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 September 30, 2004
[ ] 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 0-28161
CIK Number 0001092802
WELLSTONE FILTERS, INC.
(Exact Name of small business issuer as specified in its charter)
Delaware 33-0619264
(State or other Jurisdiction of I.R.S. Employer Identi-
Incorporation or Organization fication No.)
1250 Crown Boulevard, Timberlake, North Carolina 27583
(Address of Principal Executive Offices) (Zip Code)
(914) 333-0090
(Issuer's Telephone Number, including Area Code)
Indicate by check mark whether the Registrant (i) has filed all reports
required to be filed by Section 13, or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (of for such shorter period that the
Registrant was required to file such reports) and (ii) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date.
Common Stock, $.001 par value 237,467,991
- ---------------------------------- -----------------------
Title of Class Number of Shares outstanding
at September 30, 2004
Transitional Small Business Format Yes No X
No exhibits included.
WELLSTONE FILTERS, INC.
(A Company in the Development Stage)
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31, September 30,
2003 2004
(unaudited)
Current Assets - Cash $ 3,109 $ 67,385
Furniture and Equipment,
net of accumulated depreciation 7,211 4,960
-------------- --------------
Total Assets $ 10,320 $ 72,345
============== ==============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 25,389 $ 32,891
Accrued interest on related party notes payable 10,991 14,543
Related Party Notes payable 59,200 59,200
Related Party Accounts Payable 30,224 31,584
-------------- --------------
TOTAL CURRENT LIABILITIES $ 125,804 $ 138,218
Committments and Contingencies -- --
SHAREHOLDERS' DEFICIT
Preferred Stock, $.001 par value; 1,000,000 shares
authorized; no shares issued and outstanding -- --
Common Stock, $.001 par value; 300,000,000 shares
authorized; 236,968,200 and 237,467,991 shares
issued and outstanding 236,968 237,468
Additional paid-in capital (deficiency) (207,468) 6,882,032
Deficit accumulated during development stage (144,984) (7,185,373)
-------------- --------------
TOTAL SHAREHOLDERS' DEFICIT (115,484) (65,873)
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDER'S DEFICIT $ 10,320 $ 72,345
============== ==============
The accompanying notes are an integral part of the
financial statements.
2
WELLSTONE FILTERS, INC.
(A Company in the Development Stage)
Consolidated Statement of Operations
(unaudited)
Three Months Ended Nine Months Ended
Cumulative
September 30, September 30,
amounts since
2004 2003 2004 2003 inception
Revenues $ -- $ -- $ -- $ -- $ --
General and
Administrative expense $ 51,714 $ 41,821 $ 96,837 $ 53,752 230,706
Stock Compensation expense 6,300,000 -- 6,940,000 -- 6,940,000
Interest expense 1,184 584 3,552 1,752 14,667
------------ ------------- ------------- ------------- ----------------
Loss before
income taxes (6,352,898) (42,405) (7,040,389) (55,504) (7,185,373)
Income tax -- -- -- -- --
------------ ------------- ------------- ------------- ---------------
Net (Loss) $(6,352,898) $ (42,405) $ (7,040,389) $ (55,504) $ (7,185,373)
============ ============= ============ ============= ================
Loss per share:
basic and diluted $ (.03) $ (.00) $ (.03) $ (.00)
============ ============= ============= =============
Weighted average
shares outstanding 237,407,000 236,968,000 237,252,000 236,968,000
============ ============= ===========================
3
WELLSTONE FILTERS, INC.
(A Company in the Development Stage)
Consolidated Statement of Cash Flows
(unaudited)
Cumulative
From inception
February 17, 1998
Nine Months Ended to
September 30, September 30
2004 2003 2004
Cash flows from operating activities:
Net loss $ (7,040,389) $ (55,504) $ (7,185,373)
Depreciation 2,251 2,255 6,207
Stock options issued for services 6,940,000 -- 6,940,000
Rental expense forgiven by board member -- 12,600 29,400
Increase in accounts payable 7,502 2,000 32,891
Increase in accrued interest on related party notes payable 3,552 1,752 14,543
Increase in related party accounts payable 46,360 20,184 65,417
----------------- -------------- ------------
Net cash used in operating activities (40,724) (16,713) (96,915)
Cash flows from investing
activities -- -- --
Cash flows from financing activities:
Proceeds from sale of common stock 105,000 -- 105,000
Members' contribution -- -- 100
Proceeds from related party notes payable -- 20,000 59,200
Net cash provided by financing activities 105,000 20,000 164,300
----------------- ----------------- ------------
Net increase in cash 64,276 3,287 67,385
Cash, beginning of period 3,109 989 --
---------------- ----------------- -----------------
Cash, end of period $ 67,385 $ 4,276 $ 67,385
================ ================ =================
See accompanying Notes to Financial Statements.
4
WELLSTONE FILTERS, INC.
(A Company in the Development Stage)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2004
1. General
The accompanying financial statements are unaudited, but in the opinion
of the management of the Company, contain all adjustments, consisting
of only normal recurring accruals, necessary to present fairly the
financial position at September 30, 2004, the results of operations for
the three and nine months ended September 30, 2004 and 2003, and the
cash flows for the nine months ended September 30, 2004 and 2003.
Reference is made to the Company's Form 10-KSB for the year ended
December 31, 2003. The results of operations for the three and nine
months ended September 30, 2004 are not necessarily indicative of the
results of operations to be expected for the full fiscal year ending
December 31, 2004.
Wellstone Filters, LLC (Wellstone) was organized as a Delaware limited
liability company on February 17, 1998 (date of inception). On May 25,
2001, Wellstone Filters, Inc. (formerly Farallon Corporation) (the
"Registrant") acquired Wellstone pursuant to an Agreement and Plan of
Reorganization (the Agreement), dated as of May 25, 2001. The
Registrant acquired all of the outstanding membership interest of
Wellstone, in exchange for 70,000,000 shares of the Registrant's Common
Stock. In addition, the Company issued 5,968,200 shares of common stock
in cancellation of debt and issued 499,791 shares for cash of $150,000.
All share amounts are after giving effect to a 5-for-1 forward stock
split effected in July 2003, a .40 for one stock dividend effected in
October 2003 and a 3-for-1 forward stock split effected in September
2004.
The stockholders of Wellstone, after the acquisition, owned the
majority of the combined company. Accordingly, the combination was
accounted for as a reverse acquisition whereby, for accounting
purposes, Wellstone is the accounting acquirer and Registrant is the
accounting acquiree. Registrant and Wellstone are collectively referred
to as (the Company). The Company has adopted a December 31 year end.
The financial statements from inception through May 25, 2001, are those
of Wellstone, LLC, the accounting acquirer. Subsequent to May 25, 2001,
the financial statements reflect the consolidated position and
operations of Wellstone Filters, Inc. (Registrant) and Wellstone LLC.
The Company is engaged in the development and marketing of a
proprietary cigarette filter technology; however, the Company has not
commenced planned principal operations and has not recognized any
revenues related to such planned operations. Accordingly, the Company
is considered a development stage company as defined in SFAS No. 7.
For purposes of the statement of cash flows, the Company considers all
highly liquid investments with a maturity of three months or less to be
cash equivalents.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company
is a development stage company and has not had revenues from
operations. In addition, the Company has a deficit in working capital
and stockholders' equity, and has incurred sustained losses. These
conditions raise substantial doubt about the ability to continue as a
going concern. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty. The Company's
ability to continue as a going concern is subject to the attainment of
profitable operations and / or obtaining necessary funding from outside
sources. However, there can be no assurance they will be successful in
such efforts.
In October the Company entered into an agreement with another fund
under which it will receive $1.5 million in debt financing plus
warrants, and the agreement with Arrakis was not renewed. The $1.5
million is believed by management to be sufficient for our working
capital needs for at least the next 12 months.
5
2. Related Party Notes Payable
The related party notes payable consist of loans from officers of the
Company. The amounts are unsecured, bearing interest at 8% and are due
on demand. Accrued interest on the notes was $10,991 and $14,543 at
December 31, 2003 and September 30, 2004, respectively.
Related party accounts payable include amounts due to an officer of the
Company and the brother of an officer of the Company.
3. Stock-Based Compensation
The Company accounts for stock options granted to employees under the
recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations,
and has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards (SFAS) NO. 123, "Accounting for
Stock-Based Compensation." Accordingly, no compensation cost is
recognized in the financial statements, when options granted under
those plans have an exercise price equal to or greater than the market
value of the underlying common stock on the date of grant.
The following table illustrates the effect on net (loss) earnings per
share if the Company had applied the fair value recognition provision
of FASB Statement No. 123, Accounting for Stock-Based Compensation, to
stock-based employee compensation.
Three Months Ended Nine Months Ended
September 30 September 30,
2003 2004 2003 2004
---- ---- ---- ----
Net loss, as reported $ (42,405) $(6,352,898) $ (13,099) $ (7,040,389)
Stock-based employee
Compensation expense
Included in reported net
loss, net of related tax
Effects -- 6,300,000 -- 6,300,000
Deduct:
Total stock-based employee
Compensation expense
determined under fair
value based method for all
awards, net of related tax effects -- 8,580,488 (330) 8,580,488
-------- --------- ---------- --------------
Pro forma net (loss) income (42,405) (8,633,386) (13,429) (9,320,877)
------------ ------------ ----------- ---------------
(Loss) earnings per share:
Basic and diluted - as reported $ -- $ (.03) $ -- $ (.03)
------------- ---------- -------- -----------
Basic and diluted - pro forma $ -- $ (.04) $ -- $ (.04)
-------------- ----------- -------- ----------
4. Weighted Average Shares
The computation of basic earnings (loss) per common share is based on
the weighted average number of shares outstanding during each year.
The computation of diluted earnings per common share is based on the
weighted average number of common shares outstanding during the year,
plus the common stock equivalents that would arise from the exercise of
stock options and warrants outstanding, using the treasury stock method
and the average market price per share during the year. Options to
purchase 27,825,000 and 525,000 shares of common stock at prices
ranging from $.0007 to $.10 per share were outstanding at September 30,
2004 and 2003, respectively, but were excluded for the calculation of
diluted earnings per share because the effect of stock options was
anti-dilutive.
6
5. Supplemental Cash Flow Information
No amounts were paid for interest or income taxes during the period
from February 17, 1998 (date of inception) to September 30, 2004.
During the nine months ended September 30, 2004, the Company satisfied
$45,000 of related party accounts payable through the issuance of
common stock.
During the nine months ended September 30, 2003, the Company received a
contribution of capital of $12,600, for the use of office space
provided by an officer and board member of the Company. The arrangement
for the use of office space was mutually terminated on September 30,
2003.
Prior to January 1, 2003 the Company :
o recorded a contribution of capital of $16,800.
o acquired furniture and equipment in exchange for an increase in related party
accounts payable of $11,167 o issued 5,968,200 shares of common stock in
settlement of $2,842 of debt.
Item 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Wellstone's Strategic Direction
In the quarter ended September 30, 2004 Wellstone determined to augment
its strategic focus. Wellstone's original plan was to license its proprietary
cigarette filter technology to existing cigarette manufacturers. Because we
believe our filter compound removes certain carcinogens, Wellstone believed that
incorporation of our compound into currently marketed brands would be the
quickest way to bring its Wellstone Filters to the smoking public. After a
review of the tobacco marketplace, Management determined to join the group of
small manufacturers who have gained market share in recent years (estimated by
some to be 12% of total US 2003 market) in this multi-billion dollar market. We
intend to offer a product or products within the discount segment of the market.
Sales of the Wellstone brand are expected to begin in the second quarter of
calendar 2005.
Wellstone intends to market cigarettes that are lower in tar yet do not
compromise and may enhance the pleasurable effects of smoking. Wellstone's
strategic plan as well as its philosophy is based on two facts: First, that
quitting smoking can be difficult. Second, smokers do not apparently focus much
attention on tar levels. In 2002, 64% of all cigarettes sold in the United
States were high (more than 10 mg) in tar, according to industry reports.
Wellstone believes that part of the reason smokers prefer high tar cigarettes is
because of taste. The goal of Wellstone is to reduce tar and certain associated
carcinogens without affecting taste. We believe smokers will try Wellstone for
its lower price, and come back for its taste.
7
Wellstone will be the only small (less than $50 million in sales) US
cigarette manufacturer which is publicly traded. The remainder of the small
manufacturers in the industry are privately held or foreign. Management believes
Wellstone's access to the US capital markets will assist Wellstone in its goal
to become the largest company in the growing discount cigarette market. However,
there can be no assurance that Wellstone's access to US capital markets will
provide the necessary financing to build and grow the business.
Management has not abandoned its plan to license the formulation, and
continues discussions with industry players. Management has determined that
manufacturing and distributing a Wellstone line of cigarettes will be in the
best interests of its stockholders, particularly if Wellstone is able to
successfully market its brand. The successful launch of a Wellstone brand should
add significant value to the company. More importantly, the success of a
Wellstone brand will, it is anticipated, lead the way for other manufacturers to
utilize the filter in their own cigarettes under a Wellstone license.
Timetable to Market
Management has adopted an accelerated plan to bring the Wellstone brand
to market. Our target, originally June 2005, has been advanced to April 2005 due
to earlier than expected progress. In furtherance of its marketing plans,
Wellstone has
O Relocated from New York to North Carolina to avail itself of the
talent pool and infrastructure already in place in North Carolina. Wellstone has
leased space in a state-of-the-art cigarette manufacturing facility. In addition
to office and plant space, Wellstone also leases, on a non-exclusive basis as
needed, certain production assets to produce cigarette samples. The office space
and plant are located at 250 Crown Boulevard in Timberlake, North Carolina,
approximately 20 miles from Durham.
O Enlarged its management team by adding an experienced COO and
CFO from one of the major
manufacturers
O Completed design of its packaging. This is a crucial step since the
Federal Trade Commission must review and approve package design.
O Sourcing production capability for our cigarettes and the
filter incorporating our patented
technology
O Formulating distribution plans and are in engaged in discussions with
distributors.
Management believes that its timetable for first sales in April 2005 is
feasible. Our projected net sales for the first twelve months of sales is $11.1
million and $31.7 million for the second twelve months of sales. We expect a
loss from operations of $423,000 for the first year of sales and net operating
income of approximately $1 millon for the second year. If we commence first
sales in the beginning of April 2005, sales for calendar 2005 are projected at
$6 million with an operating loss of $500,000.
8
Results of Operations
Wellstone has not yet commenced sales of its products. Sales are not
expected until the second quarter of 2005. Our operations to date have consisted
of developing and refining our proprietary filter formulation, obtaining a US
and international patent on that formulation, and on seeking to market the
filter technology. Substantially all of our losses for the three and nine months
ended September 30, 2004 are the result of stock compensation expense for the
issuance of stock options. . In the quarter ended June 30, 2004 options were
issued to a scientific advisor to purchase 4,800,000 shares at a price of $.0007
per share resulting in expense of $640,000 during the quarter. In September 2004
options to purchase 22,500,000 shares at $.10 per share were issued to two
officer employees. These options were issued at a price less than the trading
price on the date the options were issued resulting in an expense of $6,300,000
during the quarter. General and administrative expenses increased in the quarter
ended September 30, 2004 by 24% as compared to the September 30, 2003 quarter,
and increased by 80% in the quarter ended September 30, 2004 as compared to the
September 30, 2003 quarter, as the Company intensified its developmental and
marketing efforts. General and administrative costs will increase in future
quarters as a result of leasing new offices in North Carolina, hiring new
employees including a Chief Financial and Operating Officer who has already been
hired, administrative, marketing and technical employees, and increased travel
and office expenses related to the company's expansion into cigarette
manufacturing. We anticipate that by the beginning of calendar 2005 our general
and administrative expenses will be approximately $90,000 per month.
Liquidity and Capital Resources
We have never earned revenues from operations. Through October 31, 2004,
our operations were being funded by shareholder advances and a financing
agreement with a private investment fund controlled by a related party. These
shareholder advances and financings from the related party, including accrued
interest, totaled $90,784 and $89,424 as of September 30, 2004 and December 31,
2003. On January 2, 2004, we entered into a funding agreement with Arrakis
Select, a private investment fund controlled by a brother of our Chief Executive
Officer under which agreement Arrakis Select agreed to satisfy Wellstone's
funding requirements for 90 days (renewable for additional 90 day periods), in
exchange for common stock valued at the closing bid price of the common stock as
of the 15th day of the month in which the funding was made. Through September
30, 2004 Wellstone had received $105,000 from Arrakis for the issuance of
368,442 restricted shares and satisfied $45,000 of advances payable to Arrakis
in exchange for 131,349 restricted shares.
In October the Company entered into an agreement with another fund under
which it will receive $1.5 million in debt financing plus warrants, and the
agreement with Arrakis was not renewed. The $1.5 million is believed by
management to be sufficient for our working capital needs for at least the next
12 months.
We do not have any agreements or understandings with respect to
additional sources of capital. We have not identified any potential additional
sources. If needed for our business we may need to raise other funds in the near
future.
We are a development stage company as that term is defined in
paragraphs 8 and 9 of SFAS No. 7. Our activities to date have been limited to
seeking capital; seeking supply contracts and development of a business plan.
Our auditors have included an explanatory paragraph in their report on our
financial statements, relating to the uncertainty of our business as a going
concern, due to our lack of operating history or current revenues, its nature as
a start up business, management's limited experience and limited funds. We do
not believe that conventional financing, such as bank loans, is available to us
due to these factors. Management believes that Wellstone's ability to raise
significant additional amounts of financing, will be dependent on favorable
capital markets and also on obtaining significant sales, and other risks
inherent in the business as discussed under the caption "Risks and
Uncertainties" in our Form 10-KSB for the year ended December 31, 2003 may
affect the outcome of Management's plans.
When used in this Form 10-QSB, the words "expects," "anticipates,"
"estimates" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to risks and uncertainties, including
those set forth under the "Risks and Uncertainties" set forth below that could
cause actual results to differ materially from those projected. These
forward-looking statements speak only as of the date hereof. Wellstone expressly
disclaims any obligation or undertaking to release publicly any updates or
revisions to any forward-looking statements contained herein to reflect any
change in the Company's expectations with regard thereto or any change in
events, conditions or circumstances on which any statement is based. This
discussion should be read together with the financial statements and other
financial information included in this Form 10-QSB.
Risks and Uncertainties
Substantially all of our revenues are expected to be derived from sales
in the United States. The U.S. cigarette business has been contracting in recent
years. If the U.S. cigarette market continues to contract, it could adversely
affect our potential future sales, operating income and cash flows.
9
We have no firm contracts with distributors. We have not yet entered
into firm contracts for the distribution of our new cigarette lines.
FTC Approval for package design is pending. We might not obtain FTC
approval for our packaging.
To date we have only manufactured the filter material in small batches.
Problems in purchasing equipment, establishing manufacturing facilities and
meeting demand could be expected. If we cannot produce filter material or
outsource production we cannot obtain sales revenues.
Competition could prevent us from meeting our objectives. The cigarette
industry is highly competitive. We will encounter competition from major
cigarette manufacturers as well as smaller discount manufacturers, foreign
imports, counterfeits and contraband cigarettes. Competition will affect our
ability to market our product.
Our cigarettes may not be accepted by smokers. Smokers may decide not
to purchase tobacco products made with our filters due to taste or other
preferences.
The cigarette industry is subject to substantial and increasing
regulation and taxation. Increased excise taxes may result in declines in
overall sales volume. This result could adversely affect the market for our
product. The state of New York has promulgated fire safety requirements for
cigarettes as well. We have not determined the impact of these regulations.
There are currently several pending legal actions affecting the tobacco
industry, including proceedings and claims arising out of the sale,
distribution, manufacture, development, advertising, marketing and claimed
health effects of cigarettes. We may be named as a defendant in the future. We
are unable to determine the effect of any litigation at this time.
We intend to hire experienced personnel for sales and marketing and for
administration, and to integrate, motivate and retain such additional highly
skilled sales, technical and other employees.
We may not be able to protect our patent against infringement.
Litigation to defend our patent rights could result in substantial cost.
Item 3. CONTROLS AND PROCEDURES.
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as of September 30, 2004. Based on
this evaluation, our principal executive officer and our principal financial
officer concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures were effective and adequately designed to
ensure that the information required to be disclosed by us in the reports we
file or submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in applicable rules
and forms.
(b) Changes in internal controls over financial reporting.
During the quarter ended September 30, 2004, there has been no
change in our internal control over financial reporting that has material
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
10
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS - None
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended September 30, 2004 the registrant issued 131,349
restricted shares to Arrakis Select, a private investment fund, for cash of
$45,000. No underwriter was involved. The transaction was exempt from
registration under Section 4(6) of the Securities Act of 1933 since the
purchaser is an accredited investor and there was no public solicitation or
advertising.
Item 3. DEFAULTS UPON SENIOR SECURITIES - None
Item 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - On
June 2, 2004, stockholders holding 39,000,000 (post-split)
shares of common stock authorized an amendment to the
certificate of incorporation to effect a three-for-one forward
stock split and an increase in authorized common shares to
300,000,000. An information statement was mailed to all non
consenting stockholders, and the amendment and forward stock
split was effective for shareholders of record as of September
27, 2004 with a payable date of October 5, 2004.
Item 5. OTHER INFORMATION - None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
31. Certifications
31.1 Certification of Learned J. Hand
31.2 Certification of Samuel Veasey, Chief Financial Officer.
32. Certifications
32.1 Certification pursuant to 18 U.S.C. Section 1350 of Learned J. Hand
32.2 Certification pursuant to 18 U.S.C. Section 1350 of Samuel Veasey
Reports on Form 8-K--None.
11
SIGNATURES
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.
WELLSTONE FILTERS, INC.
Date: November 15, 2004 By:/s/ Samuel Veasey
-----------------
Samuel Veasey,
Chief Financial Officer
(chief financial officer and
accounting officer and duly
authorized officer)