UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
[x] Quarterly report pursuant to
Section 13 or
15(d) of the Securities Exchange Act of
1934 for the
quarterly period ended - June 30, 2006.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the
Transition period from ______________ to _______________.
COMMISSION FILE NUMBER 000-30392
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
(Exact name of small business issuer as specified in its charter)
Florida 98-0346454
- ------------------------------ -------------------
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
335 Connie Cr.
Concord Ontario Canada L4K 5R2
(Address of principal executive offices, including postal code.)
(905) 695-4142
(Issuer's telephone number, including area code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the 12 months (or for such shorter period
that the Company was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days. YES [x] NO [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES [ ] NO [x]
The issuer had 59,265,938 shares of common stock, par value $0.001 outstanding
as of August 10, 2006.
ENVIRONMENTAL SOLUTIONS WORLDWIDE INC.
FORM 10-QSB
INDEX
PART I FINANCIAL INFORMATION PAGE NO.
ITEM 1 Financial Statements (unaudited)
Consolidated Condensed Balance Sheet as of F2
June 30, 2006
Consolidated Condensed Statements of Operations for the F3
Three and Six Months Ended June 30, 2006 and 2005
Consolidated Condensed Statement of Changes in Stockholders' F4
Equity for the six Months Ended June 30, 2006
Consolidated Condensed Statements of Cash Flows for the F5
six Months Ended June 30, 2006 and 2005
Notes to Consolidated Condensed Financial Statements F6- F14
ITEM 2 Management's Discussion and Analysis of Operations 2
ITEM 3 Controls and Procedures 12
PART II OTHER INFORMATION
ITEM 5 Other Information -- Subsequent Events 13
ITEM 6 Exhibits 15
ITEM 1. FINANCIAL STATEMENTS
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED BALANCE SHEET
AS AT JUNE 30, 2006
(UNAUDITED)
ASSETS
Current assets
Cash and cash equivalents (Note 5) $ 1,288,482
Accounts receivable (Note 2) 541,446
Inventory (Note 6) 1,098,614
Prepaid expenses and sundry assets 345,435
------------
Total current assets 3,273,977
Property, plant and equipment under construction (Note 7) 340,043
Property, plant and equipment, net of accumulated
depreciation of $ 988,583 (Note 7) 3,917,519
Patents and trademarks, net of accumulated
amortization of $1,157,294 950,813
------------
$ 8,482,352
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued liabilities $ 573,386
Note payable (Note 8) 1,200,000
Redeemable Class A special shares (Note 9) 453,900
Current portion of capital lease obligation (Note 15) 3,570
------------
Total current liabilities 2,230,856
Long Term Liabilities
Capital lease obligation (Note 15) 13,316
Convertible debentures (Note 10) 5,888,197
------------
Total liabilities 8,132,369
------------
Stockholders' Equity (Note 12)
Common stock, $0.001 par value, 125,000,000
shares authorized; 59,265,938 shares
issued and outstanding 59,265
Additional paid-in capital 17,973,197
Accumulated deficit (17,682,479)
------------
Total stockholders' equity 349,983
------------
$ 8,482,352
============
The accompanying notes are an integral part of these financial statements
F2
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE MONTH AND SIX MONTH PERIODS ENDING JUNE 30,
(UNAUDITED)
SIX MONTHS ENDED JUNE 30 THREE MONTHS ENDED JUNE 30,
2006 2005 2006 2005
------------ ------------ ------------ ------------
Revenue
Net sales $ 395,716 $ 1,310,826 $ 160,573 $ 844,095
Cost of sales 396,049 764,151 136,592 493,258
------------ ------------ ------------ ------------
Gross profit (333) 546,675 23,981 350,837
------------ ------------ ------------ ------------
Operating expenses
Marketing, office and general costs 1,718,696 1,090,810 799,042 562,059
Research and development costs 230,041 264,788 158,546 172,792
Officers' compensation and directors fees 359,974 174,423 242,752 100,000
Consulting and professional fees 48,775 202,088 24,932 99,303
Interest on long term debt 122,000 122,000 61,000 61,000
Foreign exchange loss / (gain) (30,294) (3,711) (33,293) 5,196
Depreciation and amortization 349,078 167,035 177,925 101,445
------------ ------------ ------------ ------------
2,798,270 2,017,433 1,430,904 1,101,795
------------ ------------ ------------ ------------
Loss from operations (2,798,603) (1,470,758) (1,406,923) (750,958)
Interest Income 24,633 39,689 5,164 23,807
------------ ------------ ------------ ------------
Net Loss $ (2,773,970) $ (1,431,069) $ (1,401,759) $ (727,151)
============ ============ ============ ============
Loss per share $ (0.05) $ (0.03) $ (0.02) $ (0.01)
============ ============ ============ ============
Weighted average number of shares outstanding 58,166,785 51,147,820 58,902,570 52,060,654
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
F3
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTH PERIOD ENDING JUNE 30, 2006
(UNAUDITED)
ADDITIONAL
COMMON STOCK PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------ ------- ------- -----
January 1, 2006 57,422,824 $ 57,422 $ 17,434,697 $(14,908,509) $ 2,583,610
Net Loss -- -- -- (2,773,970) (2,773,970)
Common stock issued from
exercise of options 25,000 25 4,225 -- 4,250
Common stock issued from
exercise of warrants 276,668 277 65,723 -- 66,000
Common stock issued from
exercise of warrants 56,150 56 (56) -- --
Common stock issued from
exercise of warrants 1,485,296 1,485 346,603 -- 348,088
Stock based compensation -- -- 122,005 -- 122,005
------------ ------------ ------------ ------------ ------------
June 30, 2006 59,265,938 $ 59,265 $ 17,973,197 $(17,682,479) $ 349,983
============ ============ ============ ============ ============
See accompanying notes to the consolidated financial statements
F4
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTH PERIOD ENDED JUNE 30,
(UNAUDITED)
2006 2005
----------- -----------
Net loss $(2,773,970) $(1,431,069)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 263,263 91,445
Amortization 105,477 107,590
Provision (Recovery) for uncollectible accounts -- (3,389)
Interest on debentures 122,000 122,000
Amortization of debenture warrant fair value 88,000 88,000
Stock Based Compensation 122,005 --
Increase (decrease) in cash flows from operating
activities resulting from changes in:
Accounts receivable 279,559 (76,756)
Insurance proceeds recoverable 148,500 --
Inventory (98,912) (477,123)
Prepaid expenses (86,158) (31,356)
Accounts payable and accrued liabilities (378,885) 567,400
----------- -----------
Net cash used in operating activities (2,209,121) (1,043,258)
----------- -----------
Investing activities:
Property, plant and equipment under construction (311,111) --
Acquisition of property, plant and equipment, net (891,241) (1,752,489)
Increase in patents and trademarks (977) (3,262)
----------- -----------
Net cash used in investing activities (1,203,329) (1,755,751)
----------- -----------
Financing activities:
Note payable 1,200,000 --
Issuance of common stock, net 418,338 2,000,000
Capital lease obligation (779) --
----------- -----------
Net cash provided by financing activities 1,617,559 2,000,000
----------- -----------
Net decrease in cash (1,794,891) (799,009)
Cash and cash equivalents, beginning of year 3,083,373 4,633,013
----------- -----------
Cash and cash equivalents, end of period $ 1,288,482 $ 3,834,004
=========== ===========
Supplemental disclosures:
Interest received $ 24,633 $ 39,689
=========== ===========
The accompanying notes are an integral part of these financial statements
F5
NOTE 1 - NATURE OF BUSINESS AND BASIS OF PRESENTATION
The Company develops, manufactures and sells environmental technology solutions,
and is currently focused on the international automotive, transportation and
utility engine industries. It manufactures and markets a line of catalytic
control products including a boutique line of finished products, proprietary
catalytic converter substrates and catalytic conversion technologies for a
number of applications as well as providing engine testing and certification
services.
The accompanying consolidated condensed financial statements have been prepared
without audit in conformity with U.S. generally accepted accounting principles,
which contemplate continuation of the company as a going concern. The Company,
however, has sustained continuing operating losses and presently lacks a
sufficient source of commercial income, which creates uncertainty about the
Company's ability to continue as a going concern. The Company's ability to
continue operations as a going concern and to realize its assets and to
discharge its liabilities is dependent upon obtaining additional financing
sufficient for continued operations as well as the achievement and maintenance
of a profitable level of operations. Management believes the current business
plan if successfully implemented may provide an opportunity for the Company to
achieve profitable operations and allow it to continue as a going concern. These
statements have not been audited and should be read in conjunction with the
financial statements and the notes thereto included in our Annual Report on
Forms 10-KSB and 10-KSB/A, as filed with the Securities and Exchange Commission
for the year ended December 31, 2005. The methods and policies set forth in the
year-end audited consolidated financial statements are followed in these interim
consolidated financial statements.
All adjustments considered necessary for fair presentation and of a normal
recurring nature have been included in these interim consolidated financial
statements. Revenues and operating results for the six months ended June 30,
2006 are not necessarily indicative of the results to be expected for the full
year.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated condensed financial statements include the accounts of the
Company and its wholly owned subsidiaries, ESW America, Inc., ESW Technologies,
Inc., ESW Canada, Inc. and BBL Technologies, Inc. All inter-company transactions
have been eliminated.
ESTIMATES
The preparation of consolidated condensed financial statements in conformity
with U. S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expense during
the reported period. Actual results could differ from those estimates.
CONCENTRATIONS OF CREDIT RISK
The Company's cash balances are maintained in various banks in Canada and the
United States. Deposits held in banks in the United States are insured up to
$100,000 for each bank by the Federal Deposit Insurance Corporation. The
balances at times may exceed these limits.
Accounts Receivable and Concentrations of Credit Risk: The Company performs
on-going credit evaluations of its customer's financial condition and generally
does not require collateral from those customers. Three customers accounted for
30.1%, 15.3% and 12.1% of the Company's revenue for the six months ended June
30, 2006. Three customers accounted for 73.7%, 6.2% and 7.5% of the Company's
accounts receivable as at June 30, 2006.
F6
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company extends unsecured credit to its customers in the ordinary course of
business but mitigates the associated credit risk by performing credit checks
and actively pursuing past due accounts. An allowance for doubtful accounts is
estimated and recorded based on management's assessment of the credit history
with the customer and current relationships with them. On this basis management
has determined that a reserve of nil and $27,414 was appropriate as at June 30,
2006 and December 31, 2005 respectively.
PROPERTY, PLANT AND EQUIPMENT UNDER CONSTRUCTION
The Company capitalizes at cost, customized equipment built to be used in the
future day to day operations. Once complete and available for use, the cost for
accounting purposes is transferred to property, plant and equipment, where
normal depreciation rules apply.
PATENTS AND TRADEMARKS
Patents and trademarks consist primarily of the costs incurred to acquire them
from an independent third party. SFAS No. 142 requires intangible assets with a
definite life be tested for impairment whenever events or circumstances indicate
that a carrying amount of an asset (or asset group) may not be recoverable. An
impairment loss would be recognized when the carrying amount of an asset exceeds
the estimated discounted cash flow used in determining the fair value of the
asset.
Patents and trademarks are being amortized on a straight-line basis over their
estimated life of ten years. Amortization expense for the six months ended June
30, 2006 and 2005 were $105,477 and $107,558 respectively.
REVENUE RECOGNITION
The Company derives revenue primarily from the sale of its catalytic products.
In accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition
in Financial Statements", revenue is recognized when persuasive evidence of an
arrangement exists, delivery has occurred, the amount is fixed and determinable,
risk of ownership has passed to the customer and collection of the resulting
receivable is reasonably assured.
The Company also derives revenue (less than 5.3% of total revenue) from
providing air testing and environmental certification services. Revenues from
these services are recognized upon performance.
RESEARCH AND DEVELOPMENT
The Company is engaged in research and development work. Research and
development costs, other than for the acquisition of capital assets, are charged
as operating expense of the Company as incurred. In the first six months of 2006
the Company expensed $230,041 (2005 $264,788) towards research and development
costs.
NOTE 3 - CHANGE IN ACCOUNTING POLICY
In December 2004, the FASB issued Revised Statement of Financial Accounting
Standards No. 123, Share-Based Payment (FAS 123R), which replaced FAS 123 and
superseded APB Opinion No. 25, Accounting for Stock Issued to Employees. FAS
123R requires companies to measure the cost of services received in exchange for
an award of equity instruments based on the grant-date fair value of the award,
and to recognize the cost over the requisite service period.
Effective January 1, 2006, the Company adopted SFAS 123 (revised 2004),
SHARE-BASED PAYMENT ("SFAS 123R"), which revises SFAS 123 and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires
all share-based payments to employees to be recognized in the financial
statements based on their fair values using an option-pricing model, such as the
Black-Scholes model, at the date of grant. The cost will be recognized over the
period during which an employee is required to provide services in exchange for
the award, known as the requisite service period (usually the vesting period).
The Company elected to use the modified prospective method for adoption, which
requires compensation expense to be recorded for all unvested stock options and
restricted shares beginning in the first quarter of adoption. Compensation cost
for awards granted prior to, but not vested as of, the date the Company adopted
SFAS 123R were based on the grant date fair value and attributes originally used
to value those awards.
F7
NOTE 4 - RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2006, the FASB issued FASB Interpretation (FIN) No. 48, "Accounting for
Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109." This
Interpretation provides guidance for recognizing and measuring uncertain tax
positions, as defined in SFAS No. 109, "Accounting for Income Taxes." FIN No. 48
prescribes a threshold condition that a tax position must meet for any of the
benefit of the uncertain tax position to be recognized in the financial
statements. Guidance is also provided regarding derecognition, classification
and disclosure of these uncertain tax positions. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company does not expect that this
Interpretation will have a material impact on its financial position, results of
operations or cash flows.
In March 2006, the FASB issued Statement of Financial Accounting Standards No.
156, Accounting for Servicing of Financial Assets ("SFAS No. 156"), which amends
FASB Statement No. 140 ("SFAS No.140"). SFAS 156 may be adopted as early as
January 1, 2006, for calendar year-end entities, provided that no interim
financial statements have been issued. Those not choosing to early adopt are
required to apply the provisions as of the beginning of the first fiscal year
that begins after September 15, 2006 (e.g., January 1, 2007, for calendar
year-end entities). The intention of the new statement is to simplify accounting
for separately recognized servicing assets and liabilities, such as those common
with mortgage securitization activities, as well as to simplify efforts to
obtain hedge-like accounting. Specifically, the FASB said FAS No. 156 permits a
servicer using derivative financial instruments to report both the derivative
financial instrument and related servicing asset or liability by using a
consistent measurement attribute, or fair value. The Company does not expect
that this Interpretation will have a material impact on its financial position,
results of operations or cash flows.
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS
No. 155, "Accounting for Certain Hybrid Financial Instruments-an amendment of
FASB Statements No. 133 and 140." SFAS No. 155 amends SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," and also resolves issues addressed in SFAS No. 133 Implementation
Issue No. D1, "Application of Statement 133 to Beneficial Interests in
Securitized Financial Assets." SFAS No. 155 was issued to eliminate the
exemption from applying SFAS No. 133 to interests in securitized financial
assets so that similar instruments are accounted for in a similar fashion,
regardless of the instrument's form. The Company does not believe that its
financial position, results of operations or cash flows will be impacted by SFAS
No. 155 as the Company does not currently hold any hybrid financial instruments.
NOTE 5 - CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and highly liquid investments purchased
with an original or remaining maturity of three months or less at the date of
purchase.
NOTE 6 - INVENTORY
Inventories as at June 30, 2006 are summarized as follows:
Raw materials $ 953,144
Work-In-Process 139,662
Finished goods 5,808
----------
$1,098,614
==========
NOTE 7 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at June 30, 2006 consists of the following:
2006
-----------
Plant, machinery and equipment $ 3,447,892
Office equipment 174,433
Furniture and fixtures 397,855
Vehicles 12,014
Leasehold improvements 873,908
-----------
4,906,102
Less: accumulated depreciation 988,583
-----------
$ 3,917,519
===========
F8
As at June 30, 2006, the Company had $340,043 of customized equipment under
construction.
The office equipment above includes $17,665 in assets under capital lease with a
corresponding accumulated depreciation of $2,401 at June 30, 2006.
NOTE 8 - NOTE PAYABLE
On June 27, 2006 the Company issued a $1.2 million unsecured subordinated
promissory note to a company controlled by a trust to which a director and
shareholder of our Company is the beneficiary. The note bears interest at 9% per
annum. Principal and interest is due on October 31, 2006.
The holder has the option to receive payment of principal and all accrued
interest in the form of restricted shares of the Company's common stock, par
value ($0.001) with cost free piggyback registration rights. Under this
repayment option, interest will be calculated at 12% per annum.
NOTE 9 - REDEEMABLE CLASS A SPECIAL SHARES
700,000 Class A special shares $ 453,900 (based on the historical
Authorized, issued, and outstanding. exchange rate at the time of
issuance.)
The Class A special shares are issued by the Company's wholly-owned subsidiary
BBL Technologies, Inc. ("BBL") without par value, and are redeemable on demand
by the Holder of the shares which is a private Ontario Corporation at $700,000
CDN (which translates to $627,128 USD at June 30, 2006). As the Class A special
shares were issued by the Company's wholly-owned subsidiary BBL, the maximum
value upon which the Company is liable is the net book value of BBL. As at June
30, 2006 BBL has an accumulated deficit of $1,193,837 ($1,846,101 CDN as at June
30, 2006) and therefore, the holder would be unable to redeem the Class A
special shares at their ascribed value.
NOTE 10 - CONVERTIBLE DEBENTURES
In September 2004, the Company issued $6,100,000 of convertible debentures in
which the basis of conversion into the Company's common stock is $0.50 per
share. In conjunction with the debentures, the Company issued warrants to
purchase an additional 3.05 million shares of common stock at $1.00 per share.
The debentures are for a term of three (3) years and earn interest at the rate
of 4% per annum, the principal is due at the end of the third year from the date
of issuance. The Company has computed the fair-value of the warrants utilizing
the Black-Scholes method and apportioned the fair value of the debt and warrants
accordingly. As a result, the debentures were discounted by $528,000, which is
being amortized over the three (3) year life of the debentures. The effective
yield on the debentures is 4.38%. The warrant agreements provide that should the
company at any time after the date the warrants are first issued sell additional
shares of common stock or equivalents below the then current exercise price,
then the Company is required to reduce the current exercise price of the warrant
to the price of the new issuance (See Note 12). At the Company's option, the
interest on the debentures can be paid in cash or in shares of common stock. As
per the terms of the debentures, in September 2005, the Company elected to issue
shares of our common stock as payment of interest earned on our 4% convertible
debentures issued in September 2004 and therefore a total of 348,571 shares of
common stock were issued to 10 debenture holders for the $244,000 of accrued
interest through September 13, 2005. As of June 30, 2006, interest in the amount
of $122,000 has accrued in accounts payable and accrued liabilities.
AMORTIZATION OF THE DISCOUNT:
Face value of convertible debenture 6,100,000
Less: Discounted (528,000)
----------------
Book value upon issuance $ 5,572,000
Amortization of the discount 2004 52,197
----------------
December 31, 2004 $ 5,624,197
Amortization of the discount 2005 176,000
----------------
December 31, 2005 $ 5,800,197
Amortization of the discount 2006 88,000
----------------
June 30, 2006 $ 5,888,197
================
F9
NOTE 11 - INCOME TAXES
As at June 30, 2006, there are loss carryforwards for Federal income tax
purposes of approximately $11,060,463 available to offset future taxable income
in the United States. The carryforwards expire in various years through 2023.
The Company does not expect to incur a Federal income tax liability in the
foreseeable future. Accordingly, a valuation allowance for the full amount of
the related deferred tax asset of approximately $3,871,162 has been established
until realizations of the tax benefit from the loss carryforwards are assured.
Additionally, as at June 30, 2006, the Company's two wholly owned Canadian
subsidiaries had loss carryforwards of approximately $5,092,954 that may be
used, in future periods, to offset taxable income. The deferred tax asset of
approximately $1,838,556 has been fully offset by a valuation allowance until
realization of the tax benefit from the loss carryforwards are assured.
FOR THE PERIOD ENDED JUNE 30, 2006
----------------------------------
Statutory tax rate:
U.S. 35.0%
Foreign 36.1%
Loss before income taxes:
U.S $ 1,286,472
Foreign 1,487,498
-----------
$ 2,773,970
Expected income tax recovery $ (987,252)
Differences in income taxes resulting from:
Depreciation (Foreign operations) (71,767)
-----------
$(1,059,019)
Benefit of losses not recognized 1,059,019
-----------
Income tax provision (recovery) per financial statements $ 0
-----------
Deferred income tax assets and liabilities consist of the following temporary
difference:
AS AT JUNE 30, 2006
-------------------
Assets
Capital Assets - Tax Basis (Foreign operations only) $ 1,567,978
Capital Assets - Book Value (Foreign operations only) (1,802,969)
------------
Net Capital Assets $ (234,991)
Tax loss carry forwards 16,153,417
------------
Net deductible temporary differences $ 15,918,426
============
Net deferred income tax asset $ 5,624,887
Valuation Allowance (5,624,887)
------------
Carrying Value $ 0
============
F10
NOTE 12 - ISSUANCE OF COMMON STOCK
On April 28, 2006 the Company received $348,088 for the exercise of 2,220,592
warrants to purchase 1,485,296 shares of common stock.
On April 26, 2006 the Company received nil proceeds for a cashless exercise of
102,941 warrants to purchase 56,150 shares of common stock.
On February 10, 2006 the Company received $4,250 for the exercise of options at
$0.17 per share and issued 25,000 shares of common stock.
During January to March 2006 the Company received $66,000 from the exercise of
648,235 warrants to purchase 276,688 shares of common stock. The warrants were
issued as a part of the Unit Placements in 2002 in which participants received
one warrant for each unit purchased, that allows for the purchase of one-half
share of common stock for each share of common stock purchased in the Unit
Placement. Warrants can only be exercised in even lots for full shares for an
exercise price of $0.30 per share.
NOTE 13 - STOCK OPTIONS AND WARRANT GRANTS
In January 2005, the Company issued 35,000 stock options to one employee at an
exercise price of $0.50 per share (fair-market value at the date of grant).
These options expire three years from the date of grant.
In December 2005, the board of directors approved the aggregate award of 995,000
stock options to three employees, three executive officer/directors and two
outside directors. The options have immediate vesting with an exercise price of
$1.00 per share (a premium to the fair-market value of the stock at the date of
grant) with an exercise period of five years from the date of award.
Had compensation cost for the Company's stock options that were issued during
the six month period ended June 30, 2005, been determined on the fair value at
grant date consistent with the provisions of SFAS No. 123, the Company's net
loss and loss per share would have been as follows:
PRO FORMA INFORMATION
SIX MONTHS ENDED JUNE 30,
2005
------------
Earnings (loss) per share available
to common stockholders $ (1,431,069)
Deduct: Total stock-based
Compensation expense
determined under fair
value based method, net (9,800)
------------
Net loss - pro forma $ (1,440,869)
============
Denominator for basic earnings
(loss) per share -
Weighted average shares outstanding 51,147,280
Effect of dilutive securities:
Employee stock option --
Warrants --
Convertible debt conversion --
Denominator for basic and diluted
earnings (loss) per share -
Weighted average shares outstanding 51,147,280
Earnings (loss) per share
Basic - Pro forma $ (0.028)
F11
Potential common shares of 5,431,667 related to ESW's outstanding stock options
and potential common shares of 6,322,500 related to ESW's outstanding Warrants
and potential common shares of 12,200,000 related to ESW's 4% Convertible
Debentures were excluded from the computation of diluted earnings/(loss) per
share for the six month period ended June 30, 2006, as the effect of inclusion
of these shares and the related interest expense would have been anti-dilutive.
A summary of option transactions, including those granted pursuant to the terms
of certain employment and other agreements, is as follows:
STOCK WEIGHTED
PURCHASE AVERAGE
OPTIONS EXERCISE PRICE
---------------- ----------------
Outstanding, January 1, 2005 4,526,667 $ 0.51
Granted 1,030,000 $ 0.98
Expired (50,000) ($ 1.50)
Exercised (50,000) ($ 0.50)
---------- --------
Outstanding, December 31, 2005 5,456,667 $ 0.59
Granted 0 --
Expired (0) --
Exercised (25,000) ($ 0.17)
---------- --------
Outstanding, June 30, 2006 5,431,667 $ 0.59
---------- --------
All of the options and warrants granted are exercisable on date of grant, except
500,000 options granted in August of 2003 that vest over a 3 year period. Of
these 500,000 options, 333,332 are currently vested, and 166,668 will vest in
August 2006.
A total of $122,005 for stock based compensation has been recorded as at June
30, 2006. Of this amount $8,000 is for 166,668 options due to vest in August
2006, and $114,005 is for 500,000 options that the company extended in April
2006 for a period of 3 additional years. The 166,668 options were issued to two
directors, one director/officer and one employee. The 500,000 options were
issued to two directors/officers.
At June 30 2006, the outstanding options have a weighted average remaining life
of 40 months.
The weighted average fair value of options granted during the first six months
of 2006 and 2005 was nil and $0.50 respectively and was estimated using the
Black-Scholes option-pricing model, and the following assumptions:
June 30,2005
-------------
Expected volatility 98.00%
Risk-free interest Rate 4.00%
Expected life 5.0 yrs
Dividend yield 0.00%
Forfeiture rate 0.00%
The Black-Scholes model used by the Company to calculate options and warrant
values, as well as other currently accepted option valuation models, were
developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock purchase options and warrants. These models also require highly
subjective assumptions, including future stock price volatility and expected
time until exercise, which greatly affect the calculated values. Accordingly,
management believes that this model does not necessarily provide a reliable
single measure of the fair value of the Company' s stock options and warrants.
F12
At June 30, 2006, the Company had outstanding options as follows:
NUMBER OF SHARES EXERCISE PRICE EXPIRATION DATE
- ---------------- -------------- ---------------
500,000 0.27 August 6, 2013
50,000 0.45 April 20, 2009
500,000 0.50 May 1, 2009
550,000 0.50 August 11, 2007
1,750,000 0.50 August 11, 2009
300,000 0.50 December 1, 2009
35,000 0.50 January 6, 2008
85,000 0.60 December 10, 2006
666,667 0.66 September 10,2008
995,000 1.00 December 31, 2010
---------------
5,431,667
---------------
Warrants issued in connection with various private placements of equity
securities, are treated as a cost of capital and no income statement recognition
is required. A summary of warrant transactions is as follows:
WEIGHTED
WARRANT AVERAGE
SHARES EXERCISE PRICE
---------------- ----------------
Outstanding, January 1, 2005 7,298,531 $ 0.58
Granted 3,272,500 $ 1.28
Exercised (2,336,176) ($ 0.30)
---------- --------
Outstanding, December 31, 2005 8,234,855 $ 1.14
Granted -- --
Exercised (1,912,355) ($ 0.25)
---------- --------
Outstanding, June 30, 2006 6,322,500 $ 0.93
---------- --------
Outstanding warrants as of June 30, 2006 :
NUMBER OF WARRANT SHARES EXERCISE PRICE EXPIRATION DATE
- ------------------------ -------------- -----------------
3,050,000 0.85 (A)&(B) September 13, 2007
1,300,000 0.90 (A) April 21, 2008
200,000 2.00 April 21, 2008
200,000 3.00 April 21, 2008
1,202,500 0.90 (A) July 5, 2008
185,000 2.00 July 5, 2008
185,000 3.00 July 5, 2008
---------
6,322,500
---------
(A) Contain certain anti-dilution provisions.
(B) Originally exercisable at $1.00 per share and adjusted in April 2005.
On June 23, 2005, the company, with shareholder approval, amended its 2002 Stock
Option Plan, to increase the underlying shares available under the plan to
5,000,000 shares of common stock.
F13
NOTE 14 - RELATED PARTY TRANSACTIONS
During the six months ended June 30, 2006 and 2005, the Company paid
shareholders and their affiliates for salaries and reimbursement of business
expenses. All transactions are recorded at the exchange amounts. No one
transaction or combination thereof attributed to one individual or entity
exceeding $60,000 on an annual basis.
On June 27, 2006, a company controlled by a trust of which a director and
shareholder is the beneficiary loaned the Company $1,200,000. Terms of the note
are described in note 8.
NOTE 15 - COMMITMENTS AND CONTINGENCIES
LEASES
Effective November 24, 2004, the Company's wholly owned subsidiary ESW America,
Inc. entered into a lease agreement with Nappen & Associates for approximately
40,220 square feet of leasehold space at 2 Bethlehem Pike Industrial Center,
Montgomery Township, Pennsylvania. The leasehold space houses the Company's
research and development facilities. The lease commenced on January 15, 2005 and
expires January 31, 2010.
Effective December 20, 2004, the Company's wholly owned subsidiary ESW Canada,
Inc. entered into an offer to Lease agreement with Dufcon Developments Inc. for
approximately 50,000 square feet of leasehold space in Concord, Ontario Canada.
The leasehold space houses the Company's executive offices and a high volume
manufacturing plant. The possession of the leasehold space took place on May 24,
2005 and the term of the lease will run for a period of 5 years from the
commencement date of July 15, 2005.
The following breakdown is the total, of the minimum annual lease payments, for
both leases.
2006 226,492
2007 452,984
2008 458,651
2009 464,317
2010 156,746
CAPITAL LEASE OBLIGATION
The Company is committed to the following lease payments in connection with the
acquisition of capital assets under capital leases:
2006 $ 2,294
2007 4,588
2008 4,588
2009 4,588
2010 3,441
-------
$19,499
Less imputed interest at 7.902% 2,613
-------
Total obligation under capital lease 16,886
Less current portion 3,570
-------
Total long-term portion $13,316
=======
The Company has incurred $487 interest expense on capital leases for the period.
NOTE 16 - COMPARATIVE FIGURES
Certain 2005 figures have been reclassified to conform to the financial
statements presentation adopted in the current period.
F14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS
The following discussion should be read in conjunction with our Financial
Statements and Notes thereto included elsewhere in this Report.
This Form 10-QSB contains certain forward-looking statements regarding, among
other things, the anticipated financial and operating results of our business.
Investors are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. We undertake no obligation
to publicly release any modifications or revisions to these forward-looking
statements to reflect events or circumstances occurring after the date hereof or
to reflect the occurrence of unanticipated events. In connection with the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995, we
caution investors that actual financial and operating results may differ
materially from those projected in forward-looking statements made by, or on
behalf of, us. Such forward-looking statements involve known and unknown risks,
uncertainties, and other factors that may cause the actual results, performance,
or achievements to be materially different from any future results, performance,
or achievements expressed or implied by such forward-looking statements. This
report should be read in conjunction with our Annual Report on Forms 10-KSB and
10-KSB/A (No. 1) for the year ended December 31, 2005 as filed with the
Securities and Exchange Commission.
GENERAL
We develop, manufacture and sell environmental technology solutions, and are
currently focused on the international automotive, transportation and utility
engine industries. We manufacture and market a line of catalytic control
products including a line of finished catalytic muffler products, proprietary
catalytic converter substrates and catalytic conversion technologies for a
number of applications. We also offer emissions testing and certification
services.
Our main line of business is the production of catalyzed substrates. Catalyzed
substrates are an integral part of catalytic converter systems sold worldwide.
Our company serves both original equipment vehicle manufacturers ("OEMs") and
the replacement markets, or aftermarket, worldwide. For 2006 we are organizing
into two major operating segments of business. The manufacturing of catalytic
converters and the emissions certification and verification of internal
combustion engines ranging from 0.5 to 600 horse power.
Our primary business objective is to capitalize on the growing global
requirement of reducing emissions, by offering catalyst technology solutions to
the market. We have developed certain relationships with OEM's of engines for
both automotive and other markets. As part of our efforts to grow our business,
as well as to achieve increased production and distribution efficiencies we are
making capital investments in manufacturing capability to support our products
as well as expensing money on research and development for new products to serve
potential customers.
We have recently developed a lightweight, stainless steel muffler system
custom-designed for the United States Military Marine's amphibious Light Armored
Vehicles (LAV's). The unit construction incorporates our proprietary catalyzed
wire mesh substrate integrated into an advanced sound abatement system. The
stainless steel muffler system, was specifically engineered to decrease the
vehicles overall signature by reducing the diesel engines black smoke (soot),
eye and throat irritating noxious diesel engine emissions, temperature and
sound. Our wholly owned subsidiary ESW Canada (ESWC) has entered into an
agreement to supply 1000 catalyst/muffler units. We have also developed a
proprietary substrate/catalyst branded M CAT(TM) specifically for the use in
production equipment used in the mining industry. The M CAT(TM) has been
performance tested by the Mine Safety and Health Administration (MSHA) for
applications in the coal mining sector. The M Cat(TM) utilizes our proprietary
wire mesh substrate and a high performance catalyst coating formula. This
durable combination has demonstrated its ability to reduce toxic emissions from
diesel powered mining equipment in their extremely demanding working
environment. The M Cat(TM), as tested by MSHA, when installed on an Isuzu
4JG1T-MAP diesel engine using on-highway D2 diesel fuel, exhibited significant
PM reduction, and excellent reductions in Carbon Monoxide (CO), while Nitrogen
Dioxide (NO2) levels remained within MSHA's standards.
2
In September 2004, we received a Level II California Air Resources Board (CARB)
Executive Order for our proprietary advanced Diesel Catalyst (Particulate
Reactor TM) for all diesel engine models from the 1991 through 1993 model years
used in on-road applications operating on standard CARB diesel fuel, and
subsequently requested the Executive Order be expanded to include Medium Heavy
Duty applications (up to and including 8 liter) for engine models from 1994
through 1997. In July 2006 CARB granted the extension. Additionally, we have
received an Executive Order from CARB, which permits sale of catalytic
converters for use on 4 liter or smaller gas engines for all model years up to
1995 on which GVW (gross vehicle weight) is 3,750 pounds or less.
Our subsidiary ESW America Inc. is in full compliance with ISO 9001:2000, the
ISO standards developed by the International Organization for Standardization
which provide an international benchmark for quality systems and foundation for
continuous improvement and assurance in design, development and manufacturing.
The ISO mandates that we follow strict quality guidelines, administrative
protocol and safety procedures to a recognized international standardized code.
ISO auditors confirm compliance by auditing us periodically. We passed our most
recent surveillance audit in June 2006, and are in full compliance with the ISO
requirements. We currently hold a full registration certificate effective until
March of 2007. Our subsidiary ESW Canada Inc. in its new manufacturing facility
is ISO 9001:2000 pending; registration scheduled for November 2006. Management
considers an ISO certification essential for us to do business with many export
customers.
We have developed commercially viable proprietary catalytic converter
technologies for diesel, gasoline and alternative (CNG/LPG) fueled combustion
engines. The unique technology consists of a wire based mesh substrate and wash
coat formulas, which form the basis for the catalyzed substrate. The finished
product can be produced in a myriad of sizes and shapes. The substrate creates a
turbulent flow environment. This increases catalytic activity and serves as a
filter of particulate matter, important in diesel emission control.
Our catalyst products have been extensively tested in-house, as well as by
Original Equipment Manufactures (OEM's) and by independent third parties.
Management believes they demonstrate superior performance to comparable
competing products. Our customers have incorporated our products to meet their
own needs, and have, in specific instances, received certification for their
product applications from the Environmental Protection Agency (EPA) and the
California Air Resources Board (CARB). Customers have had their engines
certified using our Clean Cat (R), Pro Cat (TM), Quiet Cat (TM) catalyst
products and services. Our catalyst products are being marketed both
domestically and internationally, including in such continents as Asia, Europe
and North America.
Factors that are critical to our success include winning new business, managing
our manufacturing to ensure proper levels in line with business needs,
maintaining competitive wages and benefits, maximizing efficiencies in
manufacturing processes, and reducing overall costs. In addition, our ability to
adapt to key industry trends, such as increasing technologically sophisticated
products, changing aftermarket distribution partners, and increasing
environmental standards, also plays a critical role in our success. Other
factors that are critical to our success include adjusting to environmental and
economic challenges such as increases in the cost of raw materials and our
ability to successfully reduce the impact of any such cost increases through
material substitutions, cost reduction initiatives and other methods.
We have a substantial amount of indebtedness. As such, our ability to generate
cash, both to fund operations and service our debt, is also a significant area
of focus for our company. See "Liquidity and Capital Resources" below for
further discussion of cash flows.
3
SIGNIFICANT ACCOUNTING POLICIES AND ACCOUNTING STANDARDS
GENERAL
Our discussion and analysis of the financial condition and results of operations
are based upon our consolidated condensed financial statements, which have been
prepared in accordance with United States Generally Accepted Accounting
Principles.
A critical accounting policy is defined as one that is both material to the
presentation of our financial statements and requires management to make
difficult, subjective or complex judgments that could have a material effect on
our financial condition and results of operations. Specifically, critical
accounting estimates generally require us to make assumptions about matters that
are highly uncertain at the time of the estimate; and if different estimates or
judgments were used, the use of these estimates or judgments would have a
material effect on our financial condition or results of operations.
The estimates and judgments we make that affect the reported amount of assets,
liabilities, revenues and expenses are based on our historical experience and on
various other factors, which we believe to be reasonable in the circumstances
under which they are made. Actual results may differ from these estimates under
different assumptions or conditions. We consider our accounting policies related
to revenue recognition, the valuation of inventories, research and development
and accounting for the value of long-lived assets and intangible assets to be
critical accounting policies.
REVENUE RECOGNITION
We recognize revenue when it is realized or realized and earned. We consider
revenue realized or realizable and earned when persuasive evidence of an
arrangement exists, delivery has occurred, the amount is fixed and determinable,
risk of ownership has passed to the customer and collection of the resulting
receivable is reasonably assured.
On a monthly basis, an aged account receivable report is produced and we review
all account receivables. We review all amounts outstanding greater than sixty
days. Based on previous customers payment history, we determine whether an (or
portion of an) allowance needs to be provided on each customers' outstanding
balance.
INVENTORIES
Raw materials are stated at the lower of cost and replacement cost. Work in
process and finished goods inventories are stated at the lower of cost and net
realizable value. These costs include the cost of materials plus direct labor
applied to the product and the applicable share of overhead. Cost is determined
on a first-in-first-out basis.
Our policy for valuation of inventory, including the determination of obsolete
or excess inventory, requires management to estimate the future demand for the
Company's product. Inventory is subject to inexact estimates by management.
We purchase on a "buy to order" basis. When a customer orders a product, then we
purchase the majority of the materials to start manufacturing the product.
VALUATION OF LONG-LIVED ASSETS AND INTANGIBLE ASSETS
We assess the impairment on long-lived assets and intangible assets whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable.
4
Intangible assets are stated at cost less accumulated amortization and are
comprised of licenses and patents. Unforeseen events, changes in circumstances
and market conditions, and material differences in the value of long-lived and
intangible assets due to changes in estimates of future cash flows could affect
the fair value of the our assets and require an impairment charge. Intangible
assets are reviewed annually to determine if any events have occurred that would
warrant further review. In the event that a further assessment is required, we
will analyze estimated undiscounted future cash flows to determine whether the
carrying value of the intangible asset will be recovered and if an impairment
charge will be required.
Patents include all costs necessary to acquire intellectual property such as
patents and trademarks, as well as legal costs arising out of litigation
relating to the assertion of any Company-owned patents.
RESEARCH AND DEVELOPMENT
We are engaged in research and development work. Research and development costs
for the acquisition of capital assets that have a future benefit have been
capitalized. Due to uncertainties all other costs relating to research and
development have been expensed as incurred.
COMPARISON OF THREE MONTH PERIOD ENDED JUNE 30, 2006 TO THREE MONTH PERIOD ENDED
JUNE 30, 2005
RESULTS OF OPERATIONS
The following management's discussion and analysis of financial condition and
results of operations (MD&A) should be read in conjunction with the MD&A
included in our Annual Report on Forms 10-KSB and 10-KSB/A (No. 1) for the year
ended December 31, 2005.
Our financial performance is heavily dependent upon the sales volume achieved.
Revenues for the three month period ended June 30, 2006 decreased by $683,522 or
81.0 percent, to $160,573 from $844,095 for the three month period ended June
30, 2005. Factors that favorably impacted revenue during the three months ended
June 30, 2005 included a large order from one of the our customers for diesel
substrates, which was not repeated for the second quarter of 2006. We believe
the balance of 2006 looks positive assuming continued demand in the overall
emissions reductions solutions market and that our net sales will improve in the
remaining quarters of fiscal year 2006 over the same periods in the prior fiscal
year as a portion of our newly introduced products are introduced and sold.
Cost of sales for the three month period ended June 30, 2006 decreased by
$356,666 or 72.3 percent, to $136,592 from $493,258 for the three month period
ended June 30, 2005. Cost of sales as a percentage of revenues for the three
month period ended June 30, 2006 was 85.0 percent compared to 58.4 percent for
the three month period ended June 30, 2005. The gross margin for the three month
period ended June 30, 2006 was 14.9 percent as compared to a gross margin of
41.6 percent for the three month period ended June 30, 2005. The reasons for the
higher costs of sales are: (i) we experienced higher direct labor costs as the
new plants were just getting started, (ii) Certain sales were made at lower
selling prices in order to gain market share resulting in higher material costs,
and (iii) higher fixed overhead cost such as rent and depreciation as a result
of the two plants coming on line whereas in the prior year we operated in one
smaller location.
5
Marketing, office and general expenses for the three month period ended June 30,
2006 increased by $236,983 or 42.2 percent, to $799,042 from $562,059 for the
three month period ended June 30, 2005. The primary reason for the increase was
due to the addition of a plant in Canada becoming operational, and consisted of
(i) $88,445 increase in administrative payroll costs, (ii) $38,673 increase in
facility costs, mainly attributable to rent, (iii) an increase of $67,398 in
plant and tool room expenses, (iv) $105,259 increase in marketing and sales as
the company added sales people, attended more trade shows and handed out more
samples, (v) $35,111 decrease in office and miscellaneous, and (vi) $27,681
decrease in investor relations as less presentations were performed. As a
percentage of revenue, marketing, office and general expenses increased to 497.6
percent for the three month period ended June 30, 2006 compared to 66.6 percent
for the three month period ended June 30, 2005.
We experienced a modest decrease in research and development costs. For the
three month period ended June 30, 2006 research and development costs decreased
by $14,246, or 8.2 percent to $158,546 from $172,792 for the three month period
ended June 30, 2005.
Officer's compensation and director's fees for the three month period ended June
30, 2006 increased by $142,752 or 142.8 percent, to $242,752 from $100,000 for
the three month period ended June 30, 2005. As a percentage of revenue,
officer's compensation and director's fees increased to 151.2 percent for the
three month period ended June 30, 2006, compared to 11.8 percent for the three
month period ended June 30, 2005. The primary reason for the increase was due to
a non cash stock compensation expense of $122,005 recorded in the second quarter
of 2006 (nil in 2005). In 2006, we instituted monthly compensation for outside
directors of $2,500. Compensation to outside directors for the second quarter
amounted to $22,500.
Consulting and professional fees for the three month period ended June 30, 2006
decreased by $74,371 or 74.9 percent, to $24,932 from $99,303 for the three
month period ended June 30, 2005. The decrease is due to fees paid in the three
month ended June 30, 2005 for consulting fees related to the development and
implementation of our two new facilities. As a percentage of revenue, consulting
and professional fees increased to 15.5 percent for the three month period ended
June 30, 2006, compared to 11.8 percent for the three month period ended June
30, 2005.
Interest expense on long-term debt was $61,000 for the three month period ended
June 30, 2006 which is consistent with the three month period ended June 30,
2005. In September 2004, we issued $6.1 million of convertible debentures in
which the basis of conversion into our common stock is $0.50 per share, which
includes warrants to purchase an additional 3.05 million shares of common stock
at $1.00 per share which subsequently have been adjusted to $0.85 effective
April 21, 2005. The debentures are for a term of three (3) years and earn
interest at the rate of 4% per annum.
Depreciation and amortization expense for the three month period ended June 30,
2006 of $177,925 includes $89,599 which would have been allocated to cost of
goods sales had we been operating at full capacity.
6
COMPARISON OF SIX MONTH PERIOD ENDED JUNE 30, 2006 TO SIX MONTH PERIOD ENDED
JUNE 30, 2005
RESULTS OF OPERATIONS
Revenues for the six month period ended June 30, 2006 decreased by $915,110, or
69.8 percent, to $395,716 from $1,310,826 for the six month period ended June
30, 2005. Factors that favorably impacted revenue during the six months ended
June 30, 2005 included a large order from one of the our customers for diesel
substrates as well as an increase for the company's diesel finished converter
products.
Cost of sales for the six month period ended June 30, 2006 decreased by 368,102
or 48.2 percent, to $396,049 from $764,151 for the six month period ended June
30, 2005. Cost of sales as a percentage of revenues for the six month period
ended June 30, 2006 was 100.1 percent, compared to 58.3 percent for the six
month period ended June 30, 2005. The gross margin for the six month period
ended June 30, 2006 was nil percent as compared to a gross margin of 41.7
percent for the six month period ended June 30, 2005. The reasons for the higher
costs of sales are: (i) we experienced higher direct labor costs as the new
plants were just getting started, (ii) Certain sales were made at lower selling
prices in order to gain market share resulting in higher material costs, and
(iii) higher fixed overhead cost such as rent and depreciation as a result of
the two plants coming on line whereas in the prior year we operated in one
smaller location.
Marketing, office and general expenses for the six month period ended June 30,
2006 increased by $627,886 or 57.6 percent, to $1,718,696 from $1,090,810 for
the six month period ended June 30, 2005. The primary reason for the increase
was due to the addition of a plant in Canada, and consisted of (i) $299,543
increase in administrative payroll costs, (ii) $84,148 increase in facility
costs, mainly attributable to rent, (iii) an increase of $134,154 in plant and
tool room expenses, (iv) $157,039 increase in marketing and sales as the company
added sales people, attended more trade shows and handed out more samples, (v)
$4,633 decrease in office and miscellaneous, and (vi) $42,365 decrease in
investor relations as less presentations were performed. As a percentage of
revenue, marketing, office and general expenses increased to 434.3 percent for
the six month period ended June 30, 2006 compared to 83.2 percent for the six
month period ended June 30, 2005.
We experienced a modest decrease in research and development costs. For the six
month period ended June 30, 2006 research and development costs decreased by
$34,747, or 13.1 percent to $230,041 from $264,788 for the six month period
ended June 30, 2005.
Officer's compensation and director's fees for the six month period ended June
30, 2006 increased by $185,551 or 106.4 percent, to $359,974 from $174,423 for
the six month period ended June 30, 2005. As a percentage of revenue, officer's
compensation and director's fees increased to 91.0 percent for the six month
period ended June 30, 2006, compared to 13.3 percent for the six month period
ended June 30, 2005. The primary reason for the increase was due to a non cash
stock option expense of $122,005 recorded for the six month period ended June
30, 2006 (nil for six month period ended June 30, 2005). In 2006, we instituted
monthly compensation for outside directors of $2,500. Compensation to outside
directors for the six month period ended June 30, 2006 amounted to $41,250.
Consulting and professional fees for the six month period ended June 30, 2006
decreased by $153,313, or 75.9 percent, to $48,775 from $202,088 for the six
month period ended June 30, 2005. The decrease is due to fees paid in the six
month ended June 30, 2005 for consulting fees related to the development and
implementation of our two new facilities. As a percentage of revenue, consulting
and professional fees decreased to 12.3 percent for the six month period ended
June 30, 2006, compared to 15.4 percent for the six month period ended June 30,
2005.
7
Interest expense on long-term debt was $122,000 for the six month period ended
June 30, 2006 which is consistent with the six month period ended June 30, 2005.
In September 2004, we issued $6.1 million of convertible debentures in which the
basis of conversion into our common stock is $0.50 per share, which includes
warrants to purchase an additional 3.05 million shares of common stock at $1.00
per share which subsequently have been adjusted to $0.85 effective April 21,
2005. The debentures are for a term of three (3) years and earn interest at the
rate of 4% per annum.
Depreciation and amortization expense for the six month period ended June 30,
2006 of $349,078 includes $176,961 which would have been allocated to cost of
goods sales had we been operating at full capacity.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of operating capital have been the proceeds of our various
financing transactions. As of June 30, 2006, the Company had cash and cash
equivalents of $ 1,288,482.
Net Cash used in operating activities for the six month period ended June 30,
2006 amounted to $2,209,121 as compared to $1,043,258 for the six month period
ended June 30, 2005. The increase was mainly attributable to (i) the net loss of
$2,773,970, (ii) less the non cash transactions such as depreciation,
amortization, interest and amortization of the fair value of the debenture
warrant, and stock compensation expense all totaling to $700,745, and (iii) plus
an increase in operating assets and liabilities of $135,896 which was primarily
due to an increase in accounts receivable, an increase of inventory, offset by a
decrease in accounts payable and accrued liabilities.
Net Cash used in investing activities was $1,203,329 for the six month period
ended June 30, 2006 as compared to $1,755,751 for the six month period ended
June 30, 2005. The capital expenditures in the first half of 2006 were primarily
dedicated to the purchase of equipment and leaseholds for the Company's research
and development facilities located in Montgomeryville Township, Pennsylvania and
the manufacturing facility in Concord Ontario, Canada.
Net cash provided in financing activities totaled $1,617,559 for the six month
period ended June 30, 2006 as compared to $2,000,000 for the six month period
ended June 30, 2005. For the six month period ended June 30, 2006, $1,200,000
was received by way of a note payable and the $418,338 through the exercise of
warrants. For the six month period ended June 30, 2005, $2,000,000 was received
through a private placement.
We made substantial capital investments in manufacturing capability to support
our products. We are in the final stages of the completion of the plants. When
fully complete, our new substrate manufacturing plant located in Concord
Ontario, Canada, is intended to enable us to control the complete manufacturing
process required for production of catalyzed substrates. Catalyzed substrates
are the integral part of all catalytic converter systems sold worldwide.
8
We have also made a substantial capital investment in our new Tech Center based
in Montgomeryville Pennsylvania. This facility provides the catalytic and
chemical wash coat products for the new Concord Ontario plant. As well all of
our emission testing laboratories and testing capabilities is located there. The
new 40,200 sq ft facility houses a state of the art 18,000 sq ft expansion of
"Air Testing Services", our EPA/CARB recognized engine/vehicle emissions testing
lab. The facilities include several new testing systems. In addition to our
existing laboratory testing capabilities, we have acquired additional heavy duty
and light duty truck chassis dynamometers, as well as a heavy-duty-diesel
transient engine emissions test dynamometer, and additional analytical test
instruments.
Our principal source of liquidity is cash provided by financing activities. Our
principal use of liquidity will be to finance capital expenditures and to
provide working capital availability. We expect that total capital expenditures
for 2006 will be approximately $1,600,000. These capital expenditures will be
used primarily for equipment and the completion of the facilities.
We believe this capital expenditure will improve our retention of small to
medium-sized customers while at the same time provide us with added sales
capacity for higher-end selling solutions. As previously noted earlier, our
wholly owned subsidiary ESW Canada (ESWC) is manufacturing 1000 catalyst/muffler
units for the United States Military Marine's amphibious Light Armored Vehicles
(LAV's). Delivery for these units are anticipated to be completed between
September and December 2006.It is anticipated that the expansion of our testing
facilities at ESW America, will bring increase revenue in the future , as ATS
will now have the capacity to service larger customers.
These capital expenditures and our intent to capitalize on an anticipated
increase in demand for our products are the steps that we are taking to try to
become profitable and generate positive cash flow. However, there can be no
assurances that these steps will be completed or that we will become profitable.
Based on our current operating plan, management believes that at June 30, 2006,
cash balances, anticipated cash flows from operating activities, and, if
necessary or appropriate, borrowings under a future credit facility or other
available financing sources, such as the issuance of debt or equity securities
will be sufficient to meet its working capital needs on a short-term basis for
at least the next six months. Overall capital adequacy is monitored on an
ongoing basis by our management and reviewed quarterly by the Board of
Directors.
Should we not become profitable before this money is expensed, we will need to
continue to finance our operations through other capital financings. We continue
to seek, equity financing and/or debt financing in the form of private
placements at favorable terms, or the exercise of currently outstanding options
or warrants that would provide additional capital in order to make available all
opportunities and keep our options flexible. However, such additional financing
may not be available to us, when and if needed, on acceptable terms or at all.
We intend to retain any future earnings to retire debt, finance the expansion of
our business and any necessary capital expenditures, and for general corporate
purposes.
9
Our operating profitability requires that we increase our sales and lower our
overall cost to manufacture our products and improve both sales and
administrative productivity through process, and system enhancements. This will
be largely dependent on the success of our initiatives to streamline our
infrastructure and drive our operational efficiencies across our company. Our
failure to successfully implement these initiatives, or the failure of such
initiatives to result in improved profit margins, could have a material adverse
effect on our liquidity, financial position, and results of operations.
DEBT STRUCTURE
On June 27, 2006, we issued a $1.2 Million unsecured subordinated promissory
note to Ledelle Holding Limited. Ledelle Holding is a corporation organized
under the laws of Cyprus which is controlled by a trust of which Mr. Bengt
George Odner, a director of the Company is the beneficiary. The Note bears
interest at 9% per annum if principal and interest are paid in cash or at 12%
per annum if principal and interest are paid in shares of restricted common
stock of the Company. The Note is due and payable October 31, 2006 and may be
extended at the option of the holder on a month to month basis. The Company may
also prepay the Note at any time without penalty.
In September 2004, we issued $6.1 million of convertible debentures in which the
basis of conversion into our common stock is $0.50 per share, which includes
warrants to purchase an additional 3.05 million shares of common stock at $1.00
per share which was subsequently adjusted to $0.85 on April 21, 2005, in
accordance with the terms of the warrants previously issued by the Company
September 15, 2004. The debentures are for a term of three (3) years and earn
interest at the rate of 4% per annum. We have computed the fair-value of the
warrants utilizing the Black-Scholes method and apportioned the fair value of
the debt and warrants accordingly. As a result, the debentures were discounted
by $528,000, which is being amortized over the three (3) year life of the
debentures. The effective yield on the debenture is 4.38%.
The principal of this debenture is payable in U.S. currency or, at our option,
in shares of common stock, par value $0.001 per share, at $.50 per share. At our
option, interest on the debenture will be payable in cash or shares of common
stock under a conversion formulas as provided in the debenture as per the terms
of the debentures. We elected to issue shares of our common stock as payment of
the first year's interest earned on our 4% convertible debentures issued in
September 2004. A total of 348,571 shares of common stock were issued to 10
debenture holders for the $244,000 of accrued interest through September 13,
2005.
Our ability to service our indebtedness in cash will depend on our future
performance, which will be affected by prevailing economic conditions and
financial, business, regulatory and other factors. Certain of these factors are
beyond our control. We believe that, based upon our current business plan, we
will be able to meet our debt service obligations when due. Significant
assumptions underlie this belief, including, among other things, that we will be
successful in implementing our business strategy and that there will be no
material adverse developments in our business, liquidity or capital
requirements. If we cannot generate sufficient cash flow from operations to
service our indebtedness and to meet our other obligations and commitments, we
might be required to refinance our debt or to dispose of assets to obtain funds
for such purpose. There is no assurance that refinancing or asset dispositions
could be effected on a timely basis or on satisfactory terms, if at all, or
raise funds through asset sales, sales of equity or otherwise, its ability to
pay principal of, and interest on, our debt would be impaired. On such
circumstance, we would have to issue shares of our common stock as repayment of
this debt, which would be of a dilutive nature to its present shareholders.
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NEW ACCOUNTING PRONOUNCEMENTS.
In June 2006 the FASB issued Interpretation No. 48 (FIN 48), "Accounting for
Uncertainty in Income Taxes," which prescribes a comprehensive model for how a
company should recognize, measure, present and disclose in its financial
statements uncertain tax positions that the company has taken or expects to take
on a tax return. Under FIN 48, the financial statements will reflect expected
future tax consequences of such positions presuming the taxing authorities' full
knowledge of the position and all relevant facts, but without considering time
values. Application of FIN 48 is required in financial statements effective for
periods ending after December 15, 2006. We are currently evaluating the impact
that this interpretation may have on our consolidated financial statements. The
Company does not expect that this Interpretation will have a material impact on
its financial position, results of operations or cash flows.
Effective January 1, 2006, we adopted the fair value recognition provisions of
FASB Statement of Financial Accounting Standard No. 123(R), "Share-Based
Payments," (SFAS 123-R), using the modified prospective application method.
Under this transition method, the Company will record compensation expense for
all stock option awards granted after the date of adoption and for the unvested
portion of previously granted stock option awards that remain outstanding at the
date of adoption. The amount of compensation cost recognized was based on the
grant-date fair value estimated in accordance with the original provisions of
SFAS No. 123. Results for prior periods have not been restated.
FOREIGN CURRENCY TRANSACTIONS
The results of operations and the financial position of our operations in Canada
is principally measured in Canadian currency and translated into U.S. dollars.
The future effects of foreign currency fluctuations between U.S. dollars and
Canadian dollars will be somewhat mitigated by the fact that expenses will be
generally incurred in the same currency in which revenues will be generated. The
future reported income of our Canadian subsidiary would be higher or lower
depending on a weakening or strengthening of the U.S. dollar against the
Canadian currency.
A portion of our assets are based in its foreign operation and are translated
into U.S. dollars at foreign currency exchange rates in effect as of the end of
each period, Accordingly, our consolidated stockholders' investment will
fluctuate depending upon the weakening or strengthening of the U.S. dollar
against the Canadian currency.
Our strategy for management of currency risk relies primarily upon conducting
our operations in the countries' respective currency and we may, from time to
time, engage in hedging intended to reduce our exposure to currency
fluctuations. At June 30, 2006, we had no outstanding forward exchange
contracts.
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ITEM 3. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURE
EVALUATION OF THE COMPANY'S DISCLOSURE AND INTERNAL CONTROLS.
The Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" as of the end of the period covered by this
report. This evaluation was done with the participation of management, under the
supervision of the Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO").
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS.
A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are 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 the 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. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a cost
effective control system, misstatements due to error or fraud may occur and not
be detected. The Company conducts periodic evaluations of its internal controls
to enhance, where necessary, its procedures and controls.
CONCLUSIONS.
Based on our evaluation the CEO and CFO concluded that the registrant's
disclosures, controls and procedures are effective to ensure that information
required to be disclosed in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the Security Exchange Commission rules and forms.
(b) CHANGES IN INTERNAL CONTROLS
Not applicable.
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PART II OTHER INFORMATION
ITEM 5. OTHER INFORMATION
SUBSEQUENT EVENTS
On June 22, 2006 the Securities and Exchange Commission declared effective, the
Company's May 5, 2006 post effective amendment No.1 to Form SB-2 (Registration
No. 333-129579) effective.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS:
31.1 Certification of Chief Executive Officer and
President pursuant to the Sarbanes-Oxley Act of
2002.
31.2 Certification of Chief Financial Officer, pursuant to the
Sarbanes-Oxley Act of 2002.
32.1 Certification pursuant to 18 U.S.C. Section
1350, as amended pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification pursuant to 18 U.S.C. Section
1350, as amended pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(B) Reports on Form 8-K
On June 27, 2006, the Company filed a Current Report on Form 8-K dated June 30,
2006 reporting the issuance of a $1.2 Million unsecured subordinated promissory
note (the "Note") to Ledelle Holding Limited. The Company intends to use the
funds from the Note for the purchase of raw materials to fulfill purchase orders
from customers as well as for general working capital.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATED: August 11, 2006
Concord, Ontario CANADA
ENVIRONMENTAL SOLUTIONS WORLDWIDE, INC.
BY: /S/ DAVID J. JOHNSON
--------------------
DAVID J. JOHNSON
CHIEF EXECUTIVE OFFICER AND PRESIDENT
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