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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
[X] EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
JUNE 30,1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
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Commission File Number
0-22971
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ZEROS USA, INC.
(Exact name of Registrant as specified in its charter)
TEXAS 76-0520236
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
507 NORTH BELT EAST, SUITE 550, HOUSTON, TEXAS 77060
(Address of Principal executive offices)
(281) 448-6070
(Registrant'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 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 NO X
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Transitional Small Business Disclosure Format (check one):
YES NO X
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Securities to be registered pursuant to Section 12(g) of the Act.
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2
ZEROS USA, INC.
BALANCE SHEET - UNAUDITED
JUNE 30, 1998
ASSETS
Current Assets:
Cash $ 42,894
Certificates of Deposit (Note 6) 1,474,000
Due from affiliates (Note 4) 250,000
Contracts Receivable, current
net of an allowance for
doubtful contracts of $0 (Note 2) 960,000
-----------
Total current assets 2,726,894
Property and equipment:
Office and system equipment 261,149
Less accumulated depreciation (12,505)
-----------
Property and equipment, net 248,644
Other assets:
Contracts receivable, noncurrent
(Note 2) 13,785,937
Master license costs, less
amortization of $313,095
(Note 3) 1,643,753
Due from affiliates (Note 4) 2,243,224
Investment (Note 5) 63,663
Organizational costs, less
amortization of $19,178 46,872
Permit costs, deposits and
other assets 21,845
-----------
Total other assets 17,805,294
-----------
Total assets $20,780,832
===========
See accompanying notes to these financial statements.
3
ZEROS USA, INC.
BALANCE SHEET - UNAUDITED
JUNE 30, 1998
Liabilities and Stockholders' Equity
Current liabilities:
Bank notes payable (Note 6) $ 1,474,000
Debentures payable (Note 7) 465,174
Accrued interest 282,566
Accounts payable 270,101
Deferred income taxes (Note 10) 121,015
Other current liabilities 23,380
-----------
Total current liabilities 2,636,236
Due to affiliates (Note 4) 356,643
Long-term contract payable (Note 8) 2,207,883
Series A convertible bonds (Note 9) 2,019,978
Deferred income taxes (Note 10) 3,459,355
Deferred revenue, licensing
contracts (Note 2) 80,000
Note payable (Note 11) 647,000
-----------
Total liabilities 11,407,095
-----------
Commitments and contingencies (Note 18)
Stockholders' equity (Note 12):
Preferred stock, $.001 par value,
20,000,000 authorized, 13,870,000
shares issued and outstanding 13,870
Common stock, $.001 par value,
20,000,000 authorized, 17,890,320
shares issued and 13,890,320
shares outstanding 17,891
Additional paid in capital 3,292,364
Retained earnings 6,109,612
Less common stock in treasury,
4,000,000 shares, at cost
(60,000)
-----------
Total stockholders' equity 9,373,737
-----------
Total liabilities and
stockholders' equity $20,780,832
===========
See accompanying notes to these financial statements.
4
ZEROS USA, INC.
STATEMENTS OF OPERATIONS - UNAUDITED
JUNE 30, 1998
Three - Month Period Ended
---------------------------------
June 30, 1997 June 30, 1998
(as restated)
------------- -------------
Revenues - licensing
(Notes 1 and 17) $ 1,939,374 $ 1,783,277
General and administrative
expenses 585,831 926,243
Depreciation and amortization 42,738 51,697
Other income (expenses):
Interest expenses (77,060) (164,554)
Interest income 123,959 303,032
----------- -----------
Earnings before income tax 1,357,704 943,815
Income taxes (Note 10) 501,943 348,928
----------- -----------
Net earnings $ 855,761 $ 594,887
=========== ===========
Basic earnings per share
(Note 16) $ 0.77 $ 0.04
Diluted earnings per share
(Note 16) $ 0.23 $ 0.02
See accompanying notes to these financial statements.
5
ZEROS USA, INC.
STATEMENTS OF CASH FLOWS - UNAUDITED
JUNE 30, 1998
Three - Month Period Ended
--------------------------------
June 30, 1997 June 30, 1998
(as restated)
------------- -------------
Operating activities:
Net earnings $ 855,761 $ 594,887
Adjustments to reconcile net
earnings to cash provided by
(used in) operating activities
Depreciation and
amortization 42,738 51,697
Preferred and common
stock issued for servies
rendered to the Company 9,000 7,180
(Increase) decrease in
contracts receivable (2,071,748) (1,875,519)
Increase (decrease) in:
Accounts payable and
other current liabilities (59,992) 106,736
Accrued interest 31,965 78,493
Deferred income taxes 501,943 348,928
Accrued interest on
contract payable 45,096 50,326
Deferred revenue 10,000 10,000
----------- -----------
Net cash used in
operating activities (635,237) (627,272)
Investing activities:
Advances to Partnership (12,687)
Advances to affiliates (216,663) (517,589)
Purchase of certificates of
deposit (275,000)
Purchase of equipment (3,353)
Permit costs, deposits and
other assets (40,000) (65)
----------- -----------
Net cash used in
investing activities (535,016) (530,341)
See accompanying notes to these financial statements.
6
ZEROS USA, INC.
STATEMENTS OF CASH FLOWS - UNAUDITED
JUNE 30, 1998
(CONTINUED)
Three - Month Period Ended
--------------------------------
June 30, 1997 June 30, 1998
(as restated)
------------- -------------
Financing activities:
Sale of stock 12,500
Proceeds from (refund of) debentures 894,760 (10,000)
Proceeds from bank notes
payable 275,000
Proceeds from Series A
convertible bonds 462,478
Proceeds from note payable 647,000
----------- -----------
Net cash provided by
financing activities 1,169,760 1,111,978
----------- -----------
Increase (decrease) in cash and
cash equivalents (493) (45,635)
Cash and cash equivalents,
beginning of period 299,741 88,529
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Cash and cash equivalents,
end of period $ 299,248 $ 42,894
=========== ===========
See accompanying notes to these financial statements.
7
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Organization
ZEROS USA, Inc., (the "Company") formerly "ZEROS," inc. was
incorporated in the state of Texas on November 12, 1996. The Company develops
and sells ZEROS approved licenses to qualified end users having a need for
industrial waste systems. The Company has a master license on the system (the
"System") called "Zero-emission Energy Recycling Oxidation System" or "ZEROS" an
energy recycling oxidation system. The Company sells licenses for the technology
and the System to qualified end-users both nationally and internationally. The
books and records of the Company are prepared on the accrual basis for financial
reporting purposes and the cash basis for federal income tax purposes. The
Company intends to change its fiscal year end to September 30 for both financial
and tax reporting purposes.
Interim Financial Statements
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB and Item 310 (b) of
Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three month period ended June 30, 1998
are not necessarily indicative of the results that may be expected for the year
ended September 30, 1998.
Revenue recognition
The Company sells the ZEROS approved licenses for technology and the
System. Licensing revenues are recognized when licensee contracts are signed
based upon the discounted value of the mandatory payments due under the
contract, less an estimate of costs to be incurred to fulfill the Company's
obligations. The amounts deferred are recognized as costs are incurred to meet
the Company's obligations. Any costs exceeding the estimated amount of deferred
revenues are expensed as incurred.
If the Company is unable to evaluate the ability to collect payments
under a license agreement as probable, revenues are then deferred and recognized
on the cash basis after deferring the estimated costs of obligations of the
Company for the respective licensing agreement.
The Company takes the position that the sale of a license to the ZEROS
technology and the underlying agreements thereof clearly provide the option to
the licensee to buy a plant or not. Therefore, the event of the license sale is
a stand alone transaction and should be recognized by the accrual method of
accounting under Generally Accepted Accounting
8
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued)
Revenue recognition (continued)
Principles and not under the principles of accounting for Franchise Fee Revenue
as asserted by the Securities and Exchange Commission ("SEC") in correspondence
to the Company. The Company has engaged recognized experts in this area and is
in the process of arbitrating the revenue recognition policy with the SEC.
HOWEVER, THE SEC HAS INDICATED THAT THEY HAVE A DIFFERING OPINION AND
SHOULD THEY PREVAIL, THE REVENUE POSITION OF THE COMPANY COULD BE SUBSTANTIALLY
NEGATIVELY IMPACTED BY APPROXIMATELY $14,700,000 FOR THE THREE-MONTH PERIOD
ENDING JUNE 30, 1998.
The Company's licensees have obtained payment guarantees for the
balance due on their license. A financial guarantee bond issued by a major
insurance carrier on a transaction by transaction basis for the licensees
provides the payment guarantee.
Organization costs
Organization costs, primarily legal costs, are being amortized over a
sixty-month period. Operating results for each of the three-month periods ended
June 30, 1997 and 1998 include amortization of $3,303.
Property and equipment
Property and equipment are recorded at cost. Depreciation is provided
on a straight-line method over the estimated useful lives of the assets as
follows:
Office system equipment 10 years
Office and computer equipment 5 years
Office furniture and fixtures 7 years
Major additions and betterments are capitalized and depreciated over
their estimated lives. Expenditures for maintenance and repairs are charged to
expense as incurred. When property and equipment are retired or disposed of, the
related costs and accumulated depreciation are removed from the applicable
accounts and any gain or loss is reflected in income. Depreciation expense for
the three-month periods ended June 30, 1997 and 1998 were $898 and $5,057,
respectively.
Investment
An investment in a real estate partnership is recorded in accordance
with the equity method and is adjusted to recognize the Company's share of
earnings or losses since the date of acquisition.
9
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued)
Acquisition and merger
In February 1997 the Company acquired the majority stock in the amount
of 10,500,000 shares which equates to 91% of the (issued and outstanding) of
Gunner Holdings, Inc. (a Utah corporation), and that had changed its name of
this subsidiary corporation to ZEROS USA, Inc. (a Utah corporation). The
acquisition was accounted under the purchase method for business combinations.
In June 1997 the subsidiary corporation was merged into ZEROS USA, Inc. Upon
consummation of the merger, 1,490,000 shares of the subsidiary's common stock
held by shareholders other than the Company's president and affiliates were
distributed Company's common stock on a share for share basis.
The shareholders ratified a share structure of the merged companies of
20,000,000 shares of common and 10,000,000 shares preferred. A distribution of
shares was made as follows:
Steve Clark 9,000,000
Capital American 1,000,000
Star Trust 400,000
Agri Capital Trust 400,000
Gunner Trust 690,000
THE BUSINESS NATURE OF AGRI CAPITAL TRUST, STAR TRUST AND GUNNER TRUST
IS BELIEVED TO BE BUSINESS INVESTMENT TRUSTS ESTABLISHED SEVERAL YEARS BEFORE
THE FORMATION OF GUNNER HOLDING, INC., AND ZEROS USA, INC., TO INVEST, MANAGE
ASSETS AND PROVIDE FINANCIAL SERVICES ON BEHALF OF THEIR BENEFICIARIES.
THE AGRI CAPITAL TRUST, STAR TRUST AND GUNNER TRUST HAVE NO AFFILIATION
TO THE OFFICERS, DIRECTORS AND PRINCIPAL SHAREHOLDERS. THE AGRI CAPITAL TRUST,
STAR TRUST AND GUNNER TRUST ARE SHAREHOLDERS OF ZEROS USA, INC.
Income taxes
The Company accounts for its income taxes using the Financial
Accounting Standards Board Statement No. 109, "Accounting for Income Taxes"
(SFAS No. 109) which requires the establishment of a deferred tax asset or
liability for taxable amounts and operating loss and tax credit carryforwards.
Deferred tax assets are recognized for deductible temporary differences
and deferred tax liabilities are recognized for taxable temporary differences.
Temporary differences are the differences between the reported amounts of assets
and liabilities and their tax bases. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
10
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued)
Cash and cash equivalents
The Company considers all liquid investments with a maturity of three
months or less, when purchased, to be "cash equivalents" for purposes of the
statement of cash flows.
Concentration of credit risk
The Company extends credit to its customers. The Company may extend
certain credit during the normal course of business operations that may be
unsecured. A substantial portion of the customers' ability to pay their debts
(Note 15) to the Company is dependent on the waste management economic sector.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures. Accordingly,
actual results could differ from those estimates.
Earnings per share
Basic earnings per share ("Basic EPS") are based upon net earnings
divided by the weighted average number of shares of common stock outstanding.
Diluted earnings per share ("Diluted EPS") is computed by dividing (a) net
earnings plus interest on debentures and Series A bonds net of applicable income
taxes and (b) common and equivalent common shares outstanding which would
include conversion of preferred stock, debentures and Series A bonds.
NOTE 2 - CONTRACTS RECEIVABLE
The Company utilized installment contracts to finance the sale of
licenses by the Company. The terms of each contract includes license prices that
range from $2,252,000 to $2,480,000 with varying payment terms before a discount
factor as indicated below. Certain assets and guarantees of the licensees and
their guarantors secure these contracts.
Unamortized discount is based upon an imputed interest rate of 9%. An
analysis of the contracts at June 30, 1998 follows:
Total contracts receivable $17,700,000
Less current amount 960,000
-----------
Contracts receivable, non-
current 16,740,000
Unamortized discount 2,954,063
-----------
Noncurrent contracts less
Unamortized amount $13,785,937
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11
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 2 - CONTRACTS RECEIVABLE (continued)
Deferred revenue of $80,000 at June 30,1998 results from estimated
costs remaining on obligations due licensees for training and assistance.
The Company at June 30, 1998 had eight contracts with terms of
approximately four years. Three of the contracts mature in February 2001. Four
of the contracts mature in February 2002. The other contract matures in May
2002. The contracts include the right of the licensor to charge the licensee a
royalty of 15% of gross income for each operating system. Each licensee obtains
a geographical area and is allowed to sell licenses subject to the approval of
the licensor. The licensor is obligated primarily to provide a training program
and counsel on operational assistance.
HOWEVER, THE SEC HAS INDICATED THAT THEY HAVE A DIFFERING OPINION AND
SHOULD THEY PREVAIL, THE REVENUE POSITION OF THE COMPANY COULD BE SUBSTANTIALLY
NEGATIVELY IMPACTED BY APPROXIMATELY $14,700,000 FOR THE THREE-MONTH PERIOD
ENDING MARCH 30, 1998.
The Company's licensees have obtained payment guarantees for the
balance due on their license. A financial guarantee bond issued by a major
insurance carrier on a transaction by transaction basis for the licenses
provides the payment guarantee.
NOTE 3 - MASTER LICENSE COSTS
The Company acquired a master license for the energy recycling
oxidation system in January 1997. The major terms of the acquisition of the
master license indicate that the Company is to pay $4,000,000 plus certain legal
costs for the master license to a foreign entity ("the Master Licensor").
The Company paid $30,000 in legal costs to transfer the master
licensing rights. Per the contract, the initial master license cost of
$4,000,000 has been earned by the licensor upon the signing of the contract. The
$4,000,000 contract amount is payable in January 2005. The present value of the
contract at its signing date of $1,926,848 reflects a discount of 9% imputed
interest rate. The master license cost has been initially recorded at
$1,956,848.
The cost of the master license is being amortized to expense based upon
the ratio of the number of current licensees' agreements to be obtained. At June
30, 1998, the projected total licensees were fifty licensees. As of June 30,
1998, there were eight licensees. See Note 17 for the correction of the error
for the prior year of recording the present value of the master license and the
related amortization.
Per the contract, an additional $12,000,000 in master licensing costs
will be earned by the Master Licensor when the sale of four equipment systems
occurs by the Company at the rate of $3,000,000 per equipment sale. These costs
will be payable as the equipment systems construction deposits are collected.
12
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 3 - MASTER LICENSE COSTS (continued)
The contract also indicates that the Company will pay certain
commissions and fees to the Master Licensor as follows:
(1) 5% of license fees sold to third parties.
(2) 5% of gross profit resulting from sales of energy recycling
systems by the licensee to other licensees.
(3) 5% of gross income resulting from the sale of products
produced from energy recycling systems sold through licensees.
(4) 5% royalty fees on gross income on units owned and operated by
the licensee (ZEROS USA, Inc.).
NOTE 4 - DUE FROM (TO) AFFILIATES
Due from affiliates is comprised of the following at June 30, 1998:
OCS, Inc. $ 1,509,317
BAF, L. L. C. 936,009
Other Affiliates 47,898
------------
$ 2,493,224
============
The receivables from OCS, Inc., the manufacturer of the ZEROS system
and system support provider for design, engineering, training and maintenance
support primarily involve advances to establish a project site for the licensee.
These advances include other design and engineering of certain plants and
equipment. The ZEROS Licensees will pay the advances made for these services
upon the funding of their plants.
Delta Logging has a guaranteed receivable policy from American Credit
Indemnity on the OCS, Inc. receivable for $250,000 for work performed on the
Piney Creek project. The receivable from BAF, L. L. C. resulted from the
assignment of a portion of the installments due from licensees.
BAF, L.L.C. provides the licensee with the initial payment resource due
on the three-year contract for license payment. The payment is due within one
year of execution of the ZEROS Approved License closing. BAF's funding is
secured by cash and marketable securities.
OCS, Inc. is currently working on several projects in California and
Mississippi on behalf of ZEROS and its technology.
Due to Affiliates is comprised of the following at June 30, 1998:
BAF, Inc. $ 345,023
Other Affiliates 11,620
------------
$ 356,643
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13
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 5 - INVESTMENT
In July 1997, the Company entered into a real estate partnership with a
licensee to operate a small commercial center.
NOTE 6 - BANK NOTES PAYABLE
At June 30, 1998, bank notes payable consisted of:
Bank note, interest due quarterly
at 7.0% and principal due April 1999
collateralized by $75,000 $ 75,000
certificate of deposit
Bank note, interest due quarterly at
7.26% and principal due May 1999
collateralized by a $100,000
certificate of deposit 100,000
Bank note, interest due quarterly at
7.26% and principal due May 1999
collateralized by a $100,000
certificate of deposit 100,000
Bank note, interest due quarterly at
7.0% and principal due July 1998
collateralized by $50,000 certificate
of deposit 50,000
Bank note, interest due quarterly at
7.0% and principal due July 1998
collateralized by $90,000 certificate
of deposit 90,000
Bank note, interest due quarterly at
7.0% and principal due December 1998
collateralized by $59,000 certificate
of deposit 59,000
Bank note, interest due quarterly at
7.0% and principal due July 1998
collateralized by $1,000,000
certificate of deposit 1,000,000
----------
$1,474,000
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14
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 7 - DEBENTURES PAYABLE
As of September 1998 the Company has four debentures payable to various
individuals and entities. The debentures including interest are due and payable
on various dates ranging from September 1998 to February 1999 in the amount of
$145,000. The interest rate on the debentures is 10% per annum. Each dollar of
debenture is securitized by two shares of Company common stock. The Company's
President originally securitized the debentures with his stock, but in
conjunction with an exchange of the President's common stock for the Company's
preferred stock, the Company assumed the securitization of the debentures.
Effective June 1997, the Company authorized 20 million shares of common stock to
complete the securitization of the Company stock for the debenture holders.
The Company's debentures payable had increased at the beginning of the
calendar year 1998 to a total of $1,936,084. Through June 30, 1998, debentures
totaling $1,460,910 have been converted into shares of primarily common stock.
This represents a 75% conversion of the debentures. There are four debenture
holders that have not elected to convert their debentures to stock. In the
period subsequent to June 30, 1998, an additional $300,174 of debentures were
converted to common stock. The Company has restructured the terms of $145,000 of
debentures to extend an additional year. The Company has negotiated with the
remaining $30,000 to pay off their debentures.
NOTE 8 - LONG-TERM CONTRACT PAYABLE
The Company has entered into a long-term contract payable for the
purchase of the exclusive master license of the "ZEROS" System Technology (Note
3). The purchase price of the contract is $ 4,000,000 due in January 2005.
Interest expense has been imputed at 9% per annum for the contract with the
calculation as follows at June 30, 1998:
Contract amount $4,000,000
Unamortized discount (1,792,117)
----------
Contract payable long-term $2,207,883
==========
Interest expense in conjunction with the amortization of the contract
for the three-month periods ended June 30, 1997 and 1998 were $45,095 and
$50,326, respectively.
NOTE 9 - SERIES A CONVERTIBLE BONDS
At June 30, 1998 the Company has $2,019,978 of Series A convertible
bonds payable to various individuals and entities. The Series A bonds principal
on the five-year bonds are due July 31, 2002. The interest on these bonds is due
semi-annually in January and July. The first interest payment will be declared
in December 1998, at which time the Company may exercise a call provision. The
interest rate on the bonds in 12% per annum. The bonds may be converted at the
holder's option for Series A preferred stock. Each dollar of bond principal is
convertible into one share of preferred stock. The Company has issued a total of
$2,382,978 in Series A
15
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 9 - SERIES A CONVERTIBLE BONDS (continued)
bonds. Through June 30, 1998, Series A bonds totaling $363,000 have been
converted into preferred stock. The Company will pay all accumulated interest on
the payment date in January 1999.
NOTE 10 - INCOME TAXES
The provision for income taxes consist of the following:
Three-Month Period Ended
------------------------------
June 30, 1997 June 30, 1998
------------- -------------
Current tax expense $ -- $ --
Deferred tax expense 501,943 348,928
------------ ------------
Total $ 501,943 $ 348,928
============ ============
The Company's deferred tax assets relate principally to non-deductible
accrued expenses, a net operating loss carryforward and deferred revenue.
Deferred tax liabilities relate to contracts receivable that are not recognized
for taxable income purposes.
A summary of deferred tax liabilities and deferred tax assets at June
30, 1998 follows:
Deferred tax liabilities $ 5,451,573
Less deferred tax assets
Temporary differences,
primarily accounts
payable and accrued
expenses (233,897)
Net operating loss
carryforwards (1,637,306)
Deferred tax assets
valuation allowance --
------------
Net deferred tax liabilities $ 3,580,370
============
No income taxes were paid during the three-month periods ended June 30,
1997 and 1998.
16
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 10 - INCOME TAXES (continued)
During the period from inception through June 30, 1998 the Company
incurred net operating losses which are allowed to be carried forward 15 years
for federal income tax purposes. The Company's net operating losses are detailed
as follows:
Tax Period Expiration Amount
---------- ---------- ------
Inception through March 31, 1997 2012 $ 598,757
Year ended March 31, 1998 2013 3,090,257
Three month period ended June 30, 1998 2014 739,729
------------
$ 4,428,743
============
NOTE 11 - NOTE PAYABLE
Note payable consists of a promissory note dated June 15, 1998 to an
investment company for advances up to a $2,000,000 limit. As of June 30, 1998,
funds totaling $647,000 had been advanced on the note. The note bears interest
at the one year London Interbank Offered Rate ("LIBOR") plus 2%. Interest shall
be due and payable annually on each anniversary date of the note. The unpaid
principal balance of the note shall be due and payable, on or before June 30,
2001. The note is secured by 4,000,000 shares of the Company's preferred stock.
NOTE 12 - STOCKHOLDERS' EQUITY
In November 1996, the Company was formed with one million shares of
authorized common stock at no par value. At March 31, 1997 the President has
been issued 900,000 shares of common stock in the restructuring and the Company
holders issued 100,000 shares of common stock to a business trust in exchange
for a stock investment with an estimated fair market value of $25,000. In June
1997 the Company amended its articles of incorporation to authorize twenty
million shares of common stock at $.001 par value and 10 million shares of
preferred stock at a $5 stated value used for dividend calculations and par
value of $.001. This amendment was done in conjunction with the merger of the
parent and the subsidiary in July 1997 (see Note 1). In February 1997 the
Company acquired the majority stock in the amount of 10,500,000 shares which
equates to 91% of the (issued and outstanding) of Gunner Holdings, Inc. (a Utah
corporation), and that had changed its name of this subsidiary corporation to
ZEROS USA, Inc. (a Utah corporation). The acquisition was accounted for under
the purchase method for business combinations. In June 1997 the subsidiary
corporation was merged into ZEROS USA, Inc.
17
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 12 - STOCKHOLDERS' EQUITY (continued)
Upon consummation of the merger, 1,490,000 shares of the subsidiary's
common stock held by shareholders other than the Company's president and
affiliates were distributed Company's common stock on a share for share basis.
This post merger common stock issue was for distribution of shares as follows:
Steve Clark 9,000,000
Capital American Associates 1,000,000
Gunner Shareholders 1,490,000
The 10,000,000 shares of Preferred stock were authorized for the
capital development needs of the Company. In September 1997 the Company
exchanged 3,000,000 preferred stock shares for 4,000,000 common shares of the
President's common stock. The 4,000,000 common shares of the President were
included in treasury stock by the Company at the Company's estimated cost. The
Company also issued 1,000,000 shares of common stock to a related party for
manufacturing rights and a split revenue agreement and restricted Mr. Clark from
on-site direct involvement in oilfield fires and blowouts. During September
1997, the Company also issued preferred stock of 750,000 shares, 2,500,000
shares, and 4,065,000 shares, respectively, to licensees, the Company President,
key officers, and shareholders for services rendered. In November 1997 the
Company issued 3,000,000 shares of preferred stocks to a related party for
certain assets and contract rights. The preferred stock is convertible one for
one into common stock and has no preferential rights, participation rights, call
prices or dates, sinking fund or redemption requirements, unusual voting rights,
or cumulated preferred dividends. In September 1997 the stock exchange for
services and certain assets and rights were based upon $.02 per share for common
stock and preferred stock and warrants at $.02 per warrant based upon an
independent firm valuation.
During the fiscal 1998 year certain debentures and Series A bonds were
converted into common and preferred shares. The debentures were converted (Note
7) on a two for one basis into primarily common stock with the excess of par
recorded in paid in capital with the total conversion of approximately
$1,220,910. The Series A bonds (Note 9) converted to primarily preferred stock
on a one for one basis with the excess of par recorded in paid in capital
totaled $230,000.
The Company issued two individuals common shares totaling 2,200,000
common shares for $1,100,000. One of these individual shareholders that
contributed $1,000,000 in this capitalization also is in a partnership of a
company that owns a license of the Company's technology.
18
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 13 - RELATED PARTY TRANSACTIONS
The Company incurred costs to related parties in the expense areas
detailed as follows:
Three-Month Period Ended
------------------------------
June 30, 1997 June 30, 1998
------------- -------------
Air charter travel expense $ 143,452 $ 512,452
Office and overhead cost 57,975 --
Consulting fees -- 70,400
Investments at June 30, 1998 include $67,475 in advances to related
real estate partnership to establish an office in Banning, California.
The Company incurred master license transfer costs of $30,000 from a
foreign corporation and will pay fees and royalties for this master license
based upon certain terms of the agreement with an initial contract amount of
$4,000,000 (see Note 3).
In November 1997 the Company obtained from a related party, certain
contract rights and other assets valued at $160,000 through exchange of cash of
$100,000 and preferred stock valued at $60,000.
In April 1997, the Company initially entered into an aircraft
reimbursement agreement with a related party which requires the Company to pay
120 regular payments of $16,000 per month for aircraft rental plus other
expenses. However, in April 1998 the Company entered into a revised aircraft
reimbursement agreement for the use of two aircraft at $800 and $1,500 per hour
with no monthly minimum.
The aircraft charter expenses, consulting fees, office, and overhead
costs are charges from related companies controlled by the President of the
Company.
The office and overhead expenses are expenses associated with an
administrative service agreement with a related party to provide administrative
support for the Company and sub-leases a regional office (Alameda, California)
on a month to month basis ($4,600 per month) from a related party.
The licensees also own shares of this Company stock either through
direct investment by the incorporated entity or indirect investment by owners of
the legal entity that holds the license. The dollar investment and total number
of shares owned by the licensees and their owners is $1,120,000 and 850,000
preferred shares and 2,242,000 shares of common stock.
The Company's President has implemented a private warrant offering to
use as an incentive to encourage debenture holders to convert to stock. The
President has received approximately $76,000 associated with these private
warrants issued. The private warrant offering expires September 30, 1998.
19
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 14 - SUPPLEMENTAL CASH FLOW INFORMATION
The Company paid no interest in the three month period ended June 30,
1997. Interest of $35,735 was paid in the three-month period ended June 30,
1998. No federal or state income tax was paid during the three-month periods
ended June 30, 1997 and 1998.
Supplemental cash flow information items regarding non-cash items are
as follows:
Three-Month Period Ended
------------------------------
June 30, 1997 June 30, 1998
------------- -------------
Change in common to $.001
par value from no par
Common stock (25,000)
Preferred stock 25,000
Issuance of common stock
for services performed by
the Company's President 8,100
Issuance of common stock
for services by a stock-
holder 900
Issuance of common stock
to a minority stockholder
of subsidiary related to
the merger 3,235
Conversion of debentures
into shares of preferred
and common stock 240,000
Conversion of Series A
bonds into shares of
preferred and common
stock 133,000
Preferred and common stock
issued for services
performed for the
Company 7,180
20
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 15 - FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash, certificates of
deposit, contracts receivable, an investment in preferred stock and a real
estate partnership, a long-term contract payable, note payable, debentures
payable and Series A convertible bonds.
Cash
The Company maintains its cash in bank deposit accounts, which, at
times, may exceed federally insured limits and a money market investment account
at a brokerage firm. The Company has not experienced any losses and believes it
is not exposed to any significant credit risks affecting cash.
Certificates of Deposit
The Company has one-year certificates of deposit with the bank, which
exceed federally insured limits. The Company has not experienced any losses and
believes it is not exposed to any significant risks affecting certificates of
deposit.
Investment
The real estate investment partnership was in accordance with the
equity method and an additional valuation allowance is not required.
Contracts receivable
Management believes the carrying value of contracts receivable (Note 2)
is fairly stated at estimated net realizable values and a reserve for
uncollectability is not required. Management also believes the carrying value of
these contracts receivable represents fair value of these financial instruments
because terms are similar to those in the lending market for comparable loans
with comparable risks using an imputed interest rate of 9% (Note 2).
Long-term contract payable
Management believes the carrying value of the long-term contract
payable represents the fair value of this financial instrument because its terms
are similar to those in the lending market for comparable loans with comparable
risks utilizing a present value rate of 9% (Note 8).
Bank notes payable
Management believes the carrying value of bank notes payable
approximates fair value of these financial instruments.
21
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 15 - FINANCIAL INSTRUMENTS (continued)
Debentures payable
Management believes the carrying value of debentures payable represents
fair value of these financial instruments because terms are similar to those in
the lending market for comparable loans with comparable risks.
Series A convertible bonds
Management believes the carrying value of the Series A convertible bond
represents fair value of these financial instruments because terms are similar
to those in the lending market for comparable loans with comparable risks.
NOTE 16 - EARNINGS PER SHARE
Basic earnings per share ("Basic EPS") are based upon net earnings
divided by the weighted average number of shares of common stock outstanding.
Diluted earnings per share ("Diluted EPS") is computed by dividing (a) net
earnings plus interest on debentures and Series A bonds net of applicable income
taxes (b) common and equivalent common shares outstanding which would include
conversion of preferred stock, debentures and Series A bonds.
A summary of the earnings per share data is as follows:
Three-Month Period Ended June 30, 1997
---------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
As Restated As Restated
Basic EPS
Net earnings available
to common share-
holders $ 855,761 1,115,275 $ .77
Effect of Dilutive
securities:
Debentures 20,148 2,675,593
---------- ---------
Diluted EPS
Net earnings available
to common shareholder
+ assumed conversions $ 875,909 3,790,868 $ .23
========== =========
22
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 16 - EARNINGS PER SHARE (continued)
Three-Month Period Ended June 30, 1997
---------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
As Restated As Restated
Basic EPS
Net earnings available
to common share-
holders $ 594,887 13,617,205 $ .04
Effect of Dilutive
securities:
Debentures (11,008) 1,177,601
Series A convertible bonds 54,810 1,857,049
Preferred stock 13,721,352
----------- ----------
Diluted EPS
Net earnings available
to common shareholder
+ assumed conversions $ 638,689 30,373,207 $ .02
=========== ==========
In June 1997 the authorized common shares where changed from 1,000,000
to 20,000,000 common shares. In June 1998 the authorized common shares were
changed to 115 million.
NOTE 17 - CORRECTION OF ERRORS
During the year ended March 31, 1998, errors were discovered in the
method utilized for recognized revenues on license contracts and in the
treatment of costs associated with the master license.
As detailed in Note 1, the Company utilized the full accrual method for
recognizing revenues on license contracts. Revenues are deferred only to the
extent that costs are required to fulfill obligations that exist under the
contracts. Previously, the Company recognized revenues on license contracts
based upon milestones in the contract process. Retroactive application of the
change resulted in an increase in net income of $157,193 ($ .14 per share) for
the three- month period ended June 30, 1997.
As detailed in Note 3, master license costs of $1,956,848 are
capitalized. These costs consist of legal costs and the present value of the
initial obligations due under the master license contract. Previously, only the
$30,000 in legal costs related to the transfer of the licensing rights was
capitalized. Retroactive application of the change resulted in a decrease in net
income of $24,290 ($ .02 per share) for the three-month period ended June 30,
1997. The decrease in net income is solely attributable to amortization of the
master license costs.
23
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 17 - CORRECTION OF ERRORS (continued)
The financial statements for the three-month period ended June 30, 1997
have been retroactively restated to reflect these accounting errors. An analysis
of the effect of these errors upon net income follows:
Amount Basic EPS
------ ---------
Net income as previously
reported $ 722,858 $ .65
Adjustment for correction
of error in recognizing
revenues from license
contracts, net of tax effect
(tax rate 36.97%) 157,193 .14
Adjustment for correction
of error in treatment of
master license costs, net
of tax effect (tax rate 36.97%) (24,290) ( .02)
--------- -------
Net income as restated $ 855,761 $ .77
========= =======
NOTE 18 - MAJOR CUSTOMERS
Since its inception on November 12, 1996 the Company has sold eight
license contracts to different licensees. The Company sold one license during
each of the three-month periods ended June 30, 1997 and 1998. Each licensee
represents approximately 12.5% of the Company's total revenues.
NOTE 19 - COMMITMENTS AND CONTINGENCIES
Leases
The Company subleases its Houston, Texas Company headquarters
from a related party on a month to month basis in conjunction with an
administrative services agreement for office rent and other overhead
cost (Note 13).
The Company also subleases a regional office (Alameda,
California) from a related party on a month to month basis, which
approximates $4,600 per month.
24
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 19 - COMMITMENTS AND CONTINGENCIES (continued)
Leases
The Company leases its office in the Liverpool/Syracuse, New
York area under a non-cancelable operating lease. The lease commenced
on October 1997 and ends in October 2000. The following is a schedule
of future minimum lease payments required under the lease:
Year Ended
March 31,
---------
1999 $8,675
2000 $9,275
2001 $5,200
Executive management employment agreements
The Company has entered into employment agreements with its
principal officers that provide for the payments of approximately $
402,000 of annual salaries in addition to certain health benefits,
expenses, and monthly automobile allowances. The agreements range in
terms of 3 to 5 years and expire in October 2000 and October 2002
respectively. The agreements generally provide for monthly payments if
the employees should be terminated without cause for six months and
have a non-compete clause for a period of one year.
Year 2000 computer compliance
The Company's computer hardware and the software it is
currently using are in compliance with the year 2000 dating issues.
Furthermore, management does not believe any additional significant
cost will be incurred in dealing with this issue and the accompanying
financial statements do not contain any reserve for this contingency.
NOTE 20 - SUBSEQUENT EVENTS
In June 1998, the Company amended it's Articles of Incorporation to
authorize 115,000,000 shares of common stock at $.001 par value and 75,000,000
shares of preferred stock at $.001 par value. The Company's board of directors
has authorized the issuance of the following series of preferred stock:
1. Series A convertible preferred. The amended articles
authorize 10.0 million shares of $.001 par value of Series A
convertible preferred stock. The Company has 133,000 shares
of Series A convertible stock
25
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 20 - SUBSEQUENT EVENTS (continued)
outstanding as of June 1998. None of the shares of the
Series A convertible preferred is entitled to any vote, and
each share of the Series A convertible preferred carries a
dividend of $0.30 per share, payable annually, provided that
if the price of the Series A convertible preferred stock is
$5 per share or more, the Company has the option to pay such
dividend in common stock. If the Company elects to pay the
dividend in common stock, the Company will round up to the
next whole number any fractional shares payable in the total
annual dividend to each shareholder. The holder of the
Series A convertible preferred stock may at any time convert
the Series A convertible preferred stock into the common
stock at the conversion ration of one share of Series A
convertible preferred stock for one share of common stock.
2. Series B convertible preferred. The amended articles
authorize 25.0 million shares of $.001 par value of Series B
convertible preferred stock. The Company has no shares of
Series B convertible preferred stock outstanding as of June
1998. None of the shares of the Series B convertible
preferred is entitled to any vote, and each share of the
Series B convertible preferred carries a dividend of $0.10
per share, payable annually, and receives an additional
dividend of 0.10 shares of common stock, payable annually.
The Company will round up to the next whole number any
fractional shares payable in the total annual dividend to
each shareholder. The holder of the Series B convertible
preferred stock may at any time convert the Series B
convertible preferred stock into the common stock at the
conversion ration of one share of Series B convertible
preferred stock for one share of common stock.
3. Series C convertible preferred. The amended articles
authorize 15.0 million shares of $.001 par value of Series C
convertible preferred stock. The Company has 11,549,996
shares of Series C convertible preferred stock outstanding
as of June 1998. Each share of the Series C convertible
preferred stock is entitled to one vote for each share held,
and receives a dividend of 0.06 shares of common stock,
payable annually. The Company will round up to the next
whole number any fractional shares payable in the total
annual dividend to each shareholder. The holder of the
Series C convertible preferred stock may at any time convert
the Series C convertible preferred stock into the common
stock at the conversion ratio of one share of Series C
convertible preferred stock for one share of common stock.
4. Series D convertible preferred. The amended articles
authorize 20.0 million shares of $.001 par value of Series D
convertible preferred stock. The Company has 1,971,802
shares of Series D convertible preferred stock outstanding
as of June 1998. None of the shares of the Series D
convertible preferred stock is entitled to any vote, and
each share of the Series D convertible preferred stock
receives a dividend of 0.10 shares of
26
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 20 - SUBSEQUENT EVENTS (continued)
common stock, payable annually. The Company will round up to
the next whole number any fractional shares payable in the
total annual dividend to each shareholder. The holder of the
Series D convertible preferred stock may at any time convert
the Series D convertible preferred stock into the common
stock at the conversion ratio of one share of Series D
convertible preferred stock for one share of common stock.
From April to June 1998 the Company debenture holders
and Series A bondholders have converted a total of
$373,000 in additional equity to common and preferred
stock. The amount of shares was 240,000 in common
stock and 133,000 in preferred stock.
In June 1998 the 13,436,000 original preferred stock
was reissued as 11,549,996 shares of Series C
convertible preferred stock and 1,886,004 of Series D
convertible preferred.
In June 1998 the Company also authorized the Series B bonds none of
which have been sold through June 1998. The Company has authorized the creation
of the Series B ten-year convertible bond (the "Series B Bonds"). Holders of the
Series B bonds are entitled to receive $100,000 per $100,000 face amount unit on
the maturity date, which has not been set, and interest at the rate of twelve
(12%) per annum semiannually on the last day of January and the last day of July
of each year, computed from the actual day of issuance. The maturity of the
Series B bonds is ten years. Subject to redemption by the Company, the holder of
the Series B bonds, may at any time, prior to the maturity date, convert the
principal amount of the Series B bonds into the Company's Series B preferred
stock at the conversion ratio of $2.00 of bond principal for one share of Series
B preferred stock. The Company may at any time prepay in whole or in part, the
principal amount, plus accrued interest to the date of pre-payment, of all
outstanding Series B bonds of this issue, upon 90 days' written notice by
certified or registered mail to the registered owners of all outstanding Series
B bonds.
In September 1998 the Company's licensees have obtained payment
guarantees for the balance due on their license. A financial guarantee bond has
been issued by a major insurance carrier on a transaction by transaction basis
for the license provides the payment guarantee.
NOTE 21 - PROFIT SHARING PLAN AND BENEFIT PLAN
The Company's 401 (k) profit-sharing plan (The Plan) covers
substantially all officers and employees with at least one year of service at
the end of the plan year. The participants can enter the plan as of January 1 or
July 1 of the plan year. The Company plan allows participants to defer between
one and fifteen percent of compensation as nontaxable income subject to the
limitations of the Tax Reform Act of 1986. Participants direct their
contributions to the various investment options at their discretion. At the
discretion of the Board of Directors, the Company can make contributions into
the employers 401K plan. These contributions will be derived from profit earned
by the Company up to a limit of 10% of the employee's earnings.
27
ZEROS USA, INC.
NOTES TO FINANCIAL STATEMENTS - UNAUDITED
THREE-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998
NOTE 21 - PROFIT SHARING PLAN AND BENEFIT PLAN (continued)
Participants vesting in employer contributions are as follows:
Credited
years at Percentage
service vested
--------- ----------
Less than 2 0%
2 but less than 3 20
3 but less than 4 40
4 but less than 5 60
5 but less than 6 80
6 or more 100
In February 1998 the Company established a health benefit program in
conjunction with a cafeteria plan. The amounts charged to expense for these
benefits at June 30,1998 were $27,008.
NOTE 22 - GOING CONCERN
The Company is experiencing rapid growth. The Company has sold eight
licenses in the period from inception through June 30, 1998. Management is
restructuring its operating expenses and has obtained sufficient private
placements of stock and financial guarantees to maintain cash flow and
operations.
28
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
EX - 27 Financial Data Schedule