordance with the provisions of SFAS 133 and EITF 00-19, and concluded that bifurcation of the conversion feature is not required.
Through February 22, 2008, Cornell converted a total of $13,100,700 principal amounts of 5% Debentures, and the Company correspondingly issued a total of 37,512,669 shares of common stock to Cornell.
On February 25, 2008, the Company redeemed all remaining principal amounts outstanding pursuant to the 5% Debentures issued by the Company in 2006 to YA Global Investments, L.P., and its affiliates (formerly known as Cornell Capital Partners, L.P.). The total redemption payment, which included principal, accrued interest and a redemption premium, totaled approximately $3,143,000. While the scheduled maturity date of the 5% Debentures was in March 2009, the 5% Debentures permitted redemption for so long as the Company’s common stock was trading below $0.05 per share, with the payment of a redemption premium. The Company recognized an immaterial gain on the early extinguishment.
10% Debenture
On March 30, 2007, the Company entered into an agreement with Cornell Capital Partners, L.P. for the private placement of (i) a Convertible Secured Debenture in the original principal amount of $3,000,000 (“10% Debenture”) and (b) warrants to purchase up to 6,000,000 shares of our common stock, which were issued and sold for an aggregate purchase price of $3,000,000. We received gross
58
proceeds of $3,000,000 (before expenses) from the financing transaction, which were used for general corporate and working capital purposes.
The 10% Debenture accrued interest at a rate of 10% per annum and matured one year from the issuance date. No payments of interest or principal are due under the 10% Debenture until maturity. Subject to limitations contained in the 10% Debenture for the maximum amount that may be converted, the 10% Debenture is convertible at any time at Cornell’s option into shares of our common stock at the conversion price of $0.50 per share. The conversion price was subject to adjustment in the event we issued shares of common stock for a consideration per share less than the conversion price in effect immediately prior to such issuance or sale, except for issuances in connection with an approved stock plan, the conversion, exchange or exercise of an outstanding security, an acquisition, or conversion of the 10% Debenture. The warrants issued to Cornell also have an initial exercise price of $0.50 per share, subject to adjustment, and a term of five years from the issuance date. We evaluated the embedded conversion feature in the March 2006 debenture in accordance with the provisions of SFAS 133 and EITF 00-19, and concluded that bifurcation of the conversion feature is not required.
The issuance of the March 30, 2007 debentures and warrants caused a reduction in the warrant exercise price for the previously issued Cornell warrants to $0.50 per share, and resulted in a non-cash interest charge for the year ended May 31, 2007 in the amount of $396,000 for the first two warrants issued and $132,000 for the third warrant issued due to the change in the estimated fair value of the warrants before and after the exercise price reduction as determined by the Black Scholes option pricing model using the following assumptions: estimated volatility of 111%; risk free interest rate of 4.48%; an estimated life of 4 years and 4.42 years respectively, and no dividend yield.
On May 21, 2007, the Company entered into a Letter Agreement (the “Amendment”) with Cornell Capital Partners, L.P. which amended certain terms of the secured convertible debentures issued by the Company to Cornell pursuant to a Securities Purchase Agreement dated March 30, 2006, as amended. Pursuant to the Amendment: (i) the ownership cap set forth in Section 3(b)(i) of each debenture, which limits the holder’s ability to convert the debenture or receive shares of common stock as payment of interest on the debenture, was increased from 4.99% to 9.99%, and (ii) the Company permanently waived the conversion limitation set forth in Section 3(b)(ii) of each debenture, which would have limited the principal amount of the debenture that could be converted at the market conversion price in any 30-day period.
On March 17, 2008, the Company entered into an Extension Agreement with YA Global Investments, L.P. (formerly Cornell Capital Partners, LP) pursuant to which the parties agreed to extend the maturity date of the 10% Debenture from March 30, 2008 to April 30, 2008.
On April 30, 2008, the Company repaid all remaining principal amounts outstanding pursuant to the series 10% Debenture. The total payment, which included principal and accrued interest, totaled approximately $3.3 million. The 10% Debenture was the only remaining convertible debenture held by YA Global Investments in the Company’s capital structure.
Discounts recorded in connection with the value of warrants, beneficial conversion features and original issue discounts in connection with the above referenced convertible notes and warrants, is being recognized as non-cash interest over the term of the respective debt using the effective interest method. Upon conversion or extinguishment prior to amortization of the total discount, recognition of expense is accelerated for any previously unamortized discount. For the years ended May 31, 2008 and 2007, the Company recognized approximately $9,989,000 and $7,080,000, respectively, of non cash interest expense in connection with the amortization of debt discount. The carrying value of the debentures will accrete to the face value over the life of the debt, as the value of the discounts is expensed.
59
The carrying value of the debentures as of May 31, 2008 and 2007 has been calculated as follows (in thousands):
|
| May 31, |
| May 31, |
| ||
Face value of debentures |
| $ | 21,000 |
| $ | 13,195 |
|
|
|
|
|
|
| ||
Less unamortized debt discounts: |
|
|
|
|
| ||
Beneficial conversion feature |
| (7,727 | ) | (2,924 | ) | ||
Warrants |
| (7,922 | ) | (3,396 | ) | ||
Original issue discount |
| — |
| (919 | ) | ||
Debentures carrying value |
| 5,351 |
| 5,956 |
| ||
Less current portion |
| — |
| (1,778 | ) | ||
Long-term portion convertible debentures |
| $ | 5,351 |
| $ | 4,178 |
|
As of May 31, 2008, the debentures, plus accrued interest of $220,000, are convertible into 42,000,000 shares of our common stock.
Note 17 – Commitments and Contingencies
Operating Leases
The Company conducts all of its operations from leased facilities. Most of the leases are for 36 month terms, contain annual escalation clauses, and some provide for renewal after the expiration of the initial term. In most cases, management expects that in the normal course of business, leases will be renewed or replaced by other leases.
Rent expense was $456,000 and $404,000 for the years ended May 31, 2008 and 2007, respectively. Future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of May 31, 2008 are as follows:
2009 |
| $ | 294,000 |
|
2010 |
| 119,000 |
| |
2011 |
| 27,000 |
| |
2012 |
| 23,000 |
| |
2013 |
| 13,000 |
| |
Total |
| $ | 476,000 |
|
Employment Contract
We entered into an Employment Agreement dated August 25, 2005, between our company and David Saltman whereby our company appointed Mr. Saltman as President and Chief Executive Officer. The term of the employment agreement is from September 15, 2005 to September 30, 2008. Pursuant to the terms of the employment agreement, our company agreed to pay Mr. Saltman an annual base salary of $250,000 plus annual bonuses as determined by our board of directors and based upon our company’s financial achievements. In connection with the original employment agreement, on August 25, 2005, the Company issued 8,235,662 shares of common stock to Mr. Saltman. Such shares were scheduled to vest quarterly over a three-year period commencing December 31, 2005, with 686,305 shares scheduled to vest for the first 11 quarters and 686,307 shares scheduled to vest in the 12th and final quarter. On January 30, 2007, the Company and Mr. Saltman amended the agreement to provide that all shares that were scheduled to vest on March 31, 2007, June 30, 2007, September 30, 2007 and December 31, 2007, would instead vest ratably on March 31, 2008, June 30, 2008, and September 30, 2008. On March 30, 2008, we entered into an amendment to the employment agreement between us and David Saltman, our chairman and chief executive officer, which provides that all restricted shares granted to Mr. Saltman that were scheduled to vest on March 31, 2008 would vest on April 20, 2008. On April 18, 2008, we entered into an additional amendment to Mr. Saltman’s employment agreement which provides that all restricted shares granted to Mr. Saltman that were scheduled to vest on: (1) April 20, 2008 would vest on May 20, 2009; (2) June 30, 2008 would vest on August 20, 2009, and (3) September 30, 2008 would vest on November 20, 2009. All unvested shares will be cancelled if the employment agreement is terminated for cause by our company or if Mr. Saltman terminates the employment agreement other than for good reason, as defined in the employment
60
agreement. Finally, Mr. Saltman is entitled to certain benefits, expenses, an automobile allowance and reasonable office support services as set out in the employment agreement.
If the Company terminates the employment agreement due to the death or disability of Mr. Saltman or for cause as defined in the employment agreement, the Company will pay Mr. Saltman, or his legal representative as applicable, a sum in cash of an amount equal to the accrued but unpaid salary and any applicable bonuses. If Mr. Saltman terminates the employment agreement for good reason, as defined in the employment agreement, or if the Company terminates the employment agreement for any reason other than for cause, then the Company will pay Mr. Saltman a termination fee in cash of an amount in accordance with section 6(b) of the employment agreement.
Supply of Materials
There is currently an industry-wide shortage of semi-conductor grade silicon, an essential raw material in the production of certain of the Company’s primary products. Continued shortages of silicon used in the manufacture of the Company’s products may result in significant price increases in PV cells or the Company’s inability to obtain needed raw materials on a timely basis, which could result in delays in manufacturing and adversely affect gross margins and results of operations.
Dependence on Limited Number of Suppliers
The Company historically purchased the majority of certain raw materials and components used to manufacture its products from one supplier. Although the Company is in discussions with multiple suppliers, it is anticipated that in the future, the Company will continue to depend on a limited number of suppliers.
Restrictions on Dividend Payments
Certain of the Company’s investment related agreements prohibit paying dividends without approval.
Note 18 – Stockholders’ Equity
Common Stock
In accordance with the employment agreement with David Saltman (see Note 17), the Company granted a total of 8,235,662 common shares that are subject to forfeiture prior to vesting. The fair value of these shares at the date of grant was estimated to be approximately $16,600,000 and was originally recorded as unearned compensation. Compensation expense for financial statement purposes will be recognized on a straight-line basis over the term of the vesting schedule which runs through September 30, 2008. 686,305 shares vested quarterly commencing on December 31, 2005. All 2007 contractual vesting was deferred in connection with these shares and the remainder of the 4,804,137 unvested shares will vest ratably on March 31, 2008, June 30, 2008 and September 30, 2008. On April 18, 2008, the Company entered into an additional amendment to Mr. Saltman’s employment agreement which provided that all restricted shares granted to Mr. Saltman that were scheduled to vest on: (1) April 20, 2008 would vest on May 20, 2009; (2) June 30, 2008 would vest on August 20, 2009, and (3) September 30, 2008 would vest on November 20, 2009.
During the years ended May 31, 2008 and 2007, the Company recorded $4,496,000 and $5,396,000, respectively, of expense related to these shares as stock based compensation expense.
In accordance with an employment agreement with an employee and former officer, the Company granted a total of 1,407,805 shares of common stock that are subject to forfeiture prior to vesting. The fair value of these shares at the date of grant was estimated to be approximately $2,700,000 and was originally recorded as unearned compensation. Compensation expense will be recognized on a straight-line basis over the term of the vesting schedule which runs through September 30, 2008. The shares vested at the rate of 117,317 shares per quarter commencing on March 15, 2006. All 2007 vesting was deferred in connection with these shares and the remainder of the 821,220 unvested shares will vest ratably on March 31, 2008, June 30, 2008 and September 30, 2008. On April 18, 2008, the Company entered into an additional amendment, which provided that all restricted shares that were scheduled to vest on: (1) March 31, 2008 and June 20, 2008 would vest on April 20, 2008, and (2) September 30, 2008 would vest on October 20, 2008.
During the years ended May 31, 2008 and 2007, the Company has recorded $992,000 and $1,024,000, respectively, of expense related to these shares as stock based compensation expense.
61
On January 12, 2007, 5% Convertible Debentures with a face value of $200,000 were converted into 695,652 shares of the Company’s common stock.
On January 24, 2007, 5% Convertible Debentures with a face value of $200,000 were converted into 695,652 shares of the Company’s common stock.
On January 27, 2007, the Company entered into a Consulting Agreement with Timothy Dougherty, pursuant to which the Company issued 338,983 shares of common stock under the Company’s 2004 Consultant Stock Plan.
On February 22, 2007, Bank Sal. Oppenheim jr. & Cie. (Schweiz) AG converted the remaining $1,500,000 principal amount of its 0% Debentures at $0.2875 per share. The Company correspondingly issued 5,217,391 shares of its common stock.
On March 29, 2007, 5% Convertible Debentures with a face value of $200,000 were converted into 670,241 shares of the Company’s common stock.
Pursuant to the SRS Stock Purchase Agreement, the Company, prior to March 31, 2007, was required to calculate and issue post-closing earnout shares to former SRS shareholders. The Company determined that 1,591,073 shares are issuable to the former SRS shareholders based on the provisions of the SRS Stock Purchase Agreement, but the Company has not yet issued said shares. On January 3, 2007, the Company recorded additional goodwill and an accrued liability of $732,000 in connection with the final post-closing transaction. Further, in accordance with the SRS Stock Purchase Agreement, the Company is required to register the shares of Registrable Stock (as defined in the SRS Stock Purchase Agreement) prior to the first anniversary of the closing of said purchase and use its best efforts to have that registration statement declared effective by the SEC within the time prescribed in the SRS Stock Purchase Agreement. On March 7, 2008, the Company entered into a settlement and general release agreement with the former stockholders of Solar Roofing Systems, Inc. to settle certain disagreements related to the rights and liabilities of the Company and the SRS Stockholders. The Company agreed to issue an aggregate of 2,202,594 shares of common stock under the terms of the settlement agreement, of which 1,834,554 shares remain to be issued as of May 31, 2008.
On April 13, 2007, 5% Convertible Debentures with a face value of $800,000 were converted into 2,751,978 shares of the Company’s common stock.
On May 15, 2007, 5% Convertible Debentures with a face value of $600,000 were converted into 2,063,983 shares of the Company’s common stock.
On May 16, 2007, 5% Convertible Debentures with a face value of $200,000 were converted into 687,994 shares of the Company’s common stock.
On May 22, 2007, Cornell exercised warrants associated with the 5% Convertible Debentures and the Company issued 1,000,000 shares of common stock.
On May 22, 2007, 5% Convertible Debentures with a face value of $1,100,000 were converted into 3,670,337 shares of the Company’s common stock.
On May 31, 2007, 5% Convertible Debentures with a face value of $305,000 were converted into 969,793 shares of the Company’s common stock.
On June 14, 2007, 5% Convertible Debentures with a face value of $900,000 were converted into 2,857,143 shares of the Company’s common stock.
On June 21, 2007, 5% Convertible Debentures with a face value of $240,000 were converted into 735,971 shares of the Company’s common stock.
On July 20, 2007, 5% Convertible Debentures with a face value of $357,449 were converted into 926,514 shares of the Company’s common stock.
62
On July 24, 2007, 5% Convertible Debentures with a face value of $221,610 were converted into 574,417 shares of the Company’s common stock.
On August 8, 2007, 5% Convertible Debentures with a face value of $1,475,941 were converted into 3,825,664 shares of the Company’s common stock.
On August 15, 2007, 5% Convertible Debentures with a face value of $575,000 were converted into 1,490,410 shares of the Company’s common stock.
On August 21, 2007, 5% Convertible Debentures with a face value of $2,500,000 were converted into 6,480,041 shares of the Company’s common stock.
On August 27, 2007, 5% Convertible Debentures with a face value of $500,000 were converted into 1,180,359 shares of the Company’s common stock.
On October 8, 2007, 5% convertible debentures with a face value of $800,000 were converted into 1,826,484 shares of the Company’s common stock.
On February 14, 2008, 5% convertible debentures with a face value of $241,900 were converted into 1,000,000 shares of the Company’s common stock and on February 22, 2008, 5% convertible debentures with a face value of $483,800 were converted into 2,000,000 shares of the Company’s common stock.
Warrant Activity for the Period and Summary of Outstanding Warrants
On June 30, 2006, pursuant to a technology license agreement, the Company issued a warrant exercisable for 2,233,438 shares of common stock at an exercise price of $1.50. The warrant has a seven year term.
In July 2006, the Company and Cornell agreed to amend investment agreements and reduced the exercise price of the warrant to be issued in connection with the purchase of the remaining $5,000,000 of 5% Debentures to $0.80 from $1.50 per share and increase the total number of warrant shares underlying such warrants to 6,250,000 from 3,000,000. These warrants were issued on the date of the amendment and have a five year term.
On March 30, 2007, warrants to purchase up to 6,000,000 shares of our common stock were issued in connection with the 10% Debentures. The warrants have an initial exercise price of $0.50 per share, subject to adjustment, and a term of five years from the issuance date.
During the year ended May 31, 2007, a warrant holder exercised warrants to purchase 1,000,000 shares of the Company’s common stock for an aggregate of $500,000.
On June 15, 2007, the Company issued warrants to acquire 4,000,000 shares of the Company’s common stock, subject to anti-dilution provisions, a floor exercise price of $0.05 per share and have a three year term. In addition, a warrant to purchase 400,000 shares of common stock at the rate of $0.50 per share that expires on June 15, 2012, was issued to an investment banker for services rendered in connection with the financing.
On August 31, 2007 the Company issued warrants to acquire 1,200,000 shares of the Company’s common stock at an exercise price of $0.709, subject to adjustment according to the anti-dilution provisions, provided that, in no event shall the exercise price be reduced to less than five cents ($0.05) per share (such floor price to be adjusted in the same manner that the exercise price is adjusted). In addition, a warrant to purchase 72,000 shares at $0.709 per share was issued to an investment banker for services rendered in connection with the financing. All warrants issued in connection with the 8/31/07 Note have a five year term.
On September 19, 2007, the Company issued warrants to acquire 40,000,000 shares of the Company’s common stock at an exercise price of $0.506, which is subject to adjustment. The 9/19/07 Warrant expires 84 months after the initial closing date of September 19, 2007. In addition, a separate warrant to purchase 1,600,000 shares of common stock at $0.50 per share was issued to an investment banker for services rendered in connection with the financing. On April 17, 2008, we issued warrants to the holder of our 9/19/2007
63
Note to acquire a total of 3,003,370 shares of our common stock with an exercise price of $0.506 per share in lieu of accrued and unpaid interest that was in arrearage. The other terms of such warrants are substantially the same as the 9/19/07 Warrants.
On December 7, 2007, the Company issued warrants to acquire 2,000,000 shares of the Company’s common stock at an exercise price of $0.506 per share, subject to adjustment, including anti-dilution protection. In addition, the Company issued warrants to acquire 80,000 shares of common stock with an exercise price of $0.50 per shares was issued to its placement agents. On May 1, 2008, we issued warrants to acquire a total of 44,667 shares of our common stock with an exercise price of $0.506 per share to a holder in lieu of accrued and unpaid interest that was in arrearage. All warrants issued in connection with the 12/7/07 Note have a seven year term.
On April 30, 2008, the Company issued warrants to acquire 615,171 shares of the Company’s common stock upon funding of $1,550,000 against the 4/30/08 Note. Interest on the 4/30/08 Note is payable in warrants to acquire shares of the Company’s common stock with an exercise price of $0.506 per share. The total number of warrants that may be issued, assuming the maximum Loan amount of $3,500,000 is funded is 1,389,096, which the parties agreed equates to an 18% per annum interest rate on the Loan. The warrants have a seven-year term.
During the year ended May 31, 2008, warrant holders exercised warrants to purchase 879,251 shares of the Company’s common stock for an aggregate of $253,000.
A summary of warrant activity for the years ended May 31, 2008 and 2007 is as follows:
|
|
|
| Initial |
| Current |
|
|
| ||
|
| Number of |
| Exercise |
| Exercise |
|
|
| ||
|
| Warrants |
| Price |
| Price |
| Expiration Date |
| ||
Outstanding at May 31, 2006 |
| 9,354,261 |
|
|
|
|
|
|
| ||
Granted |
| 2,233,438 |
| $ | 1.5000 |
| $ | 1.5000 |
| June 30, 2013 |
|
Granted |
| 6,250,000 |
| $ | 0.8000 |
| $ | 0.5000 |
| August 17, 2011 |
|
Granted |
| 6,000,000 |
| $ | 0.5000 |
| $ | 0.5000 |
| March 29, 2012 |
|
Exercised |
| (1,000,000 | ) | $ | 0.5000 |
| $ | 0.5000 |
|
|
|
Outstanding at May 31, 2007 |
| 22,837,699 |
|
|
|
|
|
|
| ||
Granted |
| 400,000 |
| $ | 0.5000 |
| $ | 0.5000 |
| June 15, 2010 |
|
Granted |
| 4,000,000 |
| $ | 0.5000 |
| $ | 0.5000 |
| June 15, 2012 |
|
Granted |
| 1,272,000 |
| $ | 0.7090 |
| $ | 0.7090 |
| August 31, 2012 |
|
Granted |
| 41,600,000 |
| $ | 0.5060 |
| $ | 0.5060 |
| September 19, 2014 |
|
Granted |
| 3,003,370 |
| $ | 0.5060 |
| $ | 0.5060 |
| April 16, 2015 |
|
Granted |
| 615,171 |
| $ | 0.5060 |
| $ | 0.5060 |
| April 19, 2015 |
|
Granted |
| 2,080,000 |
| $ | 0.5060 |
| $ | 0.5060 |
| December 6, 2010 |
|
Granted |
| 44,667 |
| $ | 0.5060 |
| $ | 0.5060 |
| April 30, 2011 |
|
Exercised |
| (879,251 | ) | $ | 2.2300 |
| $ | 0.2875 |
|
|
|
Outstanding at May 31, 2008 |
| 74,973,656 |
|
|
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Outstanding at May 31, 2008 consists of: |
|
|
|
|
|
|
|
|
| ||
|
| 1,475,010 |
|
|
| $ | 0.2419 |
| January 31, 2011 |
| |
|
| 2,233,438 |
|
|
| $ | 1.5000 |
| June 30, 2013 |
| |
|
| 1,272,000 |
|
|
| $ | 0.7090 |
| August 31, 2012 |
| |
|
| 47,343,208 |
|
|
| $ | 0.5060 |
| September 19, 2014, December 6, 2010, April 16, 2015, April 19, 2015, and April 30, 2011 |
| |
|
| 22,650,000 |
|
|
| $ | 0.5000 |
| March 31, 2011, August 17, 2011, March 29, 2012, June 15, 2010 and 2012 |
| |
|
| 74,973,656 |
|
|
|
|
|
|
|
64
We evaluated the outstanding warrants in accordance with the provisions of EITF 00-19 and concluded that classification of the fair value of the warrants as equity at May 31, 2008 was appropriate.
Consultant Compensation Plan
Under the Company’s 2004 Consultant Compensation Plan, the Board of Directors is authorized to issue up to 9,771,000 shares to consultants without further shareholder approval. On January 27, 2007, the Company entered into a Consulting Agreement with Timothy Dougherty, pursuant to which the Company issued 338,983 shares of common stock under the Company’s 2004 Consultant Stock Plan. As of May 31, 2008, a total of 9,432,017 shares issued pursuant to the plan were outstanding.
During the years ended May 31, 2008 and 2007, the Company recorded $0 and $194,000, respectively, of expense related to these shares as stock based compensation expense.
Shares Issued for Services
During the year ended May 31, 2007, the Company recorded $766,000 of expense related to shares issued for services as stock based compensation expense. During the year ended May 31, 2007, a total of 62,500 shares of common stock were issued to employees as part of their employment agreements and the Company recorded $69,000 of expense related to these shares as stock based compensation expense. No such issuances occurred during the year ended May 31, 2008 and the Company recorded $0 of expense.
Shares to be Issued
We entered into two employment agreements, one of which was with an officer of the Company, calling for the periodic issuances of common stock as partial employment compensation. Under these agreements, we committed to issue an aggregate of 225,000 shares, issuance and vesting taking place on a quarterly basis. The Company has recorded $2,000 and $35,000 during the years ended May 31, 2008 and 2007, respectively, related to these two agreements which have been recorded as selling, general and administrative expenses in the accompanying statement of operations. In the years ended May 31, 2008 and 2007, respectively, the Company issued 6,250 and 62,500 shares. During the year ending May 31, 2008, remaining shares of 143,750 were cancelled.
Note 19 - Accounting for Stock-Based Compensation
On November 2, 2006, the Board of Directors adopted the Open Energy Corporation 2006 Equity Incentive Plan (the “Plan”), which provides for the granting of stock and non-stock based compensation awards, including options, stock awards, stock appreciation rights, and cash awards to employees, officers, directors or consultants. The Board of Directors approved an original allocation of 8,500,000 shares to the Plan that was subsequently expanded to 16,500,000 shares as of August 31, 2007. As of May 31, 2008, 1,029,614 shares remained available for future grant under the Plan. Options generally vest over a three year period and expire ten years from the date of grant. Options granted under the Plan have exercise prices ranging from $0.31 to $0.58 per share.
On August 31, 2007, an option for 1,000,000 shares (500,000 options were subsequently cancelled) was granted to our Chief Executive Officer, outside of the Plan in connection with guarantees made by him in connection with the 6/15/07 Note. Based on the weighted average fair value of the options of $0.40 per share, the grant resulted in stock-based compensation expense of $200,000 for the year ended May 31, 2008.
During the years ended May 31, 2008 and 2007, the Company granted a total of 13,070,000 and 7,079,193 options, respectively. The aggregate fair value of the options granted was $6,049,269 and $1,974,350 during the years ended May 31, 2008 and 2007, respectively, the majority of which will be amortized as stock compensation expense over 3 years.
The weighted average estimated fair value of stock options granted during the years ended May 31, 2008 and 2007 was $0.47 and $0.27 per share, respectively, using the Black-Scholes option pricing model. The Company used the following weighted average assumptions for the years ended May 31, 2008 and 2007:
65
|
| May 31, |
| May 31, |
|
Dividend yield |
| 0.0 | % | 0.0 | % |
Expected volatility |
| 123 | % | 70 | % |
Risk-free interest rate |
| 4.18 | % | 4.56 – 4.69 | % |
Expected life in years |
| 6 |
| 6 |
|
Forfeiture Rate |
| 8.26 | % | 0.0 | % |
Stock-based compensation expense in connection with options vesting during the years ended May 31, 2008 and 2007 was $4,154,000 and $765,000, respectively. During the year, the Company modified approximately 5,202,000 options of certain employees and a former director, which included accelerated vesting, repricing and extension of the post-employment exercise period. Since expected vesting for the majority of the modified options was determined to be improbable at the date of the modifications, the net change to stock compensation cost as a result of the modifications was a reduction of $209,285.
A summary of the changes in options outstanding during the years ended May 31, 2008 and 2007 is as follows:
Option |
| Shares |
| Weighted |
| Weighted |
| Aggregate |
| ||||
Outstanding at May 31, 2006 |
| — |
| $ | — |
| — |
| $ | — |
| ||
Granted |
| 7,079,193 | (1) | 0.52 |
| 9.06 |
|
|
| ||||
Exercised |
| — |
| — |
|
|
|
|
| ||||
Cancelled |
| (214,583 | ) | 0.53 |
|
|
|
|
| ||||
Forfeited |
| (640,000 | ) | 0.39 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Outstanding at May 31, 2007 |
| 6,224,610 |
| $ | 0.53 |
| 9.54 |
| $ | — |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Granted |
| 13,070,000 | (2) | 0.48 |
| 9.37 |
|
|
| ||||
Exercised |
| — |
| — |
|
|
|
|
| ||||
Cancelled |
| (577,000 | ) | 0.57 |
|
|
|
|
| ||||
Forfeited |
| (1,147,224 | ) | 0.45 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Outstanding at May 31, 2008 |
| 17,570,386 |
| 0.50 |
| 9.06 |
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Exercisable at May 31, 2008 |
| 8,383,962 |
| $ | 0.48 |
| 8.82 |
| $ | — |
| ||
(1) Includes an option for 1,827,000 shares that was granted under the terms of a Consulting Agreement with Connect by Computer, LLC, outside of the plan, in connection with the achievement of certain product development, commercialization, and intellectual property milestones, of which 1,600,000 options are vested, and 227,000 were cancelled effective October 31, 2007.
(2) Includes an option for 1,000,000 shares that was granted to our Chief Executive Officer, outside of the plan, in connection with the 6/15/07 Note, of which 500,000 options are vested and 500,000 were cancelled upon repayment of the 6/15/07 Note on October 5, 2007
As of May 31, 2008, the total remaining unrecognized compensation cost related to unvested stock options amounted to $2,265,580, which is expected to be recognized over a weighted-average period of 2.21 years.
A summary of nonvested stock options as of May 31, 2008 and 2007 is as follows:
66
Nonvested Shares |
| Shares |
| Weighted |
| |
|
|
|
|
|
| |
Nonvested at May 31, 2006 |
| — |
| — |
| |
Granted |
| 7,079,193 |
| 0.27 |
| |
Vested |
| (1,686,016 | ) | 0.29 |
| |
Cancelled |
| (214,583 | ) | 0.31 |
| |
Forfeited |
| (640,000 | ) | 0.24 |
| |
|
|
|
|
|
| |
Nonvested at May 31, 2007 |
| 4,538,594 |
| $ | 0.29 |
|
Granted |
| 13,070,000 |
| 0.47 |
| |
Vested |
| (6,697,946 | ) | 0.38 |
| |
Cancelled |
| (577,000 | ) | 0.46 |
| |
Forfeited |
| (1,147,224 | ) | 0.40 |
| |
|
|
|
|
|
| |
Nonvested at May 31, 2008 |
| 9,186,424 |
| $ | 0.35 |
|
Restricted Stock
In accordance with their employment agreements, certain of the Company’s officers and a non-executive employee were awarded restricted stock grants that initially vested over periods ranging from 2.75 to 3.00 years. Stock compensation expense recognized in connection with these grants during the year ended May 31, 2008 and 2007 was approximately $5,488,000 and $6,420,000, respectively.
On March 30, 2008, the Company entered into an amendment to the employment agreement between the Company and David Saltman, Chairman and Chief Executive Officer, which provided that all restricted shares granted to Mr. Saltman that were scheduled to vest on March 31, 2008 would vest on April 20, 2008. On April 18, 2008, the Company entered into an additional amendment to Mr. Saltman’s employment agreement which provided that all restricted shares granted to Mr. Saltman that were scheduled to vest on: (1) April 20, 2008 would vest on May 20, 2009; (2) June 30, 2008 would vest on August 20, 2009, and (3) September 30, 2008 would vest on November 20, 2009 (See Note 18).
As of May 31, 2008, there was approximately $3,071,000 of total unrecognized compensation cost related to nonvested restricted stock awards, which is expected to be recognized over a weighted-average period of 1.5 years.
Stock based compensation recognized during the years ended May 31, 2008 and 2007 related to common stock granted for services was $3,000 and $233,000, respectively.
Note 20 – Income Taxes
On July 13, 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS no. 109, Accounting for Income Taxes and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 was effective for fiscal years beginning after December 15, 2006.
The Company adopted the provisions of FIN 48 on June 1, 2007, and has commenced analyzing filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. As a result of adoption, the Company has recorded no additional tax liability. As of May 31, 2008, the Company has not yet completed its analysis of the deferred tax assets for net operating losses of $40 million. As such, these amounts and the offsetting valuation allowance have been removed from the Company’s deferred tax assets. The Company will complete a Section 382 analysis regarding the limitation of the net operating loss if the Company anticipates utilizing the loss carryforward.
Due to the existence of the valuation allowance, future changes in our unrecognized tax benefits will not impact the Company’s effective tax rate.
67
The Company is subject to taxation in the U.S. and state jurisdictions. The Company’s tax years for 2002 and forward are subject to examination by the US, Canada and California tax authorities due to the carryforward of unutilized net operating losses. The Company is currently under examination by any taxing authorities.
The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. During the twelve months ended May 31, 2008, the Company did not recognize any interest or penalties. Upon adoption of FIN 48 on June 1, 2007, the Company did not record any interest or penalties.
The adoption of FIN 48 did not impact the Company’s financial condition, results of operations or cash flows. At May 31, 2008, the Company had net deferred tax assets of $5.4 million. Due to uncertainties surrounding the Company’s ability to generate future taxable income to realize these assets, a full valuation has been established to offset the net deferred tax asset. Additionally, the future utilization of the Company’s net operating loss to offset future taxable income may be subject to an annual limitation as a result of ownership changes that may have occurred previously or that could occur in the future. The Company has not yet determined whether such an ownership change has occurred; however the Company will complete a Section 382 analysis regarding the limitation of the net operating loss if the Company generates taxable income. Until this analysis has been completed, the Company has removed the deferred tax assets associated with these carryforwards from its deferred tax asset schedule and has recorded a corresponding decrease to their valuation allowance. When the Section 382 analysis is completed, the Company plans to update its unrecognized tax benefits under FIN 48.
|
| May 31, 2008 |
| May 31, 2007 |
| |||||||||||||||
|
| US |
| Foreign |
| Total |
| US |
| Foreign |
| Total |
| |||||||
Deferred tax assets |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Net operating loss |
| $ |
|
| $ |
|
| $ |
|
| $ | 7,563 |
| $ | 1,677 |
| 9,240 |
| ||
Inventory |
| 273 |
| — |
| 273 |
| 763 |
| — |
| 763 |
| |||||||
Warranty |
| 69 |
| — |
| 69 |
| 602 |
| — |
| 602 |
| |||||||
Deferred compensation |
| 4,582 |
| — |
| 4,582 |
| 2,394 |
| — |
| 2,394 |
| |||||||
Impairment of note receivable |
| 272 |
| — |
| 272 |
| 272 |
| — |
| 272 |
| |||||||
Other |
| 232 |
| — |
| 232 |
| — |
| — |
| — |
| |||||||
Credits |
| 64 |
| — |
| 64 |
| 208 |
| — |
| 208 |
| |||||||
Total gross deferred tax assets |
| 5,492 |
| — |
| 5,492 |
| 11,802 |
| 1,677 |
| 13,479 |
| |||||||
Valuation allowance |
| (5,492 | ) |
|
| (5,492 | ) | (11,802 | ) | (1,677 | ) | (13,479 | ) | |||||||
Net deferred tax assets |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Deferred tax liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Intangible assets |
| $ | (759 | ) | $ | (112 | ) | $ | (871 | ) | $ | (452 | ) | $ | (139 | ) | $ | (591 | ) | |
Goodwill |
| — |
| — |
| — |
| — |
| — |
| — |
| |||||||
Beneficial conversion feature of convertible debt |
| (3,072 | ) | — |
| (3,072 | ) | (1,161 | ) | — |
| (1,161 | ) | |||||||
Total deferred tax liabilities |
| $ | (3,831 | ) | $ | (112 | ) | $ | (3,943 | ) | $ | (1,613 | ) | $ | (139 | ) | $ | (1,752 | ) | |
A reconciliation of the expected tax computed at the U.S. federal statutory income tax rate to the total benefit for income taxes at May 31, 2008 and 2007 is as follows (in thousands):
|
| Years ended May 31, |
| ||||||||
|
| 2008 |
| 2007 |
| ||||||
Expected tax at 34% |
| $ | (12,373 | ) | (34.00 | )% | $ | (14,559 | ) | (34.00 | )% |
State income tax, net of federal |
| (2,123 | ) | (5.83 | )% | (2,498 | ) | (5.83 | )% | ||
Change in valuation allowance |
| 9,478 |
| 26.03 | % | 9,119 |
| 21.30 | % | ||
Intangibles |
| 244 |
| .67 | % | 2,805 |
| 6.56 | % | ||
Non-deductible expenses |
| 42 |
| .12 | % | 87 |
| 0.20 | % | ||
Warrants |
| 2,092 |
| 5.75 | % | 1,527 |
| 3.56 | % | ||
Recapture of BCF |
| (467 | ) | (1.28 | )% | — |
| — |
| ||
Stock options |
| 1,655 |
| 4.55 | % | 305 |
| 0.70 | % | ||
Other |
| — |
| — |
| (48 | ) | (0.11 | )% | ||
|
|
|
|
|
|
|
|
|
| ||
Provision (benefit) for income taxes |
| $ | (1,452 | ) | (3.99 | )% | $ | (3,262 | ) | (7.62 | )% |
68
At May 31, 2008, the Company had federal and California tax net operating loss carryforwards of approximately $40.00 and $41.00 million, respectively. The federal and California tax loss carryforwards will begin to expire in 2019 and 2009, respectively, unless previously utilized.
Pursuant to Internal Revenue Code Section 382, use of the Company’s net operating loss carryforwards may be limited if a cumulative change in ownership of more than 50% occurs within a three-year period.
Note 21 – Restructuring Costs
On December 13, 2007, the Company adopted a plan to shut down operations at its Aurora, Ontario facility in Canada (the “Plan”). The Plan was substantially complete as of January 31, 2008. The Plan did not involve the discontinuance of any business line. The Company is continuing development and manufacturing of its SolarSave membrane product, which was historically manufactured at its Aurora facility. In connection with the Plan, the company terminated 28 of the 30 full-time employees at the Aurora facility. Pursuant to the Plan, existing operations and specified assets at the Aurora facility were transferred to the Company’s Grass Valley, California facility. The Company sold certain of the assets located at the Aurora facility.
The Company recorded total costs associated with the Plan of $849,000. The Company incurred $272,000 related to employee termination costs, $210,000 for asset impairment and relocation costs, $171,000 for lease and lease settlement costs and $196,000 in legal and administrative costs. At May 31, 2008, $68,000 representing lease settlement costs remained outstanding and was paid monthly through July, 2008. The following schedule summarizes the restructuring activity for the year ended May 31, 2008.
Canada Restructuring Accrual: |
|
|
| |
Balance as of May 31, 2007 |
| $ | — |
|
|
|
|
| |
Provision |
| 849 |
| |
Payments |
| (781 | ) | |
|
|
|
| |
Balance as of May 31, 2008 |
| $ | 68 |
|
Note 22 – Subsequent Events
12/7/2007 Notes
On August 29, 2008, we issued warrants to one of the holders of our 12/7/2007 Notes to acquire a total of 44,667 shares of our common stock with an exercise price of $0.506 per share in lieu of accrued and unpaid interest that was in arrearage. The other terms of such warrants are substantially the same as the 12/7/07 Warrants (see Note 16).
4/30/2008 Note
On June 3 and June 10, 2008, the Company was funded the remaining $1,950,000 under the 3,500,000 Loan, bringing the total amount borrowed under this loan to $3.5 million. There is no additional borrowing capacity under this loan. As of August 15, 2008, the Company has made partial prepayments on the loan of $152,000. On June 3 and June 10, 2008, we issued warrants to the holder of our 4/30/2008 Note to acquire a total of 773,925 shares of our common stock in lieu of accrued and unpaid interest that was in arrearage.
69
Securities Purchase Agreement
On September 12, 2008, we entered into a definitive securities purchase agreement with The Quercus Trust. The securities purchase agreement provides for the purchase by Quercus of warrants to acquire 235,000,000 shares of the Company’s common stock at a purchase price of $0.02 per warrant share for a total of $4.2 million of cash, $300,000 of forgiveness of accrued interest on the Series B Convertible Notes held by Quercus and a $200,000 restructuring fee for the amendment of certain terms of the $3.5 million secured loan previously extended to the Company by Quercus. The warrants would have an exercise price equal to $0.067 per share and a term of seven years. The secured loan would be amended to (1) extend the maturity date of the secured loan from October 2008 to March 2009, (2) reduce the borrowing base collateral requirement to 100% of the outstanding loan amount, and (3) eliminate the requirement that the Company make prepayments of the secured loan with the proceeds of California state solar rebates received by the Company. The closing of the financing under the securities purchase agreement is subject to customary conditions precedent that have not been satisfied as of the date of this report.
In addition, the securities purchase agreement amended certain provisions of the Company’s outstanding Series B Convertible Notes held by Quercus and other holders, which amendments (A) provide that future interest payments shall be made in the form of warrants in the form of those issued in this financings, (B) add additional protective covenants, (C) provide for the granting of voting rights to the holders of the Series B Convertible Notes, upon the amendment of the Company’s articles of incorporation. The closing of the transactions described in the securities purchase agreement are subject to several conditions, including the execution and delivery of retention and other agreements with members of the Company’s senior management.
Forbearance and Repayment Agreement
On September 12, 2008, the Company entered into a forbearance and repayment agreement with Suntech, the Company’s largest supplier. The forbearance agreement provides for a payment plan for approximately $3 million of payables currently due from the Company to Suntech with interest at 12% per annum. Pursuant to the forbearance agreement, the Company agreed to pay $1 million on or prior to September 19, 2008, $500,000 on or prior to January 15, 2009, and six payments of $297,558 on a monthly basis beginning on March 15, 2009, until the entire amount is paid in full.
ITEM 9. |
| CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A(T). |
|
We conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.
Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of May 31, 2008 at the reasonable assurance level for the reasons discussed below related to material weaknesses in our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (“ICFR”) as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our ICFR is intended to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles, generally accepted in the United States of America (“GAAP”). Our ICFR includes those policies and procedures that:
1. |
| pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; |
|
|
|
2. |
| provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and |
70
3. |
| provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or ICFR will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitation of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Management, in conjunction with a third-party consultant, initiated its assessment of the effectiveness of our internal control over financial reporting as of May 31, 2008 based on the framework set forth in the report entitled Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. However, because of our limited staff and financial resources, this assessment was not completed by the filing date of this annual report.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Based on work completed to date and information known to management, we have concluded that our internal control over financial reporting as of May 31, 2008 was not effective because of the following material weaknesses that have been identified:
| 1. | we have not completed the design and implementation of effective internal control policies and procedures necessary to provide reasonable assurance regarding the preparation of financial statements in accordance with GAAP; |
|
|
|
| 2. | we did not maintain sufficient in-house personnel resources with the technical accounting knowledge, expertise and training in the selection, application and implementation of GAAP to certain complex or non-routine transactions; |
|
|
|
| 3. | we have not completed the design and implementation of effective internal control policies and procedures necessary to provide reasonable assurances regarding accurate and timely financial accounting, recording and reporting of routine and non-routine commitments and transactions and effective management oversight of the accounting for routine and non-routine transactions, or to monitor the effectiveness of our internal controls; |
|
|
|
| 4. | we have not completed the design and implementation of effective internal control policies and procedures necessary to provide reasonable assurance regarding accurate and timely period end financial closing and reporting; |
|
|
|
| 5. | we did not maintain adequate segregation of duties for staff members responsible for certain financial accounting and reporting functions; |
|
|
|
| 6. | we have not completed the design and implementation of effective internal control policies and procedures related to risk assessment and fraud prevention and detection activities; |
|
|
|
| 7. | we have not completed the design and implementation of effective internal control policies and procedures necessary to provide reasonable assurance regarding the accuracy and integrity of spreadsheets and other “off system” work papers that are used in the financial accounting process; and |
|
|
|
| 8. | we have not completed the design and implementation of internal control policies and procedures necessary to provide reasonable assurance with respect to the accuracy and completeness of assertions and disclosures related to significant financial statement accounts, and with respect to IT general and application controls. |
It is possible had we been able to complete our assessment of ICFR that additional material weaknesses may have been identified. We are in the process of attempting to remediate the above noted material weaknesses, but that remediation was not complete as of May 31, 2008 or the filing date of this report.
71
Our plans to remediate the identified material weaknesses include: developing action plans to complete the implementation of internal controls necessary to correct each such weakness; assessing the need to take additional actions including, but not limited, to the following: evaluate accounting and control systems to identify opportunities for enhanced controls; recruit and hire additional staff to provide greater segregation of duties; evaluate the need for other employee changes; expand executive management’s ongoing communications regarding the importance of adherence to internal controls and company policies; and evaluate such other actions as our advisors may recommend.
Management does not believe that any of the Company’s annual or interim financial statements issued to-date contain a material misstatement as a result of the aforementioned weaknesses in our ICFR.
We did not include in this filing an attestation report from our independent registered public accounting firm regarding ICFR. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to the temporary rules of the SEC that permit the company to provide only the management’s report.
Changes in Internal Control over Financial Reporting
We made no changes during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
ITEM 9B. |
|
None.
72
ITEM 10. | DIRECTORS EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
The information required by this Item is incorporated by reference from our definitive proxy statement to be delivered to Stockholders in connection with our 2008 Annual Meeting of Stockholders.
ITEM 11. | EXECUTIVE COMPENSATION |
The information required by this Item is incorporated by reference from our definitive proxy statement to be delivered to stockholders in connection with our 2008 Annual Meeting of Stockholders.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required by this Item is incorporated by reference from our definitive proxy statement to be delivered to stockholders in connection with our 2008 Annual Meeting of Stockholders.
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
The information required by this Item is incorporated by reference from our definitive proxy statement to be delivered to stockholders in connection with our 2008 Annual Meeting of Stockholders.
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
The information required by this Item is incorporated by reference from our definitive proxy statement to be delivered to stockholders in connection with our 2008 Annual Meeting of Stockholders.
ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES |
(a) Index to Consolidated Financial Statements.
See Index to Consolidated Financial Statements and financial statement schedules immediately following the signature page to this report on Form 10-K.
(b) Index to Exhibits.
See Index to Exhibits immediately following the signature page to this report on Form 10-K.
73
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
| Open Energy Corporation | |
|
|
| |
|
| By: | /s/ David Saltman |
|
|
| President and Chief Executive Officer |
Each person whose signature appears below hereby severally constitutes and appoints David Field and Aidan H. Shields, and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all amendments to this Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Commission, granting unto said attorney-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that each said attorneys-in-fact and agents or any of them or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of registrant in their capacities and on September 15, 2008.
Signature |
| Title |
| Date |
|
|
|
|
|
/s/ David P. Saltman |
| Director and Chief Executive Officer (Principal Executive Officer) |
| September 15, 2008 |
David P. Saltman |
|
|
|
|
|
|
|
|
|
/s/ Aidan H. Shields |
| Chief Financial Officer and Treasurer (Principal Financial and |
| September 15, 2008 |
Aidan H. Shields |
| Accounting Officer) |
|
|
|
|
|
|
|
/s/ David A. Field |
| Director and President and Chief Operating Officer |
| September 15, 2008 |
David A. Field |
|
|
|
|
|
|
|
|
|
|
| Director |
|
|
Steven J. Kemper |
|
|
|
|
|
|
|
|
|
/s/ Edward Douglas Ward |
| Director |
| September 15, 2008 |
Edward Douglas Ward |
|
|
|
|
|
|
|
|
|
/s/ Kenneth S. Potashner |
| Director |
| September 15, 2008 |
Kenneth S. Potashner |
|
|
|
|
74
EXHIBIT INDEX
Exhibit |
| Exhibit |
|
|
|
3.1 |
| Articles of Incorporation, incorporated by reference from Exhibit 3.1 to the Form SB-2 filed August 1, 2002. |
|
|
|
3.2 |
| Bylaws, incorporated by reference from Exhibit 3.1 to the Form 10-Q filed April 19, 2006. |
|
|
|
3.3 |
| Certificate of Amendment filed with the Secretary of State of Nevada on February 23, 2004, incorporated by reference from Exhibit 3.3 to the Form 100-KSB filed September 12, 2005. |
|
|
|
3.4 |
| Certificate of Amendment filed with the Secretary of State of Nevada on May 4, 2005, incorporated by reference from Exhibit 3 to Form 8-K filed August 31, 2005. |
|
|
|
3.5 |
| Certificate of Merger filed with the Secretary of State of Nevada on April 21, 2006, incorporated by reference from Exhibit 3.1 to the Form 8-K filed April 25, 2006. |
|
|
|
3.6 |
| Amendment No. 1 to Bylaws dated June 12, 2008, incorporated by reference from Exhibit 99.1 to Form 8-K filed June 17, 2008 |
|
|
|
4.1 |
| Secured Convertible Debenture No. CCP-4, issued on October 30, 2006 in favor of Cornell Capital Partners, LP., incorporated by reference from Exhibit 4.1 to the Form 8-K filed November 3, 2006. |
|
|
|
4.2 |
| Agreement and Plan of Merger, dated December 21, 2006, by and among Open Energy Corporation, Open Energy/WE Acquisition Corporation, WaterEye Corporation, and certain other parties thereto, incorporated by reference from Exhibit 2.1 to Form 8-K filed December 28, 2006. |
|
|
|
4.3 |
| Securities Purchase Agreement dated March 30, 2007 by and between Open Energy Corporation and Cornell Capital Partners, L.P., incorporated by reference from Exhibit 4.1 to Form 8-K filed April 5, 2007. |
|
|
|
4.4 |
| Secured Convertible Debenture dated March 29, 2007 issued by Open Energy Corporation to Cornell Capital Partners, L.P., incorporated by reference from Exhibit 4.2 to Form 8-K filed April 5, 2007. |
|
|
|
4.5 |
| Security Agreement dated March 29, 2007 by and among Open Energy Corporation, Connect Renewable Energy, Inc., Solar Roofing Systems, Inc., WaterEye Corporation and Cornell Capital Partners, L.P., incorporated by reference from Exhibit 4.3 to Form 8-K filed April 5, 2007. |
|
|
|
4.6 |
| Warrant to Purchase Common Stock dated March 29, 2007 issued by Open Energy Corporation to Cornell Capital Partners, L.P., incorporated by reference from Exhibit 4.4 to Form 8-K filed April 5, 2007. |
|
|
|
4.7 |
| Registration Rights Agreement dated March 29, 2007 by and between Open Energy Corporation and Cornell Capital Partners, L.P. incorporated by reference from Exhibit 4.5 to Form 8-K filed April 5, 2007. |
|
|
|
4.8 |
| Letter Agreement, dated May 21, 2007, between Open Energy Corporation and Cornell Capital Partners, L.P., incorporated by reference from Exhibit 10.1 to the Form 8-K filed May 24, 2007. |
|
|
|
4.9 |
| Note and Warrant Purchase Agreement dated June 15, 2007, incorporated by reference from Exhibit 10.1 to the Form 8-K filed June 21, 2007. |
|
|
|
4.10 |
| Form of Warrant, incorporated by reference from Exhibit 10.2 to the Form 8-K filed June 21, 2007. |
|
|
|
4.11 |
| Form of Stock Pledge Agreement, incorporated by reference from Exhibit 10.3 to the Form 8-K filed June 21, 2007. |
|
|
|
4.12 |
| Form of Note, incorporated by reference from Exhibit 10.4 to the Form 8-K filed June 21, 2007. |
|
|
|
4.13 |
| Convertible Debenture dated June 15, 2007, incorporated by reference from Exhibit 10.5 to the Form 8-K filed June 21, 2007. |
|
|
|
4.14 |
| Form of Default Warrant, incorporated by reference from Exhibit 10.6 to the Form 8-K filed June 21, 2007. |
|
|
|
4.15 |
| Form of Registration Rights Agreement, incorporated by reference from Exhibit 10.7 to the Form 8-K filed June 21, 2007. |
|
|
|
4.16 |
| Securities Purchase Agreement, dated August 31, 2007, by and between Open Energy Corporation and Everest Asset Management AG, incorporated by reference from Exhibit 4.1 to Form 8-K filed September 6, 2007. |
75
4.17 |
| Convertible Note, dated August 31, 2007, issued by Open Energy Corporation to Everest Asset Management AG, incorporated by reference from Exhibit 4.2 to Form 8-K filed September 6, 2007. |
|
|
|
4.18 |
| Warrant, dated August 31, issued by Open Energy Corporation to Everest Asset Management AG, incorporated by reference from Exhibit 4.3 to Form 8-K filed September 6, 2007. |
|
|
|
4.19 |
| Registration Rights Agreement, dated August 31, 2007, by and between Open Energy Corporation and Everest Asset Management AG, incorporated by reference from Exhibit 4.4 to Form 8-K filed September 6, 2007. |
|
|
|
4.20 |
| Amendment dated December 7, 2007 to Securities Purchase Agreement dated as of September 19, 2007 between the registrant and certain accredited investors, incorporated by reference to Exhibit 4.1 to the Form 8-K filed on December 13, 2007. |
|
|
|
4.21 |
| Form of Convertible Note, dated December 7, 2007, issued by the registrant to certain accredited investors, incorporated by reference to Exhibit 4.3 to the Form 8-K filed on September 25, 2007. |
|
|
|
4.23 |
| Form of Series B Warrant, dated December 3, 2007, issued to by the registrant to certain accredited investors, incorporated by reference to Exhibit 4.2 to the Form 8-K filed on September 25, 2007. |
|
|
|
4.24 |
| Amendment to Series B Convertible Notes, dated April 16, 2008, incorporated by reference from Exhibit 4.4 to the Form 10-QSB filed April 21, 2008. |
|
|
|
4.25* |
| Loan and Security Agreement dated as of April 30, 2008 by and between the registrant and The Quercus Trust. |
|
|
|
4.26* |
| Promissory Note dated as of April 30, 2008 issued by the registrant to The Quercus Trust. |
|
|
|
4.27 |
| Letter Agreement, dated August 30, 2007, by and between Open Energy Corporation and YA Global Investments, L.P., incorporated by reference from Exhibit 4.1 to Form 10-KSB/A filed on October 31, 2007. |
|
|
|
4.28* |
| Securities Purchase Agreement, dated September 12, 2008, by and between Open Energy Corporation and The Quercus Trust. |
|
|
|
10.1† |
| Open Energy Corporation 2006 Equity Incentive Plan, incorporated by reference from Exhibit 10.1 to the Form 8-K filed November 8, 2006. |
|
|
|
10.1.1† |
| Form of Stock Option Agreement under the Open Energy Corporation 2006 Equity Incentive Plan, incorporated by reference from Exhibit 10.2 to the Form 8-K filed November 8, 2006. |
|
|
|
10.1.2† |
| Form of Stock Award Agreement for Restricted Stock under the Open Energy Corporation 2006 Equity Incentive Plan, incorporated by reference from Exhibit 10.3 to the Form 8-K filed November 8, 2006. |
|
|
|
10.1.3† |
| Form of Stock Award Agreement for Stock Units under the Open Energy Corporation 2006 Equity Incentive Plan, incorporated by reference from Exhibit 10.4 to the Form 8-K filed November 8, 2006. |
|
|
|
10.2† |
| Amendment No. 1 to CBC Consulting Agreement, dated December 14, 2006, incorporated by reference from Exhibit 10.1 to the Form 8-K filed December 19, 2006. |
|
|
|
10.3 |
| Agreement and Plan of Merger dated as of December 21, 2006, by and among Open Energy Corporation, Open Energy/WE Acquisition Corporation, WaterEye Corporation, and certain other parties thereto, incorporated by reference from Exhibit 2.1 to the Form 8-K filed December 19, 2006. |
|
|
|
10.4† |
| Employment Agreement dated as of December 22, 2006, by and between Open Energy Corporation and Thomas D. Wolfe, incorporated by reference from Exhibit 10.4 to the Form 10-QSB filed February 1, 2007. |
|
|
|
10.5 |
| Indenture Agreement (Lease) and Amendment No. 1 to Lease with Acton Management Co. Limited dated November 22, 2006, incorporated by reference from Exhibits 10.1 and 10.2, respectively, to the Form 8-K filed November 29, 2006. |
|
|
|
10.6† |
| Amendment No. 1 to Executive Employment dated January 30, 2007 by and between Open Energy and David Saltman incorporated by reference from Exhibit 10.6 to the Form 10-QSB filed February 1, 2007. |
|
|
|
10.7† |
| Amendment No. 2 to Executive Employment dated January 30, 2007 by and between Open Energy and Cheryl Bostater, incorporated by reference from Exhibit 10.7 to the Form 10-QSB filed February 1, 2007. |
|
|
|
10.10† |
| Employment Agreement, dated November 1, 2006, by and between Open Energy Corporation and Jeffrey Stein, incorporated by reference from Exhibit 10.5 to the Form 10-QSB filed April 23, 2007. |
|
|
|
10.11† |
| Amendment No. 1 to Employment Agreement, dated April 6, 2007, by and between Open Energy Corporation and Jeffrey Stein, incorporated by reference from Exhibit 10.6 to the Form 10-QSB filed April 23, 2007. |
76
10.12 |
| Letter Agreement, dated May 21, 2007, between Open Energy Corporation and Cornell Capital Partners, L.P., incorporated by reference from Exhibit 10.1 to the Form 8-K filed May 24, 2007. |
|
|
|
10.13† |
| Employment Agreement with Aidan H. Shields dated June 15, 2007, incorporated by reference from Exhibit 10.9 to the Form 8-K filed June 21, 2007. |
|
|
|
10.14† |
| Employment Agreement with John E. Hart dated June 15, 2007, incorporated by reference from Exhibit 10.10 to the Form 8-K filed June 21, 2007. |
|
|
|
10.15† |
| Employment Agreement with David Field dated November 1, 2006 and Amendment No. 1 to the Employment Agreement dated June 15, 2007, incorporated by reference from Exhibit 10.11 to the Form 8-K filed June 21, 2007. |
|
|
|
10.16† |
| Amendment No. 2 to Executive Employment dated March 30, 2008 by and between Open Energy and David Saltman incorporated by reference from Exhibit 10.6 to the Form 10-QSB filed April 21, 2008. |
|
|
|
10.17† |
| Amendment No. 3 to Executive Employment dated April 18, 2008 by and between Open Energy and David Saltman incorporated by reference from Exhibit 10.7 to the Form 10-QSB filed April 21, 2008. |
|
|
|
10.18† |
| Consulting Agreement between the registrant and Patricia Eckert, dated December 26, 2007, incorporated by reference from Exhibit 10.1 to Form 10-QSB filed April 21, 2008. |
|
|
|
10.19† |
| Legal Services Agreement, dated as of January 2, 2008 by and between the registrant and Dalton W. Sprinkle, incorporated by reference from Exhibit 10.2 to Form 10-QSB filed April 21, 2008. |
|
|
|
10.20 |
| Surrender Agreement, dated as of February 21, 2008 between Hamil Inc. and the registrant, incorporated by reference from Exhibit 10.3 to Form 10-QSB filed April 21, 2008. |
|
|
|
10.21 |
| Settlement Agreement dated as of March 7, 2008, by and among the registrant and the former stockholders of Solar Roofing Systems, Inc., incorporated by reference from Exhibit 10.4 to Form 10-QSB filed April 21, 2008. |
|
|
|
10.22 |
| Extension Agreement, dated as of March 17, 2008, by and between the registrant and YA Global Investments L.P., incorporated by reference from Exhibit 10.5 to Form 10-QSB filed April 21, 2008. |
|
|
|
10.23† |
| Employment Agreement, dated as of November 1, 2007 by and between the registrant and Christopher S. Gopal, incorporated by reference from Exhibit 10.1 to Form 8-K filed on November 7, 2007. |
|
|
|
10.24 |
| Distributor Agreement, dated November 16, 2007, by and among Open Energy Corporation, Tri-Valley Supply, Inc., and solely with respect to Section 8(c), Petersen-Dean, Inc., incorporated by reference from Exhibit 10.1 to Form 8-K filed on November 27, 2007. |
|
|
|
10.25* |
| Amendment No. 1 to Joint Marketing and Distribution Agreement between the registrant and Burlingame Industries, Inc., dated April 10, 2008 (Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission). |
|
|
|
10.26† |
| Amendment No. 1 to Employment Agreement dated June 15, 2007 by and between the registrant and David Field. |
|
|
|
10.27* |
| Forbearance and Repayment Agreement dated September 12, 2008 by and between the registrant and Suntech America, Inc. |
|
|
|
14.1 |
| Code of Ethics, incorporated by reference from Exhibit 14.1 to Form 10-KSB filed September 12, 2005. |
|
|
|
16.1 |
| Letter from Peterson & Co., LLP to the Securities and Exchange Commission, dated December 1, 2006, incorporated by reference from Exhibit 16.1 to the Form 8-K/A filed December 1, 2006. |
77
21.1* | List of Subsidiaries. |
23.1* | Consent of Squar, Milner, Peterson, Miranda & Williamson, LLP. |
24.1* | Power of Attorney (included on signature page). |
31.1* | Certification of Principal Executive Officer as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2* | Certification of Principal Financial Officer as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1* | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2* | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
*Filed herewith.
†Indicates a management contract or compensatory plan.
78