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U.S. Securities and Exchange Commission
Washington, D.C. 20549
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FORM 10-QSB
(Mark One)
|X| Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended April 30, 2005.
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to
Commission file number 0-29248
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SMARTIRE SYSTEMS INC.
(Name of small business issuer in its charter)
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Yukon Territory, Canada n/a
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
#150 - 13151 Vanier Place
Richmond, British Columbia, Canada V6V 2J1
(Address of principal executive offices) (Zip Code)
604-276-9884
(Issuer's telephone number)
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 |X| No |_|
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes |_| No |_|
APPLICABLE ONLY TO CORPORATE REGISTRANTS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
The number of shares outstanding of our company's common stock at May 31,
2005 was 273,475,836
Transitional Small Business Disclosure Format (check one): |_| Yes |X| No
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INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS -
APRIL 30, 2005 (UNAUDITED) AND JULY 31, 2004
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) - THREE AND NINE MONTHS ENDED APRIL
30, 2005 AND APRIL 30, 2004
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS - NINE MONTHS
ENDED APRIL 30, 2005 (UNAUDITED) AND YEAR ENDED JULY 31, 2004
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - THREE AND NINE MONTHS ENDED APRIL 30, 2005
AND APRIL 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - NINE MONTHS ENDED APRIL 30,
2005 AND APRIL 30, 2004
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN
OF OPERATION.
ITEM 3. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
THIS QUARTERLY REPORT ON FORM 10-QSB, INCLUDING EXHIBITS HERETO, CONTAINS
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED. THESE FORWARD-LOOKING STATEMENTS ARE TYPICALLY IDENTIFIED BY THE
WORDS "ANTICIPATES", "BELIEVES", "EXPECTS", "INTENDS", "FORECASTS", "PLANS",
"FUTURE", "STRATEGY", OR WORDS OF SIMILAR MEANING. VARIOUS FACTORS COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE FORWARD-LOOKING
STATEMENTS, INCLUDING THOSE DESCRIBED IN "RISK FACTORS" IN OUR JULY 31, 2004
FORM 10-KSB. THE COMPANY ASSUMES NO OBLIGATIONS TO UPDATE THESE FORWARD-LOOKING
STATEMENTS TO REFLECT ACTUAL RESULTS, CHANGES IN ASSUMPTIONS, OR CHANGES IN
OTHER FACTORS, EXCEPT AS REQUIRED BY LAW.
ITEM 1. FINANCIAL STATEMENTS
The unaudited consolidated financial statements of SmarTire Systems Inc.
and its wholly owned subsidiaries, SmarTire USA Inc., SmarTire Europe Limited
and SmarTire Technologies Inc. ("we", "us", "our", and "SmarTire") as of April
30, 2005 and for the three and nine months ended April 30, 2005 and April 30,
2004 are attached hereto. Our consolidated financial statements are stated in
United States Dollars and are prepared in accordance with United States
Generally Accepted Accounting Principles.
It is the opinion of management that the interim financial statements for
the three and nine months ended April 30, 2005 includes all adjustments
necessary in order to ensure that the financial statements are not misleading.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
The following discussion of our financial condition, changes in financial
condition and results of operations for the three and nine months ended April
30, 2005 and 2004 should be read in conjunction with our most recent audited
annual financial statements for the financial year ended July 31, 2004, the
unaudited interim financial statements included herein, and, in each case, the
related notes.
We carry on business directly and through our three wholly-owned
subsidiaries: SmarTire USA Inc., SmarTire Europe Limited and SmarTire
Technologies Inc.
We are a "foreign private issuer", as such term is defined in Rule 3b-4
under the Securities Exchange Act of 1934. However, we have elected to file with
the Securities and Exchange Commission the same reports that a domestic
registrant would be required to file under section 13(a) of the Securities
Exchange Act of 1934.
We develop and market technically advanced tire pressure monitoring
systems ("TPMSs") for the transportation and automotive industries. Our TPMSs
are designed for improved vehicle safety, performance, reliability and fuel
efficiency. Although, the majority of our revenues in our first nine months
ended April 30, 2005 were earned from the sale of TPMSs for passenger cars,
sales of our motorcycle TPMSs and recreational vehicle TPMSs increased as a
percentage of our overall revenues. With the re-launch of our motorcycle TPMS in
April 2005 and our June 2004 launch of our high pressure transmitters, we
anticipate that there will be an increase in the percentage of our revenues from
sales of our TPMSs for the motorcycle, recreational, bus and truck markets
during the remainder of fiscal 2005.
Our vision is to become the preeminent provider of wireless sensing and
control systems for the vehicle industry. Our vision may be extended to three
basic types of systems: sensing, control and system applications.
Sensing Applications
Our vision with respect to sensing applications is to commercialize a wide
array of sensors, compatible with our tire monitoring systems for the vehicle
industry. We have developed a receiver module with Vansco Ltd. that functions as
a "wireless gateway". This module can wirelessly receive signals from up to 256
new sensors in addition to signals from tire pressure sensors. The data from
these sensors can then be placed on the vehicle bus or to a display module. This
ensures that the driver, maintenance group or monitoring agencies have access to
the sensor data as required. In addition to tire pressure monitoring, customers
would have the ability to access far more data on their vehicles. This
translates to a higher value proposition to the customer, while giving us the
ability to sell more products.
Control Applications
A natural evolution of our product family is to use the "wireless gateway"
module to not only receive signals from sensors but to act on the data received.
It can do this by controlling other electronic control units ("ECUs") or
mechanical devices directly in response to sensor data received.
The basic premise is based on using sensors to interpret a condition and
then have the "wireless gateway" module send a control signal to a device to
perform a specified action based on the sensor output. For example, when the
"wireless gateway" module receives data from a tire pressure sensor it could
activate a "horn" to provide an audible warning if the data was outside of
preset limits.
The control applications require feedback from the element being
controlled. In many cases this can be accomplished by one way communication to
the controlled element with the feedback provided by the driver of the vehicle.
An example of this would be the control or positioning of a mirror.
In other situations, the feedback may be provided by the element being
controlled. An example of this is a TPMS application in which the wireless
gateway communicates with an engine ECU to limit the speed of the vehicle as air
pressure decreases. For control applications, two way communications may be
required to complete the control loop.
System Applications
System applications are created by utilizing the information obtained from
vehicle sensors to provide a total solution to the owner of a vehicle or fleet
of vehicles. This means that the data generated by the sensors is gathered by
the "wireless gateway" module and integrated with the overall maintenance and
monitoring system utilized by the customer. This integration allows maintenance
staff, purchasing, owners and drivers to access all relevant sensor information
and warnings.
An example of this type of system is a wireless drive-by kiosk that
collects tire pressures from buses returning to a central garage at night. The
tire pressures are sent wirelessly to a kiosk which sends the data to a computer
system that processes the data and creates a work order for the maintenance crew
to correct and check tire pressures only in those vehicles that require
attention. This avoids checking the tire pressures of the whole fleet. Another
advantage of this system is that basic warnings are provided to the driver in
the event that a severe tire condition exists but detailed information is
provided to maintenance so they can schedule corrective action quickly.
Government Regulations
Our products are subject to regulation by the government agencies
responsible for radio frequencies in each country that our TPMSs will be sold.
For example, in the United States approval must be received from the Federal
Communications Commission for each product. Some countries require additional
governmental approvals in certain circumstances. For example, in the United
Kingdom, all electronic equipment to be installed in emergency and police
vehicles must be approved by the Vehicle Installation Development Group, a
governmental body. Also, as a practical matter, certain non-governmental
approvals may be necessary for market acceptance of our products in certain
countries. For example, the approval of TUV (an independent testing company) is
considered necessary to market our TPMSs in Germany.
We believe that we have all of the necessary governmental approvals for
our current TPMSs in our intended market countries. As each new TPMS is
introduced to the market, we intend to apply for the necessary approvals.
During our fiscal year ended July 31, 2001, the United States government
enacted the Transportation Recall Enhancement, Accountability, and Documentation
Act of 2000, commonly known as the TREAD Act. This new legislation was
implemented to address perceived safety concerns resulting from poor tire
maintenance, tread separation and tire blowouts. The TREAD Act, among other
things, requires that the National Highway Traffic Safety Administration,
commonly referred to by its acronym "NHTSA", develop rules and regulations that
require all new passenger cars, light trucks and multipurpose passenger vans
sold after November 1, 2003 to have TPMSs installed as standard equipment. The
TREAD Act requires that TPMSs must be capable of warning drivers if a tire is
significantly under-inflated. The mandated rules and regulations were scheduled
to be finalized in November 2001 for implementation in 2003.
In July 2001, NHTSA published and circulated a Notice of Proposed Rule
Making that included provisions related to the tire monitoring requirements of
the TREAD Act. The Notice of Proposed Rule Making outlined the parameters of
systems that the NHTSA would consider compliant with the legislation and the
proposed periods for complying with the regulations. Two forms of tire
monitoring technologies were to be considered:
o Direct tire monitoring technologies are based on dedicated
sensor/transmitters located within the cavity of the tire that are
usually mounted on the wheel. The transmitter monitors and measures
contained air pressure and temperature within each tire and
wirelessly transmits this information to a receiver located in or
around the instrument panel of the vehicle. Our products are an
example of a direct system.
o Indirect tire monitoring technologies typically work with the
vehicle's anti-lock brake system. Most indirect TPMSs compare each
wheel's rotational speed with the rotational speed of other wheels.
If one tire becomes significantly under-inflated while the others
remain at proper pressure, the indirect system eventually detects
the problem because that wheel's rotational speed is on average
slightly higher than that of other wheels.
In the Notice of Proposed Rule Making, the NHTSA concluded that direct
measurement systems have major advantages over indirect systems as they:
o actually measure the pressure in each tire and can detect when any
tire or combination of tires is under-inflated, including when all
tires are under-inflated;
o operate while the vehicle is stationary;
o are highly accurate and can detect small pressure losses, some even
as low as one pound per square inch;
o provide full time monitoring even when the vehicle is driven on
bumpy roads, has mismatched tires or has a tire out of balance or
alignment;
o do not need substantial time to calibrate the system and reduce the
very real possibility for human error; and
o can tell the operator which tire is under-inflated.
On May 31, 2002, the NHTSA issued part one of a two-part final rule. Part
one established a new Federal Motor Vehicle Safety Standard that required a TPMS
be installed in passenger vehicles and light trucks to warn the driver when a
tire is below specified pressure levels. During the first year of the
implementation schedule, beginning November 1, 2003, at least 10% of each auto
manufacturer's total production was to be equipped with TPMSs. This requirement
increases was to increase to 35% during the second year, 65% by the third and
100% after October 31, 2006.
Part one of the NHTSA final rule contemplated two compliance options
during the period from November 1, 2003 to October 31, 2006. Under the first
compliance option, a vehicle's TPMS must alert the driver if one or more tires,
up to four tires, are 25% or more under-inflated. Under the second compliance
option, a vehicle's TPMS must alert the driver if any of the vehicle's tires is
30% or more under-inflated. The second compliance option was adopted by the
NHTSA because indirect TPMSs are currently not capable of meeting the stricter
four-tire, 25% requirement under the first compliance option, and it was deemed
appropriate to permit manufacturers to continue to use current indirect TPMSs
while they work to improve those systems.
At the time that it issued the first part of its final rule, the NHTSA
announced that it would closely monitor the performance of indirect measurement
TPMSs under the second compliance option. We initially expected the NHTSA to
issue the second part of its final rule on or before March 1, 2005, and, at that
time, to announce whether indirect TPMSs based on anti-lock brake systems would
be a permissible compliance option under the TREAD Act after October 31, 2006.
However, due to a Court of Appeals ruling discussed below, we no longer hold
these expectations as to the timing and content of the second part of the final
rule.
Three not-for-profit advocacy organizations, Public Citizen, Inc., New
York Public Interest Research Group and The Center for Auto Safety filed a
petition in United States Court of Appeals for the Second Circuit seeking review
of the NHTSA's final rule. The Secretary of Transportation was named as the
respondent in the matter, and Alliance of Automobile Manufacturers was an
intervener. On August 6, 2003, the United States Court of Appeals, Second
Circuit, granted the petition for review, vacated the NHTSA's final rule, and
remanded the matter to the NHTSA for further rulemaking proceedings in a manner
consistent with the court decision.
The court stated that the NHTSA decision to adopt the second compliance
option was both contrary to law and arbitrary, but that the adoption of the
first compliance option was appropriate. In coming to this conclusion, the court
found that, according to the rule-making record, the one-tire, 30%
under-inflation standard contemplated by the second compliance option would
allow automakers to install indirect TPMSs that fail to warn drivers in
approximately half of the instances in which tires are significantly
under-inflated, and that the four-tire, 25% under-inflation standard
contemplated by the first compliance option would prevent more injuries, save
more lives and be more cost-effective.
On September 10, 2004 the NHTSA issued a Notice of Proposed Rulemaking
("NPRM") document defining their current position. Comments on the proposed
rulemaking were to be received on or before 60 days after date of publication of
the NPRM in the Federal Register. The NHTSA proposed a new Federal Motor Vehicle
Safety Standard requirement for four tire, 25% under-inflation detection. The
rule proposed requirements for covered vehicles manufactured on or after
September 1, 2005.
On April 7, 2005 the NHTSA released their final rule. The NHTSA is
proposing the lead time and phase in schedule described below.
Compliance with the final rule is set to start on October 5, 2005. Subject
to the special provisions discussed below, the phase-in schedule is as follows:
o 20% of a vehicle manufacturer's light vehicle production is required
to comply with the standard during the period from October 5, 2005,
to August 31, 2006;
o 70% must comply during the period from September 1, 2006 to August
31, 2007; and
o 100% of all light vehicles built on or after September 1, 2007 must
comply.
However, the NHTSA has deferred vehicle manufacturers' compliance with the
new system malfunction indicator light requirements until September 1, 2007.
This requirement is discussed below.
The NHTSA has also decided to encourage early compliance by permitting
carry-forward and carry-back credits. Vehicle manufacturers can earn
carry-forward credits for compliant vehicles produced in excess of the phase-in
requirements that are manufactured between April 8, 2005 and the conclusion of
the phase-in. However, beginning September 1, 2007 all covered vehicles would be
required to comply with the standard, without regard to any earlier carry
forward credits. It will not be permissible for a dealer to install tires on a
new vehicle that would take the vehicle out of compliance with TPMS standard.
With carry-back credits, manufacturers may defer compliance with a part or all
of the certification requirements under the standard for the first period of the
phase-in, provided they certify a correspondingly increased number of vehicles
during the second period of the phase-in.
Special provisions related to the phase-in include:
o The NHTSA has excluded multi-stage manufacturers and alterers from
the requirements of the phase-in and has extended by one year the
time for compliance by those manufacturers (i.e., until September 1,
2008).
o The final rule also excludes small volume manufacturers (i.e.,
manufacturers producing less than 5,000 vehicles for sale in the
U.S. market in one year) from the phase-in, requiring vehicles
produced by such manufacturers to comply with the standard on
September 1, 2007.
Requirements of the final rule are summarized as follows: New Federal
Motor Vehicle Safety Standard 138 requires passenger cars, multi-purpose
passenger vehicles, trucks, and buses with a gross vehicle weight rating of
4,536 kg (10,000 pounds) or less, except those with dual wheels on an axle, to
be equipped with a TPMS to alert the driver when one or more of the vehicle's
tires, up to a total of all four tires, is significantly under-inflated.
Specifically, the TPMS must warn the driver when the pressure in one or more of
the vehicle's tires is 25% or more below the vehicle manufacturer's recommended
cold inflation pressure, or a minimum level of pressure specified in the
standard, whichever pressure is higher. Under the new standard, if any tire
drops below the standard's activation threshold, the TPMS is required to provide
the low tire pressure warning by illuminating a yellow telltale within 20
minutes of additional travel within a speed range of 50-100 km/hr. This telltale
must remain illuminated (and re-illuminate upon subsequent vehicle start-ups)
until the under-inflation condition has been corrected.
Some additional details of the final rule are as follows:
o The TPMS to be used would be required to include a system
malfunction indicator (provided either by a separate telltale or a
combined low tire pressure/malfunction indicator telltale) that
would alert the driver in situations in which the TPMS is unable to
detect low tire pressure. This malfunction indicator is required to
detect incompatible replacement tires, as well as other system
faults. Similar to the low tire pressure warning, the system is
required to trigger a TPMS malfunction warning telltale within 20
minutes of additional travel within a speed range of 50-100 km/hr
after such a malfunction occurs. This malfunction indicator light
telltale must remain illuminated (and re-illuminate upon subsequent
vehicle start-ups) until the TPMS malfunction has been corrected.
o A specific test course (i.e., the Southern loop of the tread wear
test course, San Angelo, Texas), which is both objective and
representative of a range of driving conditions, would be required
to be used.
o The TPMS would not be required to monitor the spare tire (if
provided) either when it is stowed or when it is installed on the
vehicle.
o For vehicle's certified under the standard, vehicle manufacturers
would be required to provide in the owners manual an explanation of
the purpose of the low tire pressure warning telltale, the potential
consequences of significantly under-inflated tires, the meaning of
the telltale when it is illuminated, and what action the driver
should take when the telltale is illuminated.
On June 6, 2005, a lawsuit was filed in the U.S. Court of Appeals for the
District of Columbia by Public Citizen, the Goodyear Tire & Rubber Company,
Bridgestone Firestone North American Tire, Cooper Tire & Rubber Co., Pirelli and
the Tire Industry Association.
The plaintiffs allege that the NHTSA rule, issued in April 2005, doesn't
require tire pressure monitoring systems to operate with replacement tires and
that this is a dangerous omission given that an estimated 61 percent of
passenger and 54 percent of light truck mileage occurs on replacement tires.
Under the rule, a malfunction light will come on to alert motorists that the
system is not working with the tires. The plaintiffs allege that not only would
this undermine public confidence in the systems, but it would likely lead to
consumers ignoring the warning light or having it disabled.
Our direct measurement TPMS generally exceeds the standard for tire
pressure monitoring established by the NHTSA. Accordingly, we believe the auto
manufacturers must accelerate their implementation plans in order to meet these
new NHTSA regulations, which will create additional opportunities to market our
products to original equipment manufacturers ("OEMs") in the automobile
industry. In addition, although the TREAD Act only applies to passenger
automobiles, we believe that other motor vehicles, including medium and heavy
trucks, buses and motorcycles will be impacted by this legislation in subsequent
years. We also believe that compliance with the TREAD Act by European, Japanese,
Chinese and other automakers will accelerate the adoption of TPMSs globally.
It is difficult to predict the magnitude of the expected sales increase or
the exact timing of the increase since our products will continue to face
competition from other TPMSs manufactured by our competitors, and the timing of
additional legislative initiatives on tire safety, if any, in the United States
and abroad remains uncertain. We expect that as TPMSs become standard equipment
for new passenger vehicles, demand for TPMSs as dealer installed options and
aftermarket products will gradually decline.
RESULTS OF OPERATIONS
Three months ended April 30, 2005 and April 30, 2004
Revenue
Gross revenue for the three months ended April 30, 2005 decreased to
$330,406 from $401,423 for the three months ended April 30, 2004. The breakdown
of the sources of our gross revenue is as follows:
o Sales of aftermarket passenger car TPMSs decreased to $133,670 for
the three months ended April 30, 2005 from $335,279 for the three
months ended April 30, 2004.
o Sales of OEM passenger car TPMSs increased to $109,631 for the three
months ended April 30, 2005 from $18,096 for the three months ended
April 30, 2004. The increase was primarily due to an increase in
sales to Aston Martin, Ford's flagship division. We anticipate sales
to increase by approximately 100% in the next quarter, mainly as a
result of an increase in sales to Aston Martin.
o Sales of aftermarket motorcycle systems were $34,011 for the three
months ended April 30, 2005 compared to $0 for the three months
ended April 30, 2004. The majority of these sales were in April
after the release of our redesigned sensor that enabled the
motorcycle TPMS to fit most rim designs. Although interest in the
motorcycle product by existing and potential customers remains
positive, it is difficult for us to predict what the volume of sales
will be, as this will depend primarily on market acceptance.
o Sales of aftermarket recreational vehicle TPMS decreased to $34,592
for the three months ended April 30, 2005 from $42,744 for the three
months ended April 30, 2004.
o Sales of OEM recreational vehicle TPMSs increased to $1,166 for the
three months ended April 30, 2005 from $0 for the three months ended
April 30, 2004.
o Sales of aftermarket high pressure TPMSs for use on commercial
vehicles were $6,350 for the three months ended April 30, 2005
compared to $0 for the three months ended April 30, 2004. The
majority of these systems are currently being used for test
purposes. Although interest in this product is high, it is difficult
for us to predict what the volume of sales will be, as this will
depend primarily on market acceptance.
o Sales of OEM high pressure TPMS for use on commercial vehicles were
$580 for the three months ended April 30, 2005 compared to $0 for
the three months ended April 30, 2004. The majority of these systems
are currently being used for test purposes. Although interest in
this product is high, it is difficult for us to predict what the
volume of sales will be, as this will depend primarily on market
acceptance.
o Sales of aftermarket TPMS for use on buses were $0 for the three
months ended April 30, 2005 compared to $0 for the three months
ended April 30, 2004. Although it is difficult for us to predict
what the volume of sales will be, we anticipate a substantial
increase in sales in sales of OEM TPMSs for use on buses during the
next year when we commence shipping TPMSs to Motorcoach Industries
International and New Flyer Bus for the Chicago Transit Authority.
o Sales of miscellaneous products were $10,406 for the three months
ended April 30, 2005 compared to $5,304 for the three months ended
April 30, 2004.
Gross Margin
Gross margin on product sales decreased to 23% for the three months ended
April 30, 2005 from 28% for the three months ended April 30, 2004. The decrease
in margin was mainly a result of the write-down of $30,000 of inventory.
Expenses
Expenses increased to $7,001,729 for the three months ended April 30, 2005
from $1,840,318 for the three months ended April 30, 2004, due to increases in,
marketing, engineering, research and development expenses and depreciation and
amortization expenses. The increase in expenses was primarily due to a non-cash
compensation expense of $5,197,538 which was primarily a result of the increase
in the value of outstanding employee stock options. Excluding the non-cash
compensation expense, expenses were $1,976,779 for the three months ended April
30, 2005.
Engineering, research and development expenses increased to $2,086,354 for
the three months ended April 30, 2005 from $454,715 for the three months ended
April 30, 2004. Excluding the non-cash compensation expense of $1,591,600,
expenses for the three months ended April 30, 2005 were $494,754, or an increase
of $40,039 from the three months ended April 30, 2004. The increase was mainly
due to an increase in engineering employees and engineering-related wages.
Marketing expenses increased to $1,368,330 for the three months ended
April 30, 2005 from $468,312 for the three months ended April 30, 2004.
Excluding the non-cash compensation expense of $962,550, expenses for the three
months ended April 30, 2005 were $405,780, or a decrease of $62,532 from the
three months ended April 30, 2004. The decrease was mainly a result of lower
advertising and promotion expenses and lower travel expenses. This decrease was
partially offset by an increase marketing-related wages as a result of an
increase in the number of marketing employees.
General and administrative expenses increased to $3,170,568 for the three
months ended April 30, 2005 from $560,871 for the six months ended April 30,
2004. Excluding the non-cash compensation expense of $2,470,800, expenses for
the three months ended April 30, 2005 were $699,768, or an increase of $138,897
from the three months ended April 30, 2004. The increase was primarily
attributed to higher professional fees and an increase in insurance costs. The
increase was partially offset by a decrease in investor relation fees and travel
costs.
Depreciation and amortization expense increased to $376,477 for the three
months ended April 30, 2005 from $356,420 for the three months ended April 30,
2004.
Interest and finance charges decreased to $188,491 for the three months
ended April 30, 2005 from $1,214,435 for the three months ended April 30, 2005.
Interest and finance charges for the three months ended April 30, 2005 included
non-cash interest of $144,866 compared to non-cash interest of $1,111,447 for
the three months ended April 30, 2004.
Interest Income
Interest income of $1,382 was earned for the three months ended April 30,
2005 as compared to $849 for the three months ended April 30, 2004 and was the
result of higher average cash balances during the three months ended April 30,
2005.
Foreign exchange loss
A foreign exchange loss of $14,355 was incurred for the three months ended
April 30, 2005 as compared to a foreign exchange loss of $10,405 for the three
months ended April 30, 2004. Foreign exchange gains or losses are due to
fluctuations in currency exchange rates and are impossible to predict.
Gain on settlement of convertible debt
A gain on settlement of convertible debt was incurred for the three months
ended April 30, 2005 as compared to $0 for the three months ended April 30,
2004.
Nine months ended April 30, 2005 and April 30, 2004
Revenue
Gross revenue for the nine months ended April 30, 2005 decreased to
$1,022,484 from $1,259,140 for the nine months ended April 30, 2004. The
breakdown of the sources of our gross revenue is as follows:
o Sales of aftermarket passenger car systems decreased to $215,832 for
the nine months ended April 30, 2005 from $923,613 for the nine
months ended April 30, 2004.
o Sales of OEM passenger car systems increased to $428,424 for the
nine months ended April 30, 2005 from $117,000 for the nine months
ended April 30, 2004. The increase was primarily due to an increase
in sales to Aston Martin, Ford's flagship division.
o Sales of the aftermarket motorcycle system were $79,053 for the nine
months ended April 30, 2005 compared to $1,555 for the nine months
ended April 30, 2004. In August 2004, we discovered that the
sensor/transmitter may break during installation on the subset of
motorcycle rims with curved rim surfaces when the strap is torqued
to its required value. On September 14, 2004 we contacted the
National Highway Transportation Safety Administration (NHTSA) to
determine if a Safety Defect and Non Compliance Report was required
and was advised that this was necessary. Our remedy for the defect
was to recall 100% of affected sensor/transmitter items from the
field and replace both recalled and inventory sensor/transmitters
with sensor/transmitters previously manufactured by a different
supplier that have been tested and known to use plastics that
provide the required mechanical properties. Additionally to ensure
that transmitters are used only on rims with flat drop center wells
(as originally designed for) and not curved, the additional
precautionary steps were taken:
1) Adding improved warnings and instruction sheet to new
product as well as product in inventory at dealers and
distributors that clarify flat rim drop center well
application only; and
2) Removal of TPMSs on motorcycles with rims with curved
drop center wells.
We anticipate the cost of this recall will be approximately $67,000.
Recall costs incurred to the end of April 2005 were $41,411. We have made
a provision in accounts payable for the additional $25,589 that we
anticipate incurring. In addition, we have developed a solution to enable
us to sell our TPMSs on motorcycles with rims with curved drop center
wells. We released this enhanced product during April 2005. To date, the
response to the recall by our customers has been very positive. Although
interest in the motorcycle product by existing and potential customers
remains positive, it is difficult for us to predict what the volume of
sales will be, as this will depend primarily on market acceptance.
o Sales of aftermarket recreational vehicle TPMSs were $156,025 for
the nine months ended April 30, 2005 compared to $58,781 for the
nine months ended April 30, 2004.
o Sales of OEM recreational vehicle systems were $63,218 for the nine
months ended April 30, 2005 compared to $10,682 for the nine months
ended April 30, 2004.
o Sales of aftermarket TPMSs for use on commercial vehicles were
$34,799 for the nine months ended April 30, 2005 compared to $1,088
for the nine months ended April 30, 2004. Although interest in this
product is high, it is difficult for us to predict what the volume
of sales will be, as this will depend primarily on market
acceptance.
o Sales of OEM high pressure TPMSs for use on commercial vehicles were
$4,233 for the nine months ended April 30, 2005 compared to $0 for
the nine months ended April 30, 2004. The majority of these systems
are currently being used for test purposes.
o Sales of aftermarket TPMSs for use on buses were $3,252 for the nine
months ended April 30, 2005 compared to $0 for the nine months ended
April 30, 2004. Although it is difficult for us to predict what the
volume of sales will be, we anticipate a substantial increase in
sales of OEM TPMS for use on buses during next year when we commence
shipping TPMS to Motorcoach Industries International and New Flyer
Bus for the Chicago Transit Authority.
o Revenue of $0 was recorded for engineering changes to modify our
products pursuant to the Hyundai Autonet agreement for the nine
months ended April 30, 2005 compared to $96,079 for the nine months
ended April 30, 2004. Revenue from engineering services is
recognized on services as they are rendered and pre-defined
milestones are achieved.
o Sales of miscellaneous products were $37,648 for the nine months
ended April 30, 2005 compared to $50,342 for the nine months ended
April 30, 2004.
Gross Margin
Gross margin on product sales decreased to 6% for the nine months ended
April 30, 2005 from 18% for the nine months ended April 30, 2004. The decrease
in gross margin for the nine months ended April 30, 2005 was due to an inventory
write-down of $230,000 for slow moving aftermarket passenger car tire pressure
monitoring systems. Without the inventory write-down, the gross margin would
have increased to 25% for the nine months ended April 30, 2005. Factors that
would have resulted in higher margins if not for the inventory write-down are:
o the product mix of systems sold in the nine months ended April 30,
2005 had higher gross margins than the product mix of systems sold
in the nine months ended April 30, 2004; and
o the decrease in the value of the $US against the Pound Sterling
increased our margins as a higher proportion of our sales during the
nine months ended April 30, 2005 were in Pound Sterling.
Expenses
Expenses increased to $11,027,054 for the nine months ended April 30, 2004
from $5,404,057 for the nine months ended April 30, 2004 due to increases in,
marketing, engineering, research and development expenses and depreciation and
amortization expenses. The increase in expenses was primarily due to a non-cash
compensation expense of $5,197,538 which was primarily a result of the increase
in the value of outstanding employee stock options. Excluding the non-cash
compensation expense, expenses were $6,002,104 for the nine months ended April
30, 2005.
Engineering, research and development expenses increased to $3,083,704 for
the nine months ended April 30, 2005 from $1,201,634 for the nine months ended
April 30, 2004. Excluding the non-cash compensation expense of $1,591,600,
expenses for the nine months ended April 30, 2005 were $1,492,104, or an
increase of $290,470 from the nine months ended April 30, 2004. The increase was
primarily attributed to higher prototype development costs, an increase in
product testing on products that we plan to release in the current fiscal year
and an increase in the number of engineering employees and engineering-related
wages. Wages included a non-cash expense of $30,338 related to the issuance of
common stock to senior engineering employees.
Marketing expenses increased to $2,275,843 for the nine months ended April
30, 2005 from $1,329,636 for the nine months ended April 30, 2004. Excluding the
non-cash compensation expense of $962,550, expenses for the nine months ended
April 30, 2005 were $1,313,293 or a decrease of $16,343 from the nine months
ended April 30, 2004. The decrease was a primarily a result of lower advertising
and promotion expenses and lower travel expenses. The decrease was offset by
higher marketing-related wages, which increased as a result of an increase in
the number of marketing employees.
General and administrative expenses increased to $4,550,610 for the nine
months ended April 30, 2005 from $1,841,877 for the nine months ended April 30,
2004. Excluding the non-cash compensation expense of $2,470,800, expenses for
the nine months ended April 30, 2005 were $2,079,810 or an increase of $237,933
from the nine months ended April 30, 2004. The increase was primarily attributed
to higher administration wages, insurance costs and professional fees. The major
increase in administration wages was primarily due to a non-cash expense related
to the issuance of common stock to senior management valued at $142,251. The
increase was partially offset by lower investor relation costs and lower travel
costs.
Depreciation and amortization expense increased to $1,116,897 for the nine
months ended April 30, 2005 from $1,030,910 for the nine months ended April 30,
2004.
Interest and finance charges increased to $2,763,609 for the nine months
ended April 30, 2005 from $2,960,488 for the nine months ended April 30, 2004.
Interest and finance charge for the nine months ended April 30, 2005 included
non-cash interest of $2,607,518 compared to non-cash interest of $2,770,481 for
the nine months ended April 30, 2004.
Interest Income
Interest income of $3,173 was earned for the nine months ended April 30,
2005 as compared to $5,416 for the nine months ended April 30, 2004 and was the
result of lower average cash balances during the nine months ended April 30,
2005.
Foreign exchange gain
A foreign exchange gain of $114,634 was incurred for the nine months ended
April 30, 2005 as compared to a gain of $15,931 for the nine months ended April
30, 2004. Foreign exchange gains or losses are due to fluctuations in currency
exchange rates and are impossible to predict.
Gain on settlement of convertible debt
A gain on settlement of convertible debt was incurred for the three months
ended April 30, 2005 as compared to $0 for the three months ended April 30,
2004.
LIQUIDITY AND CAPITAL RESOURCES
CURRENT POSITION
We have continued to finance our activities primarily through the issuance
and sale of securities. We have incurred losses from operations in each year
since inception. As at April 30, 2005, we had an accumulated deficit of
$73,369,474. Our net loss for the three months ended April 30, 2005 was
$5,306,734 and for the nine months ended April 30, 2005 was $11,794,574 compared
to $2,950,259 for the three months ended April 30, 2004 and $8,118,581 for the
nine months ended April 30, 2004. As of April 30, 2005, our stockholders' equity
was $3,977,748 and we had a working capital of $2,103,290.
Our cash position at April 30, 2005 was $420,270 as compared to $112,951
at July 31, 2004. This increase was due to the net increase from our operating,
financing and investing activities as described below.
Our net loss of $11,794,574 for our nine months ended April 30, 2005
includes non-cash charges of $1,116,897 for depreciation and amortization,
$5,197,538 for compensation expense, $200,000 for an inventory write-down and
$2,607,518 for interest and finance charges. Decreases in non-cash working
capital during this period amounted to $532,183. Non-cash working capital
changes included increases in increase in inventory and decreases in prepaid
expenses, accounts receivable and in accounts payable and accrued liabilities.
During the nine months ended April 30, 2005, we realized aggregate gross
cash proceeds of $11,453,598 as follows:
We issued 78,867,710 shares of common stock to Cornell Capital Partners
LP pursuant to nine draw downs totaling $2,725,000 from our $15.0 million equity
line of credit, which is described below.
On May 19, 2004, we entered into a Standby Equity Distribution Agreement
with Cornell Capital Partners LP, an accredited investor, in connection with a
24-month, $15.0 million equity line of credit facility. This agreement was
terminated on May 20, 2005 and replaced with a $30.0 million equity line of
credit facility. The new Standby Equity Distribution Agreement contemplates the
potential future issuance and sale of up to $30.0 million of our common stock to
Cornell Capital Partners, subject to certain restrictions and other obligations.
For more information about the Standby Equity Distribution Agreement refer to
Item 2, Part II.
On September 24, 2004, we and holders of the discounted convertible
debentures signed an agreement which provided for an immediate exercise of
18,226,274 warrants at $0.03 for gross proceeds of $546,788.
On November 16, 2004 we received gross proceeds of $250,000 upon the
issuance of an unsecured short-term promissory note to an accredited investor.
The note bears interest at a rate of 12% per annum and is repayable within 30
days of issuance with accrued interest.
On November 30, 2004 we received gross proceeds of $275,000 upon the
issuance of an unsecured short-term promissory note to an accredited investor.
The note bears interest at a rate of 12% per annum and is repayable within 30
days of issuance with accrued interest. As a commitment fee to loan the Company
money, the holder of the note received $27,500.
On February 9, 2005 we received gross proceeds of $350,000 upon the
issuance of an unsecured short-term promissory note to an accredited investor.
The note bears interest at a rate of 10% per annum and is repayable within 30
days of issuance with accrued interest. As a commitment fee to loan the Company
money, the holder of the note received $35,000.
On December 15, 2004, we received gross proceeds of $2,695,000 upon the
issuance of a three year $2,500,000 5% convertible debenture and five two year
5% convertible debentures aggregating $195,000. Principal under the 5%
convertible debentures may be converted by the holder in whole or in part and
from time to time at a conversion price equal to the lesser of:
(i) $0.035 or;
(ii) an amount equal to 80% of the lowest closing bid price of our common
stock, as quoted on Bloomberg, L.P., for the 5 trading days immediately
preceding the conversion date, subject to adjustment as provided for in
the debentures.
The outstanding principal under the convertible debentures bears interest
at the rate of 5% per annum, calculated on the basis of a 360-day year. Interest
on the debentures aggregating $195,000 is payable semi-annually beginning June
15, 2005 and every subsequent six month period that the principal balance
remains unpaid.
On March 22, 2005, we issued 5% convertible preferred stock for gross
proceeds of $4,000,000. The proceeds were used to repay the $2,500,000
convertible debenture entered into on December 15, 2004 and a $350,000
promissory note entered into on February 9, 2004. Additional expenses related to
this offering were $20,000.
On May 20, 2005, we issued a $1,500,000 one year 5% convertible debenture
convertible at the option of the holder at $0.028 per share. Between April 25
and April 29, 2005, $1,100,000 of the convertible debenture was placed in escrow
with our lawyer. From escrow, $457,999 was paid on April 27, 2005 to two
debenture holders to redeem their convertible debentures.
We anticipate that we will require between $4.3 million and $7.9 million
in financing through the next twelve months in order to continue in business as
a going concern, the availability of which is uncertain.
Due to the uncertainty of our ability to meet our current operating and
capital expenses, in their report on the annual consolidated financial
statements for the year ended July 31, 2004, our independent auditors included
additional comments in their Auditors' report indicating concerns about our
ability to continue as a going concern. Our consolidated financial statements
contain additional note disclosures describing the circumstances that led to
this disclosure by our independent auditors. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
As the continuation of our business is dependent upon obtaining further
financing, successful and sufficient market acceptance of our current products
and any new products that we may introduce, the continuing successful
development of our products and related technologies, and, finally, achieving a
profitable level of operations. The issuance of additional equity securities by
us could result in a significant dilution in the equity interests of our current
stockholders. Obtaining commercial loans, assuming those loans would be
available, will increase our liabilities and future cash commitments.
We plan to raise any additional capital required to meet the balance of
our estimated funding requirements for the next three months, primarily through
the private placement of our securities. We are presently working on a plan to
meet our financial capital requirements.
FUTURE OPERATIONS
Presently, our revenues are not sufficient to meet operating and capital
expenses. We have incurred operating losses since inception, and this is likely
to continue for the foreseeable future.
We project a requirement for a minimum of $4.3-$7.9 million to fund our
debt repayment, ongoing operating expenses and working capital requirements
through April, 2006 as follows:
Marketing $ 1,400,000 $ 1,800,000
Engineering, research and development 1,600,000 2,000,000
General and administrative 2,000,000 2,400,000
Capital Purchases 60,000 200,000
Debt repayment (1) 91,726 1,936,806
General Working Capital (851,726) (436,806)
----------- -----------
TOTAL $ 4,300,000 $ 7,900,000
=========== ===========
(1) Assumes redemption of the 8% convertible debentures, the discounted
convertible debentures and $195,000 of the 5% convertible debentures and
assumes we can settle the outstanding litigation claim for between $91,726
and $110,071.
Our working capital requirements are impacted by our inventory
requirements and any potential loss in litigation above the $110,071 which we
have recorded as a liability. Therefore, any increase in sales of our products
will be accompanied not only by an increase in revenues, but also by an increase
in our working capital requirements. Our new products, the market acceptance of
which will impact on our inventory needs and therefore will impact on our
working capital requirements, include the following:
o Our motorcycle TPMS was introduced for sale into the aftermarket in
September 2002. We introduced a substantially improved second
generation motorcycle TPMS in mid-February, 2004 and began delivery
of this system to our distributors in May 2004. We had a recall in
September and re-launched a new TPMS that fits most curved rims
during April 2005.
o During our fiscal 2004 year, we introduced low pressure TPMSs for
the recreational vehicle market. Marketed as "RoadVoiceTM" and
"TrailerVoiceTM", they represent the first tire monitoring systems
targeted specifically at the recreational vehicle, towed vehicle and
trailer markets.
o During our 2004 fiscal year, we introduced high pressure TPMSs for
the recreational vehicle market, bus and commercial market.
o In November, 2004, design validation testing and the initial pilot
build of 300 weatherproof, J1939 controller area network (CAN),
chassis-mounted receivers was completed. The 300 units are being
utilized to validate the reliability of the production line and to
satisfy early test and validation demands from our existing and
potential OEM customers. Vansco will manufacture the CAN,
chassis-mounted receiver for us. As such, we anticipate the
manufacture of CAN receivers for commercial vehicles.
The continuation of our business is dependent upon obtaining further
financing, market acceptance of our current products and any new products that
we may introduce, the continuing successful development of our products and
related technologies, and, finally, achieving a profitable level of operations.
As discussed above under the heading "Liquidity and Capital Resources, we
plan to raise any additional capital required to meet the balance of our
estimated funding requirements through April 30, 2006, primarily through the
private placement of our securities (including the registration of additional
shares of our common stock for issuance upon use of our $30.0 million standby
equity distribution agreement entered into on May 22, 2005).
The issuance of additional equity securities by us could result in a
significant dilution in the equity interests of our current stockholders.
Obtaining commercial loans, assuming those loans would be available, will
increase our liabilities and future cash commitments.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and accompanying notes are prepared
in accordance with generally accepted accounting principles in the United
States. Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. We believe that understanding the basis and
nature of the estimates and assumptions involved with the following aspects of
our consolidated financial statements is critical to an understanding of our
financials.
GOING CONCERN
As at April 30, 2005, we had an accumulated deficit of $72,634,863. Our
net loss for the nine months ended April 30, 2005 was $11,794,574 compared to
$8,118,581 for the nine months ended April 30, 2004. As of April 30, 2005, our
stockholders' equity was $3,977,748 and we had working capital of $2,103,240.
We require additional financing to fund our operations. During the nine
months ended April 30, 2005, we used $5,026,837 cash in operating activities and
$28,918 to purchase capital assets. Accordingly, during the nine months ended
April 30, 2005, we raised gross cash proceeds of $4,000,000 from the issuance of
preferred shares, $3,152,999 form the issuance of convertible debentures,
$2,725,000 from draw downs on our equity line of credit, $875,000 from the
issuance of promissory notes, $153,811 from the exercise of stock options and
$546,788 from the exercise of warrants. In addition, during May 2005, we raised
gross proceeds of $1,500,000 from the issuance of a convertible debenture.
Between April 25 and April 29, 2005, funds for $1,100,000 of the convertible
debenture were placed in escrow with our legal council. From escrow, $457,999
was paid on April 27, 2005 to two debenture holders to redeem their convertible
debentures.
Although we have a $30.0 million standby equity distribution agreement,
there can be no assurance that we will be able to register shares. Our
consolidated financial statements have been prepared on the going concern basis,
which assumes that adequate sources of financing will be obtained as required
and that our assets will be realized, and liabilities settled in the ordinary
course of business. Accordingly, our consolidated financial statements do not
include any adjustments related to the recoverability of assets and
classification of assets and liabilities that might be necessary should we be
unable to continue as a going concern.
INVENTORY
Inventory is carried at the lower of cost, determined on a weighted
average cost method, and net realizable value. The determination of net
realizable value is based on several assumptions and estimates. We provide an
allowance that we consider to be reasonable for non-moving or slow moving
inventory items and for items with expected future realizable value lower than
cost. These assumptions and estimates may be inaccurate and may be revised.
The markets in which we compete are rapidly changing due to technological
developments and increasing focus on automotive safety. Other companies offer
products similar to those offered by us, and target the same customers as we do.
Many of these companies have substantially greater financial, marketing and
technical resources. We also anticipate that the competition within these
markets will increase as demand for the products escalates. It is possible that
new competitors or alliances among existing competitors may emerge and such
competitors may rapidly acquire significant market share and make it difficult
for us to sell our current inventory. All of these elements could reduce the net
realizable value of our inventory.
WARRANTY OBLIGATIONS
On an ongoing basis, we record our best estimate of our warranty
obligations and product returns related to products sold. These estimates are
made after the consideration of contractual warranty obligations and historical
experience. Unforeseen events, including increased technological difficulties
with products, could occur that have not been anticipated in estimating the
warranty provision. Additional costs or estimates will be recognized as
determined.
REVENUE RECOGNITION
We recognize revenue when there is persuasive evidence of an arrangement,
goods are shipped and title passes, collection is probable, and the fee is fixed
or determinable. Customer acceptance is used as the criterion for revenue
recognition when the product sold does not have an established sales history to
allow management to reasonably estimate returns and future provisions.
Provisions are established for estimated product returns and warranty costs at
the time the revenue is recognized. We record deferred revenue when cash is
received in advance of the revenue recognition criteria being met. Revenue from
engineering services is recognized on services as they are rendered and
pre-defined milestones are achieved. Engineering services revenue for the nine
months ended April 30, 2005 were $0 (nine months ended April 30, 2004 -
$96,079).
OTHER ASSETS
Other assets are recorded at cost and are being amortized over five years
on a straight-line basis. Other assets are comprised of licenses to manufacture
and sell TPMSs to the original equipment manufacturers. On an ongoing basis,
management assesses whether the expected net recoverable amount of the licenses
exceeds the book value of the licenses. The net recoverable amount is determined
on a projected cash flow basis, discounted at an appropriate rate. In making our
cash flow estimates, we consider recent market trends and transactions, as well
as reasonable estimates of future events based on current economic
characteristics. Although we expect to generate cash flow from sales to the
original equipment manufacturer market place, it is possible that we will not
generate cash flow from sales to the original equipment manufacturer marketplace
in excess of net book value, or that we will generate cash flow from sales to
the original equipment manufacturer market in future years after the other
assets have been fully amortized.
ITEM 3. CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), as of the end of the period covered by this
quarterly report, being April 30, 2005, we have carried out an evaluation of the
effectiveness of the design and operation of our company's disclosure controls
and procedures. This evaluation was carried out under the supervision and with
the participation of our company's management, including our President and Chief
Executive Officer and our Chief Financial Officer. Based upon that evaluation,
our President and Chief Executive Officer and our Chief Financial Officer
concluded that our company's disclosure controls and procedures are effective.
There have been no changes in our company's internal controls during our quarter
ended April 30, 2005 that has materially affected or is reasonably likely to
affect our internal controls over financial reporting.
Disclosure controls and procedures and other procedures that are designed
to ensure that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time period specified in the Securities and Exchange
Commission's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed in our reports filed under the Exchange Act is
accumulated and communicated to management, including our President and Chief
Executive Officer and our Chief Financial Officer as appropriate, to allow
timely decisions regarding required disclosure.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 21, 2005, a holder of discounted debentures in the amount of
$91,726 commenced a lawsuit in the Supreme Court of New York against us,
essentially alleging that we wrongfully refused to honor its request to convert
the debt into 9,268,875 shares of our common stock. The lawsuit seeks an order
compelling us to issue the foregoing shares and for damages and attorneys fees.
The Court heard argument on a motion for preliminary injunction requiring
us to issue the shares on May 5, 2005 and has not yet ruled on the motion.
On June 6, 2005, we filed an Answer, Affirmative Defenses and
Counterclaims, denying liability to the debenture holder and seeking damages
from the debenture holder on account of its prior, wrongful conduct.
The parties have not conducted any written discovery or taken any
depositions. In light of the status of the case, which is in its initial phases
and the fact that there has not been any discovery, we can not determine the
outcome of the legal action.
During August 2004, we defaulted on payments to holders of our discounted
convertible debentures. As disclosed in our 8-Ks filed between September 13 and
October 1, 2004, in response to the default, certain debenture holders filed
legal actions against us. On September 24, 2004, we and holders of the
discounted convertible debentures signed an agreement which provided for:
withdrawal of legal action; an immediate exercise of 18,226,274 warrants at
$0.03 for gross proceeds of $546,788; conversion of $734,389 of debentures into
24,479,630 common shares; and a lock-up provision that establishes a daily limit
on the number of shares that can be traded by the debenture holders.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following changes in our securities occurred during the three months
ended April 30, 2005:
o By notice of a cashless warrant exercise dated April 28, 2005,
Crescent International Ltd. elected to exercise 3,846,154 warrants.
In response, we issued 3,205,128 shares of our common stock to
pursuant to Rule 506 of Regulation D under the Securities Act.
o By notice of a cashless warrant exercise dated April 25, 2005, HPC
Capital Management elected to exercise 250,000 warrants. In
response, we issued 197,368 shares of our common stock to pursuant
to Rule 506 of Regulation D under the Securities Act.
o By notice of a cashless warrant exercise dated April 25, 2005,
Talisman Management Limited elected to exercise 1,000,000 warrants.
In response, we issued 789,474 shares of our common stock to
pursuant to Rule 506 of Regulation D under the Securities Act.
o By notice of a cashless warrant exercise dated April 25, 2005,
Palisades Master Fund, L.P. elected to exercise 3,290,596 warrants.
In response, we issued 2,597,839 shares of our common stock to
pursuant to Rule 506 of Regulation D under the Securities Act.
o By conversion notice dated April 20, 2005, Crescent International
Ltd. elected to convert $59,700 of convertible debentures. In
response, we issued 2,132,143 shares of our common stock to pursuant
to Rule 506 of Regulation D under the Securities Act.
o By conversion notice dated April 20, 2005, Palisades Master Fund,
L.P. elected to convert $3,864 of convertible debentures. In
response, we issued 138,000 shares of our common stock to pursuant
to Rule 506 of Regulation D under the Securities Act.
o By conversion notice dated April 20, 2005, Goldplate Investment
Partners elected to convert $66,080 of convertible debentures. In
response, we issued 2,360,000 shares of our common stock to the
debenture holder pursuant to Rule 506 of Regulation D under the
Securities Act.
o On March 23, 2005, we closed on a transaction pursuant to which we
entered into an Investment Agreement dated as of March 22, 2005 with
Cornell Capital Partners in which we sold an aggregate of $4,000,000
of our Series A 5% Convertible Preferred Stock, no par value per
share (the "Preferred Stock"). The purchase price was $4,000,000, of
which $2,850,000 was previously funded pursuant to certain
transaction documents we previously entered into with the Cornell
Capital Partners. These transaction documents were terminated by
the parties on March 22, 2005 . On March 23, 2005, we received net
proceeds of $1,015,000, after deducting the $2,850,000 which was
previously funded, a $115,000 commitment fee and legal fees in the
amount of $20,000. We issued the Preferred Stock to the investor
pursuant to Rule 506 of Regulation D as promulgated under the
Securities Act and/or Section 4(2) of the Act.
o By conversion notice dated March 21, 2005, PEF Advisors, LLC elected
to convert $65,800 of outstanding under the convertible debentures.
In response, we issued 2,350,000 shares of our common stock to
pursuant to Rule 506 of Regulation D under the Securities Act.
o By conversion notice dated March 18, 2005, Bristol Capital Advisors,
LLC elected to convert $30,000 of outstanding under the convertible
debentures. In response, we issued 1,071,429 shares of our common
stock to the debenture holder pursuant to Rule 506 of Regulation D
under the Securities Act.
o By conversion notice dated March 11, 2005, Bristol Capital Advisors,
LLC elected to convert $20,000 of outstanding under the convertible
debentures. In response, we issued 714,286 shares of our common
stock to the debenture holder pursuant to Rule 506 of Regulation D
under the Securities Act.
The following changes in our securities occurred after the three months ended
April 30, 2005:
o On May 4, 2005, we issued 10,641,670 shares of our common stock
pursuant to a redemption, settlement and release agreement with
Alpha Capital Aktiengesellschaftt pursuant to Rule 506 of
Regulation D under the Securities Act.
o On May 2, 2005, we issued 4,143,268 shares of our common stock
pursuant to a redemption, settlement and release agreement with
Gamma Opportunity Capital Partners, pursuant to Rule 506 of
Regulation D under the Securities Act.
o By notice of a warrant exercise dated May 5, 2005, Morval Bank &
Trust Cayman, Ltd, elected to exercise 714,286 warrants. In
response, we issued 714,286 shares of our common stock to pursuant
to Regulation S under the Securities Act.
o On May 23, 2005, we issued 1,495,195 shares of our common stock
pursuant to a redemption, settlement and release agreement with
Goldplate Investment Partners pursuant to Rule 506 of Regulation D
under the Securities Act.
On May 27, 2005, we entered into a Standby Equity Distribution Agreement
with Cornell Capital Partners for the future issuance and purchase of shares of
our common stock. This Standby Equity Distribution Agreement establishes what is
sometimes termed an equity line of credit or an equity draw down facility and
replaces our previous $15.0 million Standby Equity Distribution Agreement, which
was terminated by the parties on May 12, 2005.
In general, the draw down facility operates like this: Cornell Capital
Partners committed to provide us up to $30.0 million as we request it over a
24-month period, in return for common stock that we will issue to Cornell
Capital Partners. In addition, we engaged Newbridge Securities Corporation, a
registered broker-dealer, to advise us in connection with the equity line of
credit. For its services, Newbridge Securities Corporation will receive $10,000
of shares of our common stock. As of May 31, 2005 we have $30.0 million
available under this facility. We may request an advance every seven trading
days. The amount of each advance is subject to a maximum amount of $1 million
every seven trading days. A closing will be held six trading days after such
written notice at which time we will deliver shares of common stock and Cornell
Capital Partners will pay the advance amount. For each share of common stock
purchased under the equity line of credit, Cornell Capital Partners will pay 98%
of the lowest closing bid price on the OTC Bulletin Board or other principal
market on which our common stock is traded for the five days immediately
following the notice date. Cornell Capital Partners is a private limited
partnership whose business operations are conducted through its general partner,
Yorkville Advisors, LLC. Further, Cornell Capital Partners will retain 5% of
each advance under the equity line of credit. The issuance of these shares is
conditioned upon us registering these shares with the Securities and Exchange
Commission. We may request advances under the equity line of credit once the
underlying shares are registered with the Securities and Exchange Commission.
Thereafter, we may continue to request advances until Cornell Capital Partners
has advanced $30.0 million or two years after the effective date of the
accompanying registration statement, whichever occurs first.
The amount of capital available under the equity line of credit is not
dependent on the price or volume of our common stock. Cornell Capital Partners
may not own more than 9.9% of our outstanding common stock at any time. Because
Cornell Capital Partners, can repeatedly acquire and sell shares, this
limitation does not limit the potential dilutive effect or the total number of
shares that Cornell Capital Partners may receive under the equity line of
credit.
We cannot predict the actual number of shares of common stock that will be
issued pursuant to the equity line of credit, in part, because the purchase
price of the shares will fluctuate based on prevailing market conditions and we
have not determined the total amount of advances we intend to draw. Nonetheless,
we can estimate the number of shares of our common stock that will be issued
using certain assumptions. For example, we would need to issue 300,000,000
shares of common stock in order to raise the maximum amount under the equity
line of credit at a net purchase price of $0.10.
On May 27, 2005, we also entered into a Securities Purchase Agreement with
Cornell Capital Partners. In accordance with the Securities Purchase Agreement,
we issued to Cornell Capital Partners pursuant to Rule 506 of Regulation D under
the Securities Act, for a purchase price of $1.5 million, a 5% convertible
debenture that is convertible, at the option of Cornell Capital Partners, into
shares of common stock. The convertible debenture matures on May 20, 2006. The
outstanding principal under the convertible debentures bears interest at the
rate of 5% per annum, calculated on the basis of a 360-day year. Principal will
be due and payable in 12 equal installments of $125,000 each, plus accrued
interest and a redemption premium equal to 10% of each such installment or the
highest rate permitted by applicable law, if lower. The installments of
principal will be due and payable commencing on October 1, 2005 and subsequent
installments will be due and payable on the first day of each calendar month
thereafter. Interest on the outstanding principal balance is due and payable
monthly, in arrears, commencing on August 1, 2005 and will continue on the first
day of each calendar month thereafter. All principal, and all accrued and unpaid
interest, under the convertible debentures is due and payable at maturity.
The remaining principal as of May 31, 2005 under the convertible debenture
in the aggregate principal amount of $1,500,000 may be converted by Cornell
Capital Partners in whole or in part and from time to time into shares of our
common stock at a conversion price of $0.028 per share, subject to adjustment as
provided for in the debenture.
The convertible debenture contains a contractual restriction on beneficial
share ownership. It provides that Cornell Capital Partners may not convert the
convertible debenture, or receive shares of our common stock as payment of
interest, to the extent that the conversion or the receipt of the interest
payment would result in Cornell Capital Partners, together with its affiliates,
beneficially owning in excess of 4.9% of our then issued and outstanding shares
of common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Item 1 above.
As of April 30, 2005, we were in violation of all convertible debenture
agreements as a registration statement was not filed with the Securities and
Exchange Commission on the date specified in the agreements. For the remaining
balance of convertible debentures, we have accreted interest and penalties to
adjust the debt to its redemption value of $2,136,496. We are currently in
negotiations with the debenture holders to address the violations of their
debenture agreements.
The Company has received an extension of its 5% $4,000,000 preferred
shares to file a registration statement with the Securities and Exchange
Commission by June 30, 2005 and has received a waiver from Cornell Capital
Partners for any penalties.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
10.1 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Robert Rudman (1)
10.2 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Allan Kozak (1)
10.3 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Jeff Finkelstein (1)
10.4 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Erwin Bartz (1)
10.5 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Shawn Lammers (1)
10.6 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and William Cronin (1)
10.7 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Martin Gannon (1)
10.8 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Johnny Christiansen (1)
10.9 Investment Agreement dated as of March 22, 2005 by and between
SmarTire Systems Inc. and Cornell Capital Partners (2)
10.10 Registration Rights Agreement dated as of March 22, 2005 by and
between SmarTire Systems Inc. and Cornell Capital Partners (2)
10.11 Termination Agreement dated as of March 22, 2005 by and between
SmarTire Systems Inc. and Cornell Capital Partners (2)
10.12 Articles of Amendment dated as of March 18, 2005 to the Articles of
Incorporation of SmarTire Systems Inc. with respect to the Series A
Convertible Preferred Stock. (2)
10.13 Redemption, settlement and release agreement dated April 27, 2005 by
and between SmarTire Systems Inc. and Palisades Master Fund, L.P.
and PEF Advisors, Ltd. **
10.14 Redemption, settlement and release agreement dated May 2, 2005 by
and between SmarTire Systems Inc. and Gamma Opportunity Partners,
L.P. **
10.15 Redemption, settlement and release agreement dated May 4, 2005 by
and between SmarTire Systems Inc. and Alpha Capital
Aktiengesellschaftt, L.P. **
10.16 Redemption, settlement and release agreement dated May 13, 2005 by
and between SmarTire Systems Inc. and Crescent International Ltd.
**
10.17 Redemption, settlement and release agreement dated May 23, 2005 by
and between SmarTire Systems Inc. and Goldplate Investment
Partners. **
10.18 Registration Rights Agreement dated as of May 27, 2005 by and
between SmarTire Systems Inc. and Cornell Capital Partners LP**
10.19 Standby Equity Distribution Agreement dated as of May 27, 2005 by
and between SmarTire Systems Inc. and Cornell Capital Partners**
10.20 Investor Registration Rights Agreement dated as of May 27, 2005 by
and between SmarTire Systems Inc. and Cornell Capital Partners**
10.21 Amended and Restated Convertible Debenture dated as of June 10, 2005
by and between SmarTire Systems, Inc. and Cornell Capital Partners**
10.22 Securities Purchase Agreement dated as of May 27, 2005 by and
between SmarTire Systems Inc. and Cornell Capital Partners LP**
31.1 Certification pursuant to section 302 of the Sarbanes-Oxley Act of
2002**
31.2 Certification pursuant to section 302 of the Sarbanes-Oxley Act of
2002**
32.1 Certification pursuant to18 U.S.C. section 1350, as adopted pursuant
to section 906 of the Sarbanes-Oxley Act of 2002**
32.2 Certification pursuant to18 U.S.C. section 1350, as adopted pursuant
to section 906 of the Sarbanes-Oxley Act of 2002**
** Filed herewith.
(1) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed with the
Securities Exchange Commission on February 9, 2005.
(2) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed with the
Securities Exchange Commission on March 29, 2005.
(3) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed with the
Securities Exchange Commission on April 1, 2005.
(b) Reports on form 8-K.
On February 9, 2005 we filed a Current Report on Form 8-K relating to amendment
agreements relating to certain management agreements and directors' compensation
on termination agreements.
On March 18, 2005 we filed a Current Report on Form 8-K relating to our
financial results for the six and three months ended January 31, 2005.
On March 29, 2005 we filed a Current Report on Form 8-K relating to the issuance
of $4,000,000 of our Series A 5% Convertible Preferred Stock.
On April 1, 2005 we filed a Current Report on Form 8-K/A relating to the
issuance of $4,000,000 of our Series A 5% Convertible Preferred Stock.
SIGNATURES
In accordance with the requirements for the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SMARTIRE SYSTEMS INC.
/s/ Robert Rudman
- ---------------------------------
Robert V. Rudman
Director, President and Chief Executive Officer
(On behalf of the Registrant and as Principal Executive Officer)
Date: June 14, 2005
/s/ Jeff Finkelstein
- ---------------------------------
Jeff Finkelstein
Chief Financial Officer
(On behalf of the Registrant and as Principal Financial Officer)
Date: June 14, 2005
Consolidated Financial Statements
Unaudited
(Expressed in United States dollars)
In accordance with United States Generally Accepted
Accounting Principles
SMARTIRE SYSTEMS INC.
Nine months ended April 30, 2005 and 2004
SMARTIRE SYSTEMS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
=======================================================================================================
April 30, July 31,
2005 2004
- -------------------------------------------------------------------------------------------------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 420,270 $ 112,951
Receivables, net of allowance for doubtful accounts
of nil (2004 - nil) 245,617 259,508
Inventory 3,285,197 3,245,807
Prepaid expenses 192,190 189,477
- -------------------------------------------------------------------------------------------------------
4,143,274 3,807,743
Capital assets 721,745 824,616
Deferred financing costs -- 157,020
Other assets (note 5) 1,347,765 2,147,749
- -------------------------------------------------------------------------------------------------------
$ 6,212,784 $ 6,937,128
=======================================================================================================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 839,030 $ 1,293,251
Deferred revenue 11,389 10,830
Promissory notes payable (note 6) -- 1,500,000
Current portion of convertible debt 1,189,615 271,257
- -------------------------------------------------------------------------------------------------------
2,040,034 3,075,338
Convertible debt, net of equity portion of $457,998
(July 31, 2004 - $1,955,356) (note 7) 195,001 395,574
Preferred shares, net of equity portion of $3,999,999, 1 --
subject to mandatory redemption (note 8)
Stockholders' equity:
Share capital (note 9):
Preferred shares, par value $1,000 Cdn per share:
100,000 shares authorized
Issued and outstanding: 25,000 series A
Common shares, without par value:
Unlimited shares authorized
255,798,467 shares issued and outstanding at
April 30, 2005 (July 31, 2004 - 103,130,761) 65,627,789 58,368,020
Additional paid-in capital 11,036,386 4,417,323
Deficit (72,634,863) (59,018,256)
Accumulated other comprehensive loss (51,564) (300,871)
- -------------------------------------------------------------------------------------------------------
3,977,748 3,466,216
- -------------------------------------------------------------------------------------------------------
$ 6,212,784 $ 6,937,128
=======================================================================================================
Going concern (note 3)
Subsequent events (note 12)
Contingencies (note 13)
See accompanying notes to financial statements. Approved on behalf of the Board:
"Robert V. Rudman" Director "Bill Cronin" Director
- ------------------------ ------------------------
1
SMARTIRE SYSTEMS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
----------------------------------- -----------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------
Revenue $ 330,406 $ 401,423 $ 1,022,484 $ 1,259,140
Cost of goods sold (including in the
nine months ended April 30, 2005
inventory write-down of $230,000) 255,980 287,373 966,235 1,034,523
- ------------------------------------------------------------------------------------------------------------------------------
74,426 114,050 56,249 224,617
Expenses:
Depreciation and amortization 376,477 356,420 1,116,897 1,030,910
Engineering, research and
development 2,086,354 454,715 3,083,704 1,201,634
General and administrative 3,170,568 560,871 4,550,610 1,841,877
Marketing 1,368,330 468,312 2,275,843 1,329,636
- ------------------------------------------------------------------------------------------------------------------------------
7,001,729 1,840,318 11,027,054 5,404,057
- ------------------------------------------------------------------------------------------------------------------------------
Loss from operations (6,927,303) (1,726,268) (10,970,805) (5,179,440)
Other earnings (expenses):
Interest income 1,382 849 3,173 5,416
Net interest and financing
expense (188,491) (1,214,435) (2,763,609) (2,960,488)
Foreign exchange gain (loss) (14,355) (10,405) 114,634 15,931
Gain on settlement of convertible
debt (note 7(a)) 1,822,033 -- 1,822,033 --
- ------------------------------------------------------------------------------------------------------------------------------
1,620,569 (1,223,991) (823,769) (2,939,141)
- ------------------------------------------------------------------------------------------------------------------------------
Loss for the period $ (5,306,734) $ (2,950,259) $ (11,794,574) $ (8,118,581)
==============================================================================================================================
Basic and diluted loss per share $ (0.03) $ (0.04) $ (0.07) $ (0.10)
Weighted average number of common
shares used in the computation of
basic and diluted loss per share 238,545,317 80,450,524 205,742,511 77,461,046
==============================================================================================================================
See accompanying notes to consolidated financial statements.
2
SMARTIRE SYSTEMS INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Loss
(Expressed in United States dollars)
Prepared in accordance with U. S. generally accepted accounting principles
Nine months ended April 30, 2005 (unaudited) and year ended July 31, 2004
(audited)
=====================================================================================================================
Common shares Additional
-------------------------- paid-in
Shares Amount capital Deficit
$ $ $
- ---------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2003 55,039,065 48,204,995 6,681,893 (48,031,230)
Exercise of stock options for cash 79,400 15,880 -- --
Intrinsic value of beneficial conversion feature of
convertible debentures plus fair value
of warrants issued -- -- 2,457,023 --
Conversion of convertible debentures and accrued
interest to common shares allocated pro-rata
between additional paid-in-capital and common
shares, net of issuance costs of $156,133 20,882,076 5,344,961 (2,788,277) --
Exercise of warrants for cash, net of issuance
costs of $78,370 12,463,231 3,702,985 (1,601,970) --
Issuance of shares and warrants as fees for
services received 200,000 34,800 63,375 --
Fair value of agent's warrants issued on private
placement of convertible debentures -- -- 15,699 --
Issuance of shares as fees on equity line of credit 3,605,769 375,000 (375,000) --
Cash cost incurred for equity line -- -- (35,420) --
Shares issued upon draw downs on equity line of
credit, net of issuance cost of $60,601 10,861,220 689,399 -- --
Loss for the period -- -- -- (10,987,026)
Translation adjustment -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2004 103,130,761 58,368,020 4,417,323 (59,018,256)
=====================================================================================================================
Exercise of stock options for cash (note 9(c)) 5,127,048 794,692 (640,881) --
Conversion of convertible debentures and accrued
interest to common shares allocated pro-rata between
additional paid-in-capital and common shares (note 7) 37,883,920 1,615,292 (505,528) --
Intrinsic value of beneficial conversion feature of
convertible debt (note 7) -- -- 1,188,845 --
Settlement of convertible debt (note 7(a)) -- -- (677,966) (1,822,033)
Intrinsic value of beneficial conversion feature of
preferred shares (note 8) -- -- 3,999,999 --
Financing cost related to preferred shares (note 8) -- -- (177,325) --
Exercise of warrants for cash, net of issuance costs of
$46,872 (note 9(a)(ii)) 18,226,274 1,517,215 (1,017,299) --
Exercise of warrants on a cashless basis (note 9(a)) 6,789,809 654,216 (654,216) --
Shares issued upon draw downs on equity line, net of
issuance cost of $219,234 (note 9(a)(i)) 78,887,710 2,505,766 78,484 --
Shares issued as compensation for services (note 9(b)) 5,752,945 172,588 -- --
Compensation expense (note 4) -- -- 5,024,950 --
Loss for the period -- -- -- (11,794,574)
Translation adjustment -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Balance at April 30, 2005 255,798,467 65,627,789 11,036,386 (72,634,863)
=====================================================================================================================
=======================================================================================================
Accum. other
comprehensive Stockholders' Comprehensive
loss equity income (loss)
$ $ $
- -------------------------------------------------------------------------------------------------------
Balance at July 31, 2003 (568,354) 6,287,304 (9,505,692)
Exercise of stock options for cash -- 15,880 --
Intrinsic value of beneficial conversion feature of
convertible debentures plus fair value
of warrants issued -- 2,457,023 --
Conversion of convertible debentures and accrued
interest to common shares allocated pro-rata
between additional paid-in-capital and common
shares, net of issuance costs of $156,133 -- 2,556,684 --
Exercise of warrants for cash, net of issuance
costs of $78,370 -- 2,101,015 --
Issuance of shares and warrants as fees for
services received -- 98,175 --
Fair value of agent's warrants issued on private
placement of convertible debentures -- 15,699 --
Issuance of shares as fees on equity line of credit -- -- --
Cash cost incurred for equity line -- (35,420) --
Shares issued upon draw downs on equity line of
credit, net of issuance cost of $60,601 -- 689,399 --
Loss for the period -- (10,987,026) (10,987,026)
Translation adjustment 267,483 267,483 267,483
-----------
- -------------------------------------------------------------------------------------------------------
Balance at July 31, 2004 (300,871) 3,466,216 (10,719,543)
=======================================================================================================
Exercise of stock options for cash (note 9(c)) -- 153,811 --
Conversion of convertible debentures and accrued
interest to common shares allocated pro-rata between
additional paid-in-capital and common shares (note 7) -- 1,109,764 --
Intrinsic value of beneficial conversion feature of
convertible debt (note 7) -- 1,188,845 --
Settlement of convertible debt (note 7(a)) -- (2,499,999) --
Intrinsic value of beneficial conversion feature of
preferred shares (note 8) -- 3,999,999 --
Financing cost related to preferred shares (note 8) -- (177,325) --
Exercise of warrants for cash, net of issuance costs of
$46,872 (note 9(a)(ii)) -- 499,916 --
Exercise of warrants on a cashless basis (note 9(a)) -- -- --
Shares issued upon draw downs on equity line, net of
issuance cost of $219,234 (note 9(a)(i)) -- 2,584,250 --
Shares issued as compensation for services (note 9(b)) -- 172,588 --
Compensation expense (note 4) -- 5,024,950 --
Loss for the period -- (11,794,574) (11,794,574)
Translation adjustment 249,307 249,307 249,307
-----------
- -------------------------------------------------------------------------------------------------------
Balance at April 30, 2005 (51,564) 3,977,748 (11,545,267)
=======================================================================================================
See accompanying notes to consolidated financial statements.
3
SMARTIRE SYSTEMS INC.
Consolidated Statements of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
==============================================================================================================================
Three months ended Nine months ended
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used for):
Operating activities:
Loss for the period $(5,306,734) $ (2,950,259) $(11,794,574) $ (8,118,581)
Items not affecting cash:
Depreciation and amortization 376,477 356,420 1,116,897 1,030,910
Stock-compensation expense 5,024,950 -- 5,197,538 --
Non-cash interest, penalties and finance charges 144,866 1,111,447 2,607,518 2,770,483
Inventory write-down -- -- 200,000 --
Issuance of shares and warrants for services received -- -- -- 82,838
Gain on settlement of convertible debt (note 7(a)) (1,822,033) -- (1,822,033) --
Change in non-cash working capital:
Receivables 28,024 163,076 25,969 86,722
Deferred revenue -- 14,703 -- 15,415
Inventory 98,158 (235,644) (38,681) (1,991,079)
Prepaid expenses 75,205 (92,081) 8,891 (138,511)
Accounts payable and accrued liabilities 54,256 138,090 (528,362) 135,752
- ------------------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (1,326,831) (1,494,248) (5,026,837) (6,126,051)
Investing activities:
Purchase of capital assets (3,408) (206,138) (28,918) (441,619)
Financing activities:
Cash received on exercise of stock options 153,811 -- 153,811 15,880
Cash received on exercise of warrants (note 9(a)) -- 52,000 546,788 2,059,385
Proceeds from equity line of credit (note 9(a)) -- -- 2,725,000 --
Proceeds from convertible debt (note 7) 457,999 -- 3,152,999 2,725,000
Proceeds from preferred shares (note 8) 4,000,000 -- 4,000,000 --
Proceeds from promissory notes (note 6) 350,000 750,000 875,000 750,000
Repayment of convertible debentures (2,957,999) (14,583) (2,957,999) (14,583)
Financing costs (180,000) (27,900) (695,478) (437,696)
Repayment of promissory notes (note 6) (350,000) -- (2,375,000) --
- ------------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities 1,473,811 759,517 5,425,121 5,097,986
Effect of exchange rate differences on cash and cash equivalents 29,038 (140,717) (62,047) (88,406)
- ------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 172,610 (1,081,586) 307,319 (1,558,090)
Cash and cash equivalents, beginning of period 247,660 1,367,190 112,951 1,843,694
- ------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 420,270 $ 285,604 $ 420,270 $ 285,604
==============================================================================================================================
4
SMARTIRE SYSTEMS INC.
Consolidated Statements of Cash Flows (Continued)
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
====================================================================================================================================
Three months ended Nine months ended
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Supplementary information:
Interest and finance charges paid $ 59,761 $ 114,007 $ 156,091 $ 190,005
Non-cash investing and financing activities:
Conversion of convertible debentures to common shares 245,444 528,182 1,102,832 2,084,485
Fair value of agents warrants issued in conjunction with private
placements -- -- -- 15,699
Financing costs included in accounts payable -- 45,000 -- 45,000
Shares issued for services -- 172,588 --
====================================================================================================================================
See accompanying notes to consolidated financial statements.
5
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
1. Basis of presentation:
These interim consolidated financial statements have been prepared using
United States generally accepted accounting principles. The interim
financial statements include all adjustments, consisting solely of normal
recurring adjustments, which in management's opinion are necessary for a
fair presentation of the financial results for the interim periods
presented.
The disclosures in these statements do not conform in all respects to the
requirements of generally accepted accounting principles for annual
financial statements. These statements follow the same accounting policies
and methods of their application as the most recent annual financial
statements. These statements should be read in conjunction with the
significant accounting policies and other information in the Company's
most recent annual financial statements which are included in the
Company's annual report on Form 10-KSB for the year ended July 31, 2004.
2. Operations:
The Company and its subsidiaries develop and market products incorporating
wireless data transmission and processing technologies for the automotive
and transportation industries. The Company's primary product is a wireless
tire monitoring system which it currently markets for use on passenger
vehicles, motorcycles, recreational, commercial and industrial vehicles.
All sales of its product are made in these industry segments.
3. Going concern:
The Company requires additional financing to fund its operations. The
Company has incurred recurring operating losses and has a deficit of
$72,634,863 and working capital of $2,103,240 as at April 30, 2005. During
the nine months ended April 30, 2005, the Company used cash of $5,055,755
in operating and investing activities.
The Company is pursuing various alternatives to meet its immediate and
long-term financial requirements. During the nine months ended April 30,
2005, the Company realized net cash proceeds of $5,425,121 from financing
activities to fund its operations. The Company also has an undrawn equity
line of credit of $11,525,000 as at April 30, 2005 to fund future
operations. Subsequent to the period end this equity line was replaced by
a $30 million equity line of credit (note 12(a)). There can be no
assurance that the Company can draw down amounts under the equity line of
credit when required and that additional financing will be available to
the Company when needed or, if available, that it can be obtained on
commercially reasonable terms. These consolidated financial statements
have been prepared on the going concern basis which assumes that adequate
sources of financing will be obtained as required and that the Company's
assets will be realized and liabilities settled in the ordinary course of
business. Accordingly, these consolidated financial statements do not
include any adjustments related to the recoverability of assets and
classification of assets and liabilities that might be necessary should
the Company be unable to continue as a going concern.
6
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
4. Significant accounting policy:
Stock-based compensation:
The Company has elected under FAS 123, Accounting for Stock-based
Compensation, to account for employee stock options using the intrinsic
value method. This method is described in Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations. As the Company grants stock options with an
exercise price not less than the market value of the underlying common
shares on the date of grant, no compensation expense is required to be
recognized under APB 25. If the exercise price of employee stock option
award is not fixed in the functional currency of the Company or in the
currency the employee is paid, the award is accounted for as a variable
award until the award is exercised, forfeited, or expires unexercised. The
Company measures compensation as the amount by which the quoted market
value of the common shares of the Company's stock covered by the grant
exceeds the option price, with changes in the market price included in the
measurement of loss.
FAS 123 uses the fair value method of calculating the cost of stock option
grants. Had compensation cost for employee stock options been determined
by this method, net loss and net loss per share would have been as
follows:
===============================================================================================================
Three months ended Nine months ended
------------------------------- -------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
---------------------------------------------------------------------------------------------------------------
Net loss:
As reported $ (5,306,734) $ (2,950,259) $(11,794,574) $ (8,118,581)
Stock-based compensation
expense (recovery) recognized
using intrinsic value method
(variable award) 5,024,950 -- 5,024,950 --
Stock-based compensation
expense determined under fair
value based method for
all awards (4,507) 111,910 (1,087,519) (1,264,063)
---------------------------------------------------------------------------------------------------------------
Pro forma $ (286,291) $ (2,838,349) $ (7,857,143) $ (9,382,644)
===============================================================================================================
Basic and diluted loss per share:
As reported $ (0.03) $ (0.04) $ (0.07) $ (0.10)
Pro forma (0.01) (0.04) (0.05) (0.12)
===============================================================================================================
The Company recognizes compensation expense on a straight-line basis over
the vesting period beginning on the date the stock option is granted.
7
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
4. Significant accounting policy (continued):
The fair value of each option and warrant granted is estimated on the date
of grant using the Black-Scholes option valuation model with the following
weighted average assumptions.
==========================================================================
April 30, April 30,
2005 2004
--------------------------------------------------------------------------
Expected dividend yield 0% 0%
Expected stock price volatility 140% 135%
Risk-free interest rate 3.74% 4.13%
Expected life of options and warrants 5 Years 2 Years
==========================================================================
Weighted-average fair values of options granted during the period are as
follows:
==========================================================================
April 30, April 30,
2005 2004
--------------------------------------------------------------------------
Options whose exercise price at date of grant:
Equals the market price of stock $0.03 $ --
Exceeds the market price of stock 0.02 0.16
Is less than the market price of stock -- --
==========================================================================
The Company recognizes compensation expense for stock options, common
stock and other instruments issued to non-employees for services received
based upon the fair value of the equity instruments issued as the services
are performed and the instrument is earned.
8
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
5. Other assets:
The rights are being amortized over five years on a straight-line basis.
================================================================================
Accumulated Net book
April 30, 2005 Cost amortization value
--------------------------------------------------------------------------------
OEM - most medium and heavy duty
trucks $1,737,500 $1,473,491 $ 264,009
OEM - all other vehicles 3,300,000 2,216,244 1,083,756
--------------------------------------------------------------------------------
$5,037,500 $3,689,735 $1,347,765
================================================================================
Management believes that the net book value of its other assets of
$1,347,765 as at April 30, 2005 is recoverable based on expectations of
future cash flows from the Company's future sales of tire monitoring
systems. Management's belief is based on an undiscounted cash flow
analysis of management's current best estimate of projected annual sales
to the passenger vehicle and light truck OEM market plus management's
projected sales to the heavy truck OEM market.
6. Promissory notes:
(a) On November 16, 2004, the Company received gross proceeds of
$250,000 upon the issuance of an unsecured short-term promissory
note to an accredited investor. There were no fees on the note. The
note bears interest at a rate of 12% per annum and was repayable on
December 15, 2004.
(b) On November 30, 2004, the Company received gross proceeds of
$275,000 upon the issuance of an unsecured short-term promissory
note to an accredited investor. The note bore interest at a rate of
12% per annum and was repaid on December 30, 2004. As a commitment
fee, the holder of the note received $27,500.
(c) On February 9, 2005, the Company received gross proceeds of $350,000
upon the issuance of an unsecured short-term promissory note to an
accredited investor. The note bore interest at a rate of 10% per
annum and was repaid on March 16, 2005. As a commitment fee, the
holder of the note received $35,000.
(d) During the nine months ended April 30, 2005, the Company repaid
$2,375,000 of principal and $61,462 in interest on its promissory
notes.
9
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
7. Convertible debt:
=================================================================================================
Balance to
Redemption Debt be accreted
value of debt component to operations
-------------------------------------------------------------------------------------------------
Balance as at July 31, 2003 $ 1,966,667 $ 3 $ 1,966,664
Issuance of 11% discounted convertible
debenture with cash finance cost of
$264,894 and discount of $768,590 3,493,590 1,036,567 2,457,023
Accretion of deemed debt discount to
interest expense -- 3,236,921 (3,236,921)
Discount in convertible debentures -- (768,590) 768,590
Conversion of 7%, 8% and $840,681 of
discounted convertible debentures to
common shares (2,532,355) (2,532,355) --
Cash payment on discounted convertible
debentures (305,715) (305,715) --
-------------------------------------------------------------------------------------------------
Balance as at July 31, 2004 2,622,187 666,831 1,955,356
Issuance of 5% convertible debenture with
cash finance cost of $ 323,239 (note a) 2,695,000 1,964,153 730,847
Accretion of deemed debt to interest
expense (note d) -- 2,008,237 (2,008,237)
Penalties and premiums accrued for
default on convertible debentures (note d) 128,259 128,259 --
Conversion of $60,000 of 8% and $1,042,832
discounted convertible debentures to
common shares (note b) (1,102,832) (1,102,832) --
Cash payment on discounted convertible
debentures (note b) (381,666) (381,666) --
Premiums paid on repayment of discounted
convertible debentures (note b) (76,333) (76,333) --
Repayment of 5% convertible debentures
(note a) (2,500,000) (1,822,034) (677,966)
Issuance of 5% convertible debenture (note c) 457,999 1 457,998
-------------------------------------------------------------------------------------------------
Balance as at April 30, 2005 1,842,614 1,384,616 457,998
Current portion of convertible debt 1,189,615 1,189,615 --
-------------------------------------------------------------------------------------------------
$ 652,999 $ 195,001 $ 457,998
=================================================================================================
10
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
7. Convertible debt (continued):
At April 30, 2005, $215,000 of the 8% convertible debentures issued on
July 17, 2003, $974,615 of the convertible debentures issued at a 22%
original discount from the face principal amount on December 24, 2004 and
principal of $195,000 and $457,999 of the two 5% convertible debentures
were outstanding.
(a) On December 15, 2004, the Company closed two private placements of
5% convertible debentures for gross proceeds of $2,695,000 and net
cash proceeds of $2,394,644. Advisors to the transactions received
cash commissions of $279,250. Additional expenses related to these
offerings were $21,106. The financing cost was recorded as deferred
financing cost and was amortized over the lesser of the life of the
convertible debentures or the date of redemption or conversion into
common shares.
Principal under convertible debentures was convertible at the option
of the holder as per the terms of the agreement.
The Company also had the right to redeem the convertible debentures,
in whole or in part, at 120% of the face value of each convertible
debenture and the investor to receive 50,000 redemption warrants for
every $100,000 redeemed.
For accounting purposes the Company calculated the intrinsic value
of the beneficial conversion feature amounting to $730,847 and
recorded it as additional paid-in capital. The remaining value of
$1,964,153 is recorded as a liability and accreted to its face value
of $2,695,000 over the maturity period.
The $2,500,000 convertible debenture was due and payable at maturity
on December 15, 2007.
Interest on the remaining outstanding principal under the
convertible debentures that aggregate $195,000 is payable
semi-annually beginning June 15, 2005 and every subsequent six month
period that the principal balance remains unpaid. The maturity date
for these convertible debentures is December 15, 2006.
On March 22, 2005, the Company settled the $2,500,000 convertible
debt. For accounting purposes, the consideration paid was allocated
between equity and liability components based on the intrinsic value
of the beneficial conversion option as equity and the remaining
amount as liability at the date of transaction. The difference
between the carrying value of liability and equity components and
fair value of the consideration paid was charged to income and
deficit respectively. This resulted in a gain on settlement of
$1,822,003 being recorded in statement of operations and a charge to
deficit of the same amount.
11
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
7. Convertible debt (continued):
(b) During August 2004, the Company defaulted on payments to holders of
its discounted convertible debentures. In response to the default,
certain debenture holders filed legal actions against the Company.
On September 24, 2004, the Company and holders of the discounted
convertible debentures signed an agreement which provided for:
withdrawal of legal action; an immediate exercise of 18,226,274
warrants at $0.03 for gross proceeds to the Company of $546,788;
conversion of $734,388 of discounted debentures into 24,479,630
common shares; a lock-up provision that establishes a daily limit on
the number of shares that can be traded by the debenture holders. In
addition, the holders of $308,444 of discounted debentures and
$60,000 of 8% debentures converted these debentures to common
shares.
On April 27, 2005, the Company entered into a redemption, release
and settlement agreement with two holders of the Company's
discounted convertible debentures. Pursuant to such redemption, the
Company made cash payments of $457,999. This payment included a 20%
premium amounting to $76,333.
(c) On May 20, 2005, the Company finalized the agreement to issue a
$1,500,000 one year 5% debenture convertible at the option of the
holder at $0.028 per share and matures on May 20, 2006. Between
April 25 and April 29, 2005, funds for $1,100,000 of the convertible
debenture were placed in escrow with the Company's legal council.
From escrow, $457,999 was paid on April 27, 2005 to two debenture
holders to redeem their convertible debentures and is recorded as an
issuance of new debt. For accounting purposes, the Company
calculated the intrinsic value of the beneficial conversion feature
amounting to $457,998 and recorded it as additional paid-in capital.
The remaining value of $1 is recorded as a liability and accreted to
its face value of $457,999 over the maturity period.
(d) The Company was in violation of all convertible debenture agreements
at January 31, 2005 and at April 30, 2005 with the exception of new
5% convertible debentures issued in April 2005 as a registration
statement was not filed with the Securities and Exchange Commission
on the date specified in the agreements. As a result of this
violation, the Company accreted interest to adjust the carrying
value of the convertible debentures to their redemption value. The
Company also accrued penalties and premiums of $128,259.
On April 21, 2005, a holder of discounted debentures in the amount
of $91,726 filed a legal claim against the Company demanding a
conversion of debenture into common shares at $0.01 per share (note
13).
12
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
8. Preferred shares subject to mandatory redemption:
On March 22, 2005, the Company closed a private placement of 5%
convertible Class A preferred shares for gross proceeds of $4,000,000 and
net cash proceeds of $3,865,000. Advisors to the transactions received
cash commission of $115,000. Additional expenses related to this offering
were $20,000. Proceeds of $2,850,000 from this financing were used to
settle $2,500,000 convertible debenture entered into on December 15, 2004
and $350,000 promissory note entered into on February 9, 2004.
Principal under convertible preferred shares may be converted into common
shares by the holder in whole or in part from time to time at a conversion
price of $0.01. Upon providing 3 business days advance written notice to
holders, during which time the holder may elect to convert up to all of
their convertible preferred stock, the Company may redeem up to 80% of the
convertible preferred stock, in whole or in part, at 120% of the face
value. The $4,000,000 convertible preferred stock is due and payable at
maturity on December 22, 2006.
While the legal form of this financial instrument is that of preferred
shares, due to the mandatory redemption on December 22, 2006, the
substance of the instrument is that of a financial liability. For
accounting purposes, these shares are considered to have both a debt and
equity component. The equity component is related to the intrinsic value
of the beneficial conversion feature at the issuance of the instrument and
it equalled $3,999,999. The equity component value is recorded as
additional paid-in capital. The remaining value of $1 is recorded as a
liability. The carrying value of the liability portion is being accreted
to its retraction value of $4,000,000, over a period from the date of
issuance to its maturity date of December 22, 2006. Total financing costs
of $135,000 is charged to additional paid-in capital as substantially all
the value of preferred shares is treated as equity.
As at April 30, 2005, the Company was in violation of preferred share
agreements as a registration statement was not filed with the Securities
and Exchange Commission on the date specified in the agreement. The
Company has received an extension from the preferred shareholders to file
a registration statement by June 30, 2005 and has received a waiver for
any penalties. If the registration statement is not filed by the Company
by this date, the entire amount of $3,999,999 will be accreted to the
income statement as an interest charge.
13
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
9. Share capital:
(a) During the nine months ended April 30, 2005, the Company realized
gross cash proceeds of $3,271,788 and net cash proceeds of
$3,084,166 as follows:
(i) The Company issued 78,887,710 shares at effective prices
ranging from $0.028 to $0.05 per share pursuant to the Standby
Equity Distribution Agreement for gross proceeds of $2,725,000
and net proceeds of $2,584,250. In addition, $78,484 was
reclassified from additional paid-in capital to share
financing expense to record the proportionate share of costs
on the equity line against the gross amount of draw downs. The
issuance of these shares reduced the set price that the
holders of the convertible debentures can convert the
convertible debentures into common stock and the exercise
price of 14,612,907 warrants outstanding to $0.028.
(ii) As described in note 7, on September 24, 2004, the holders of
the discounted convertible debentures exercised 18,226,274
warrants at $0.03 for gross proceeds of $546,788, and net
proceeds of $499,916. The fair value of these warrants of
$1,017,299 initially recorded as additional paid-in-capital is
reclassified to share capital on exercise of warrants.
(b) On January 19, 2005 the Company issued 5,752,945 shares of common
stock to certain members of senior management of the Company for
services rendered. The fair value of the shares at the date of
issuance was $0.03 per share of $172,588.
(c) A summary of stock option transactions and balances during the
period ended April 30, 2005 is as follows:
====================================================================
Weighted
average
Options exercise
outstanding price
--------------------------------------------------------------------
Balance at July 31, 2004 8,469,800 $ 0.63
Options granted 40,320,000 0.03
Options exercised (5,127,048) 0.03
Options forfeited (920,000) 0.93
--------------------------------------------------------------------
Balance at April 30, 2005 42,742,752 $ 0.13
====================================================================
All options outstanding, with the exception of 200,000 options, as
at April 30, 2005 are fully vested.
Stock compensation expense of $640,881 related to options exercised
was reclassified from additional paid-in capital to share capital.
14
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
9. Share capital (continued):
(d) During April 2005, the Company received notices of a cashless
warrant exercise from holders of the discounted convertible
debentures to exercise 8,386,750 warrants. The exercise price of
these warrants was $0.028. In response, the Company issued 6,789,809
shares of common stock to the warrant holders.
(e) As at April 30, 2005, warrants outstanding were exercisable for
10,759,861 (July 31, 2004-37,483,485) common shares of the Company.
The warrants entitle the holders to purchase common shares of the
Company at prices ranging from $0.028 to $2.80 per share that expire
on various dates until June 30, 2009.
10. Related party transactions:
During the nine months ended April 30, 2005, the Company incurred expenses
of $60,000 (2004 - nil) for a research report to a company in which a
director of the Company has significant influence.
11. Segmented information:
The Company operates in the wireless tire monitoring technology industry.
Management of the Company makes decisions about allocating resources based
on this one operating segment. Geographic information is as follows:
Revenue from external customers:
==========================================================================
Three months ended Nine months ended
------------------------ ------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
--------------------------------------------------------------------------
United Kingdom $ 157,827 $ 31,027 $ 507,520 $ 153,312
United States 119,533 164,798 372,075 423,334
Korea 4,217 1,350 30,423 93,619
China -- 141,488 15,998 453,877
Germany 21,917 17,244 32,378 33,339
Other 26,912 45,516 64,090 101,659
--------------------------------------------------------------------------
$ 330,406 $ 401,423 $1,022,484 $1,259,140
==========================================================================
As at April 30, 2005, 53% (July 31, 2004-53%) of the Company's fixed
assets were in Canada, 18% (July 31, 2004 - 17%) were in Europe and 29%
were in Korea (July 31, 2004 - 30%).
15
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
11. Segmented information (continued):
Major customers, representing 10% or more of total sales, include:
==========================================================================
Three months ended Nine months ended
----------------------- -----------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
--------------------------------------------------------------------------
Customer A $103,832 $ 18,907 $393,184 $ 98,380
Customer B 50,947 20,542 159,510 33,431
Customer C -- 141,488 15,998 423,945
==========================================================================
12. Subsequent events:
(a) On May 20, 2005, the Company entered into a Standby Equity
Distribution Agreement with Cornell Capital Partners which provides
for the potential issuance and sale of up to $30.0 million of our
common stock to Cornell Capital Partners. Under this arrangement,
the Company, at its sole discretion, may draw down on this facility,
from time to time over a period of 24 months after the effective
date of registration statement to be filed with Securities and
Exchange Commission or until Cornell Capital Partners purchases
$30.0 million of shares of our common stock, whichever occurs first.
For each share of common stock purchased under the Standby Equity
Distribution Agreement, Cornell Capital Partners will pay 98% of the
lowest closing bid price of our common stock on the OTC Bulletin
Board for the five trading days immediately following the date of
the notice for the draw down. The amount of each advance is subject
to a maximum of $1.0 million per advance, with a minimum of five
trading days between advances. Cornell Capital Partners intends to
sell the shares purchased under the Standby Equity Distribution
Agreement at the then prevailing market price. In addition, Cornell
Capital Partners may deduct the amount of any fees, expenses and
disbursements that we have not paid from any advance. This Standby
Equity Distribution Agreement replaced the Company's previous $15.0
million Standby Equity Distribution Agreement, dated May 19, 2004,
with Cornell Capital Partners, which was terminated by the parties.
(b) On May 20, 2005, the Company also entered into a Securities Purchase
Agreement with Cornell Capital Partners. In accordance with the
Securities Purchase Agreement, we issued to Cornell Capital Partners
for a purchase price of $1,500,000 million, a 5% convertible
debenture that is convertible, at the option of Cornell Capital
Partners into shares of our common stock at a price of $0.028 per
share and matures on May 20, 2006 (note 7(c)).
16
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
12. Subsequent events (continued):
(c) Between May 2, 2005 and May 23, 2005, the company entered into
release, redemption and settlement agreements whereby it redeemed
$863,581 of discounted convertible debentures. Consideration
consisted of $408,067 and the issuance of 9,738,759 shares of common
stock which were issued at an effective conversion price of $0.028
per share.
13. Contingencies:
As described in note 12 (c) the company has settled a series of discounted
convertible debentures with the exception of one with a carrying value of
$91,726. On April 21, 2005, one holder of this discounted debenture in the
amount of $91,726 provided the Company with notice of a summons with the
Supreme Court of the State of New York. The holder is alleging that the
Company wrongfully refused to honor its request to convert this debt into
9,268,875 common shares of the Company. The holder is seeking issuance of
these shares and damages and attorneys fees. It is not possible to
determine whether the debenture holder will be successful in their legal
action. The Company has recorded a liability of $128,259 which includes
the original principal, premium and penalties.
14. Differences between Canadian and United States Generally Accepted
Accounting Principles and Practices:
These consolidated financial statements have been prepared in accordance
with accounting principles and practices generally accepted in the United
States ("US GAAP") which differ in certain respects from those principles
and practices that the Company would have followed had its consolidated
financial statements been prepared in accordance with accounting
principles and practices generally accepted in Canada ("Canadian GAAP").
(a) Under U.S. GAAP, the adoption of U.S. dollar in 2001 as reporting
currency was implemented retroactively, such that prior period
financial statements were translated under the current rate method
using foreign exchange rates in effect on those dates. Under
Canadian GAAP, a change in reporting currency is implemented by
translating all prior year financial statement amounts at the
foreign exchange rate on the date of change in reporting currency,
which was July 31, 2001. As a result, there is a difference in share
capital, deficit and cumulative translation adjustment amount under
Canadian GAAP as compared to US GAAP.
17
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
14. Differences between Canadian and United States Generally Accepted
Accounting Principles and Practices (continued):
(b) Under U.S. GAAP, the Company has elected to continue to apply the
guidance set out in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretation in accounting for its employee stock option. As the
Company grants options with an exercise price not less than the
market value of the underlying common shares on the date of grant,
no compensation expense is required to be recognized under APB 25.
If the exercise price of employee stock option award is not fixed in
the functional currency of the Company or in the currency the
employee is paid, the award is accounted for as variable award until
the award is exercised, forfeited, or expires unexercised. The
Company measures compensation expense as the amount by which the
quoted market value of the common shares of the Company's common
stock covered by the grant exceeds the option price, with changes in
the market price included in the measurement of loss.
Prior to 2003, under Canadian GAAP, no compensation was recorded for
employee options. Subsequent to August 1, 2003, the Company elected
to use the fair-value based method under Canadian GAAP, on a
prospective basis, to record compensation expense for options. Had
the Company determined compensation expense for option grants made
to employees after July 31, 2002 based on the fair values at grant
dates of the stock options consistent with the fair value method,
the Company's loss and loss per share would have been as follows:
=====================================================================================================
Three months ended Nine months ended
----------------------------- -----------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
-----------------------------------------------------------------------------------------------------
Net loss:
As reported $(1,750,749) $(2,243,554) $(8,621,025) $(6,966,770)
Stock-based compensation
expense included in reported
net loss 4,508 7,973 1,089,282 1,125,667
Stock-based compensation
expense determined under
fair value based method
for all awards (4,508) 115,643 (1,087,519) (1,230,338)
-----------------------------------------------------------------------------------------------------
Pro forma $(1,750,749) $(2,119,938) $(8,619,262) $(7,071,441)
=====================================================================================================
Basic and diluted loss per share:
As reported $ (0.01) $ (0.04) $ (0.05) $ (0.10)
Pro forma (0.01) (0.03) (0.04) (0.09)
=====================================================================================================
18
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
14. Differences between Canadian and United States Generally Accepted
Accounting Principles and Practices (continued):
(c) Under U.S. GAAP, the proceeds from the issuance of convertible
debentures with detachable warrants are allocated to the fair value
of warrants issued and intrinsic value of beneficial conversion
feature. The remaining proceeds are allocated to debt which is being
accreted to the redemption value of the convertible debentures over
the maturity period. On the date of conversion of debt to equity,
the difference between the carrying amount and redemption amount is
charged to statement of operations as interest expense.
Under Canadian GAAP, the proceeds from the issuance of convertible
debentures with detachable warrants are allocated to the warrants
issued and the beneficial conversion feature based on their fair
values. The remaining proceeds are allocated to debt which is then
being accreted to the redemption value of the convertible debentures
over the maturity period. On the date of conversion of debt to
equity, the carrying value of debt is reclassified to equity with no
additional interest accretion. When the Company has the option of
repaying the convertible debentures in cash or its common shares,
the entire principal amount of is recorded as equity. The principal
equity is accreted to the redemption value of the convertible
debentures over the maturity period and is charged to deficit.
(d) Under US GAAP, the discount on convertible debt is netted against
the value of debenture, and debt issuance cost is recorded as
deferred financing cost and is amortized over the maturity period.
Under Canadian GAAP, the discount is recorded as deferred financing
cost and is being amortized over the maturity period. Debt issuance
cost is charged to equity.
(e) For US GAAP, on settlement of a debenture, a gain was recorded in
the statement of operations of $1,822,033 and a charge to retained
earnings was recorded for the same amount (note 7(a)). For Canadian
GAAP, no gain arises, since the carrying value of liability and
equity component of the debenture is the same as the allocated fair
values between liability and equity of the consideration paid.
19
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
14. Differences between Canadian and United States Generally Accepted
Accounting Principles and Practices (continued):
===============================================================================================================
April 30, 2005 July 31, 2004
------------------------------- -------------------------------
Consolidated Canadian US Canadian US
balance sheets GAAP GAAP GAAP GAAP
---------------------------------------------------------------------------------------------------------------
Current assets $ 4,143,274 $ 4,143,274 $ 3,807,743 $ 3,807,743
Capital assets 721,745 721,745 824,616 824,616
Deferred financing costs (d) -- -- 443,016 157,020
Other assets 1,347,765 1,347,765 2,147,749 2,147,749
Current liabilities (c) 2,040,034 2,040,034 2,804,081 3,075,338
Long term convertible
debentures (c) 195,001 195,001 1 395,574
Preferred shares subject to
mandatory redemption 1 1 -- --
Stockholders' equity 3,977,748 3,977,748 4,419,042 3,466,216
===============================================================================================================
===============================================================================================================
Three months ended Nine months ended
------------------------------- -------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
---------------------------------------------------------------------------------------------------------------
Net loss in accordance with
U.S. GAAP $ (5,306,734) $ (2,950,259) $(11,794,574) $ (8,118,581)
Effects of differences in accounting for:
Stock based compensation expense
under U.S. GAAP (b) 5,024,950 -- 5,024,950 --
Stock based compensation
recovery under Canadian GAAP (b) (4,508) (7,973) (1,089,282) (1,125,667)
Interest accretion and amortization of
debenture finance costs recorded
under US GAAP (c) (d) 357,576 782,196 2,439,497 2,409,906
Interest accretion and amortization of
debenture finance cost under
Canadian GAAP (d) -- (67,518) (1,379,583) (132,428)
Gain on settlement of convertible
debt (e) (1,822,033) -- (1,822,033) --
---------------------------------------------------------------------------------------------------------------
Net loss in accordance with Canadian
GAAP (1,750,749) (2,243,554) (8,621,025) (6,966,770)
Beginning deficit in accordance with
Canadian GAAP (59,534,828) (46,486,028) (51,971,332) (41,762,812)
Interest on convertible debentures and
amortization of financing charges (d) (362,543) (646,857) (1,055,763) (646,857)
---------------------------------------------------------------------------------------------------------------
Ending deficit in accordance with
Canadian GAAP $(61,648,120) $(49,376,439) $(61,648,120) $(49,376,439)
===============================================================================================================
Basic and diluted loss per share (in
accordance with Canadian GAAP) $ (0.01) $ (0.04) $ (0.05) $ (0.10)
===============================================================================================================
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SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
- --------------------------------------------------------------------------------
15. Comparative figures:
Certain figures have been reclassified to conform to the financial
statement presentation adopted for the current year.
21