UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------
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 January 31, 2006.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from ___________ to ____________
Commission file number 0-29248
---------------------------
SMARTIRE SYSTEMS INC.
(Exact name of small business issuer as specified in its charter)
---------------------------
Yukon Territory, Canada Not applicable
(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, including area 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 [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
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 ISSUERS
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 common stock at February 28, 2006 was
293,121,513.
Transitional Small Business Disclosure Format (check one): [ ] Yes [X] No
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS - JANUARY 31, 2006 (UNAUDITED)
AND JULY 31, 2005
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) - FOR THE
THREE AND SIX MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31,
2005
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
COMPREHENSIVE INCOME - FOR THE SIX MONTHS ENDED JANUARY 31,
2006 (UNAUDITED) AND YEAR ENDED JULY 31, 2005
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - SIX
MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31, 2005
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - SIX
MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31, 2005
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
SIGNATURES
PART I - FINANCIAL INFORMATION
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,"
"ESTIMATES," "MAY," "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, 2005 FORM 10-KSB. WE ASSUME NO OBLIGATIONS TO UPDATE THESE
FORWARD-LOOKING STATEMENTS TO REFLECT NEW INFORMATION, 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
January 31, 2006 and for the three and six months ended January 31, 2006 and
January 31, 2005 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 six months ended January 31, 2006 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 six months ended
January 31, 2006 and 2005 should be read in conjunction with our most recent
audited annual financial statements for the financial year ended July 31, 2005,
the unaudited interim financial statements included herein, and, in each case,
the related notes.
We have three wholly owned subsidiaries: SmarTire Technologies Inc.,
SmarTire USA Inc. and SmarTire Europe Limited. SmarTire Technologies Inc. was
incorporated on June 3, 1988 under the laws of the Province of British Columbia,
and was the original developer of our patented technology. SmarTire USA Inc., a
Delaware corporation incorporated on May 16, 1997, is our exclusive marketing
agency for SmarTire in North America. SmarTire Europe Limited, a United Kingdom
corporation incorporated on February 25, 1998, is our exclusive sales and
distribution operation for Europe.
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 SEC Annual Reports on Form 10-KSB, Quarterly Reports on Form 10-QSB and
Current Reports in Form 8-K.
We develop and market technically advanced tire pressure monitoring
systems ("TPMSs") for the transportation and automotive industries that monitor
tire pressure and tire temperature. Our TPMSs are designed for improved vehicle
safety, performance, reliability and fuel efficiency.
Although we currently sell only TPMSs for passenger cars, buses,
recreational vehicles, trucks and motorcycles, our vision is to become a
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 is to commercialize a wide array of sensors, compatible with
our TPMSs for the vehicle industry. We developed a receiver module with Vansco
Electronics LP that functions as a "wireless gateway" that we began shipping to
customers in August 2005. This receiver 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 on 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 vehicle. This translates to a higher value proposition to the customer,
while giving us the ability to sell more products. We plan to develop one
additional application in the next year that can be integrated into our receiver
module.
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.
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 sensor it can control a
"horn" to provide an audible warning, activate a lamp or provide information to
a vehicle display control.
We have trademarked our wireless gateway product line as the
SmartWave(TM) brand. The SmartWave brand will apply to all products developed
under our wireless gateway architecture and we are currently evaluating a number
of other control applications.
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 TPMSs is
introduced to the market, we intend to apply for the necessary approvals.
Our direct measurement TPMSs generally exceeds the standard for tire
pressure monitoring established by the National Highway Transportation Safety
Administration ("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 OEMs in the automobile industry. In addition, although the Transportation
Recall Enhancement, Accountability, and Documentation Act of 2000 ("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.
On November 21, 2005 we entered into a manufacturing agreement with
Vansco Electronics LP. Under the agreement, Vansco will manufacture key
subsystems for our wireless gateway family of products. Vansco specializes in
the design and manufacturing of electronic, electro-mechanical and
electro-hydraulic controls and instrumentation and offers engineering design
expertise in system integration, hardware, software, wire harness and
electronics packaging.
On November 21, 2005, we and Hyundai Autonet Company, Ltd ("HACO")
mutually terminated our contract manufacturing agreement entered into in October
2003. This termination was a result of HACO's acquisition by Hyundai Motor
Company. The termination has not impacted our business, nor were there any costs
of termination.
RESULTS OF OPERATIONS
Three months ended January 31, 2006 and January 31, 2005
Revenue
Gross revenue for the three months ended January 31, 2006 increased to
$839,615 from $390,909 for the three months ended January 31, 2005. The
breakdown of the sources of our gross revenue is as follows:
o Sales of OEM TPMSs for use on buses were $388,525 for the three months
ended January 31, 2006 compared to $0 for the three months ended
January 31, 2005. Sales of this product include sales to OEMs for
installation on new and existing buses. Although we anticipate an
increase in sales of this product, it is difficult for us to predict
what the volume of sales will be in this market.
o Sales of aftermarket TPMSs for use on buses were $6,845 for the three
months ended January 31, 2006 compared to $5,389 for the three months
ended January 31, 2005. Although we anticipate as increase in sales of
this product, it is difficult for us to predict what the volume of
sales will be in this market.
o Sales of OEM passenger car TPMSs increased to $258,368 for the three
months ended January 31, 2006 from $171,531 for the three months ended
January 31, 2005. The increase was primarily due to an increase in
sales to Aston Martin, Ford's flagship division. We anticipate sales of
this product to continue to increase as we are now on a third platform
of Aston Martin.
o Sales of aftermarket passenger car TPMSs increased to $35,657 for the
three months ended January 31, 2006 from $35,161 for the three months
ended January 31, 2005. It is difficult for us to predict what the
volume of sales of this product will be.
o Sales of OEM recreational vehicle TPMSs increased to $72,820 for the
three months ended January 31, 2006 from $36,830 for the three months
ended January 31, 2005. We anticipate sales of this product to the OEM
market to continue to increase.
o Sales of aftermarket recreational vehicle TPMSs decreased to $59,170
for the three months ended January 31, 2006 from $69,764 for the three
months ended January 31, 2005. We anticipate sales of this product to
increase substantially during the remainder of the fiscal year; however
it is difficult for us to predict what the volume of sales will be.
o Sales of OEM TPMSs for use on truck vehicles were $0 for the three
months ended January 31, 2006 compared to $3,653 for the three months
ended January 31, 2005. 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 TPMSs for use on trucks were $2,700 for the three months ended
January 31, 2006 compared to $17,660 for the three months ended January
31, 2005. 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 motorcycle TPMSs decreased to $3,912 for the
three months ended January 31, 2006 from $29,285 for the three months
ended January 31, 2005. As sales to this market are seasonal, we
anticipate sales to increase during our quarter ended April 30, 2006;
however it is difficult for us to predict what the volume of sales will
be in this market.
o Sales of miscellaneous products were $11,618 for the three months
ended January 31, 2006 compared to $21,636 for the three months ended
January 31, 2005.
Gross Margin
Gross margin on product sales increased to 24% for the three months
ended January 31, 2006 from -25% for the three months ended January 31, 2005.
The negative margin for the three months ended January 31, 2005 was due to an
inventory write-down of $200,000 for slow moving aftermarket passenger car
TPMSs. Without the inventory write-down, our gross margin would have been 26%
for the three months ended January 31, 2005. Excluding the inventory write-down
for the three months ended January 31, 2005, our gross margin decreased by 2%.
The decrease occurred as the product mix of TPMSs sold in the three months ended
January 31, 2006 had lower gross margins than the product mix of TPMSs sold in
the three months ended January 31, 2005. We anticipate our gross margin to
increase as our sales volumes increase as we expect we will be able to achieve
lower costs with higher sales volumes.
Expenses
Expenses decreased to $1,945,680 for the three months ended January 31,
2006 from $2,087,585 for the three months ended January 31, 2005. Excluding a
stock-based compensation recovery of $310,200, operating expenses increased by
$168,295 to $2,255,880 for the three months ended January 31, 2006. The
stock-based compensation recovery resulted as the market value of our vested
options decreased during the three months ended January 31, 2006 as discussed in
note 2 (b) (ii) to the financial statements.
Engineering, research and development expenses increased to $550,863
for the three months ended January 31, 2006 from $495,665 for the three months
ended January 31, 2005. Excluding a stock-based compensation recovery of
$118,926 recorded in the three months ended January 31, 2006, engineering,
research and development expenses increased by $174,124 to $669,789. The
increase, excluding the stock-based compensation recovery, was mainly due to an
increase in wage expense which resulted from an increase in the number of
engineering related employees. In addition we incurred higher rent and utility
expenses as we leased additional space to accommodate the additional engineering
related employees. The increase was partially offset by a decrease in product
testing expenses.
Marketing expenses decreased to $365,195 for the three months ended
January 31, 2006 from $410,726 for the three months ended January 31, 2005.
Excluding a stock-based compensation recovery of $11,494 recorded in the three
months ended January 31, 2006, marketing expenses decreased by $34,037 to
$376,689. The decrease, excluding the stock-based compensation recovery, was a
result of lower wage expense as a result of less sales and marketing employees
for the three months ended January 31, 2006 than the three month period ended
January 31, 2005. The decrease was partially offset by higher advertising and
promotion costs and increased attendance at trade shows.
General and administrative expenses decreased to $686,370 for the three
months ended January 31, 2006 from $800,911 for the three months ended January
31, 2005. Excluding a stock-based compensation recovery of $179,780 recorded in
the three months ended January 31, 2006, general and administrative expenses
increased by $65,239 to $866,150. The increase, excluding the stock-based
compensation recovery, was mainly a result of higher professional fees and
higher investor relations costs. The increase in professional fees was primarily
due to the cost of legal services incurred to defend against a lawsuit from a
debenture holder, the cost of restructuring both our $30 million 10% convertible
debentures issued on June 23, 2005 by us to Cornell Capital Partners, LP and our
$160 million equity line of credit entered into in June 2005, issued to us by
Cornell Capital Partners, LP., which was replaced with a new $100 million
Standby Equity Distribution Agreement on December 30, 2005 and the cost of
filing a registration statement on January 11, 2005 and an amended registration
statement on February 27, 2005 with the Securities and Exchange Commission to
register our debentures.
Depreciation and amortization expense decreased to $343,252 for the
three months ended January 31, 2006 from $380,283 for the three months ended
January 31, 2005.
Interest and finance charges decreased to $1,669,366 for the three
months ended January 31, 2006 from $1,990,097 for the three months ended January
31, 2005. Non-cash interest and finance charges for the three months ended
January 31, 2006 were $921,864 compared to $1,904,690 for the three months ended
January 31, 2005.
Interest Income
Interest income of $61,656 was earned for the three months ended
January 31, 2006 as compared to $1,307 for the three months ended January 31,
2005 and was the result of higher average cash balances during the three months
ended January 31, 2006.
Loss on settlement of debt
A loss on the settlement of debt of $214,274 was incurred for the three
months ended January 31, 2006 as compared to nil for the three months ended
January 31, 2005. The loss on settlement of debt represents the aggregate
consideration provided less the face value of the debt. The settlement of debt
is described in greater detail under Item 1-Legal Proceedings.
Foreign exchange loss
A foreign exchange loss of $73,376 was incurred for the three months
ended January 31, 2006 as compared to a foreign exchange gain of $71,345 for the
six months ended January 31, 2005. We are adversely impacted by a lower $US
against the $CDN as a significant portion of our operations are paid in Canadian
dollars. Foreign exchange gains or losses are due to fluctuations in currency
exchange rates and are impossible to predict.
Six months ended January 31, 2006 and January 31, 2005
Revenue
Gross revenue for the six months ended January 31, 2006 increased to
$1,432,481 from $692,078 for the six months ended January 31, 2005. The
breakdown of the sources of our gross revenue is as follows:
o Sales of OEM TPMSs for use on buses were $551,393 for the six months
ended January 31, 2006 compared to $0 for the six months ended January
31, 2005. Sales of this product include sales to OEMs for installation
on new and existing buses. Although it is difficult for us to predict
what the volume of sales of this product will be, we anticipate sales
of this product to continue to increase.
o Sales of aftermarket TPMSs for use on buses were $8,842 for the six
months ended January 31, 2006 compared to $5,389 for the six months
ended January 31, 2005. Although we anticipate an increase in sales of
this product, it is difficult for us to predict what the volume of
sales will be in this market.
o Sales of OEM passenger car TPMSs increased to $481,689 for the six
months ended January 31, 2006 from $318,793 for the six months ended
January 31, 2005. The increase was primarily due to an increase in
sales to Aston Martin, Ford's flagship division. We anticipate sales of
this product to continue to increase as we are now on a third platform
of Aston Martin.
o Sales of aftermarket passenger car TPMSs increased to $100,830 for the
six months ended January 31, 2006 from $82,162 for the six months ended
January 31, 2005. It is difficult for us to predict what the volume of
sales of this product will be.
o Sales of OEM recreational vehicle TPMSs increased to $125,763 for the
six months ended January 31, 2006 from $62,052 for the six months ended
January 31, 2005. We anticipate sales of this product to the OEM market
to continue to increase.
o Sales of aftermarket recreational vehicle TPMSs decreased to $97,082
for the three months ended January 31, 2006 from $121,433 for the six
months ended January 31, 2005. We anticipate sales of this product to
increase substantially during the remainder of the fiscal year, however
it is difficult for us to predict what the volume of sales will be.
o Sales of OEM TPMSs for use on trucks vehicles were $3,750 for the six
months ended January 31, 2006 compared to $3,653 for the six months
ended January 31, 2005. 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 TPMSs for use on trucks were $8,858 for the six
months ended January 31, 2006 compared to $28,449 for the six months
ended January 31, 2005. 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 motorcycle TPMSs decreased to $11,269 for the six
months ended January 31, 2006 from $46,019 for the six months ended
January 31, 2005. As sales to this market are seasonal, we anticipate
sales to increase starting in April 2006; however it is difficult for
us to predict what the volume of sales will be in this market.
o Sales of miscellaneous products were $43,005 for the six months
ended January 31, 2006 compared to $24,128 for the six months ended
January 31, 2005.
Gross Margin
Gross margin on product sales increased to 26% for the six months ended
January 31, 2006 from -3% for the six months ended January 31, 2005. The
negative margin for the six months ended January 31, 2005 was due to an
inventory write-down of $200,000 for slow moving aftermarket passenger car
TPMSs Without the inventory write-down our gross margin would have been 26% for
the six months ended January 31, 2005. We anticipate our gross margin to
increase as our sales volumes increase as we expect we will be able to achieve
lower costs with higher sales volumes.
Expenses
Expenses were $2,540,704 for the six months ended January 31, 2006,
compared to expenses of $4,025,325 for the six months ended January 31, 2005.
Excluding stock-based compensation recovery of $1,944,175 recorded in the six
months ended January 31, 2006, operating expenses would have increased by
$459,554 to $4,484,879 for the six months ended January 31, 2006. The
stock-based compensation recovery resulted as the market value of our vested
options decreased during the three months ended January 31, 2006 as discussed in
note 2 (b) (ii) to the financial statements.
Engineering, research and development expenses for the six months ended
January 31, 2006 decreased to $517,418 from $997,350 for the six months ended
January 31, 2005. Excluding a stock-based compensation recovery of $760,122
recorded in the six months ended January 31, 2006, engineering, research and
development expenses increased by $280,190 to $1,277,540 for the six months
ended January 31, 2006. The increase, excluding the stock-based compensation
recovery, was mainly due to an increase in wage expense which resulted from an
increase in the number of engineering related employees. We also incurred higher
travel costs which were a result of an increase in application engineering
required to install our TPMS at our new customers and to set up our
manufacturing in the US with Vansco. In addition higher rent and utility
expenses were incurred as we leased additional space to accommodate additional
engineering related employees. The increase was partially offset by a decrease
in prototype development expenses.
Marketing expenses for the six months ended January 31, 2006 decreased
to $781,403 from $907,513 for the six months ended January 31, 2005. Excluding a
stock-based compensation recovery of $49,976 recorded in the six months ended
January 31, 2006, marketing expenses decreased by $76,134 to $831,379 for the
six months ended January 31, 2006. The decrease, excluding the stock-based
compensation recovery, was a result of lower wage expense as a result of less
sales and marketing employees for the three months ended January 31, 2006 than
the three month period ended January 31, 2005. The decrease was partially offset
by higher advertising and promotion costs.
General and administrative expenses for the six months ended January
31, 2006 decreased to $526,803 from $1,380,042 for the six months ended January
31, 2005. Excluding a stock-based compensation recovery of $1,134,077 recorded
in the six months ended January 31, 2006, general and administrative expenses
increased to $1,660,880 for the six months ended January 31, 2006. The increase,
excluding the stock-based compensation recovery, was mainly a result of
increased professional fees and higher investor relation costs. The increase in
professional fees was primarily due to the cost of legal services incurred to
defend against a lawsuit from a debenture holder, the cost of restructuring both
our $30 million 10% convertible debentures issued on June 23, 2005 by us to
Cornell Capital Partners, LP and our $160 million equity line of credit entered
into in June 2005, issued to us by Cornell Capital Partners, LP., which was
replaced with a new $100 million Standby Equity Distribution Agreement on
December 30, 2005 and the cost of filing a registration statement on January 11,
2005 and an amended registration statement on February 27, 2005 with the
Securities and Exchange Commission to register our debentures.
Depreciation and amortization expense decreased to $715,080 for the six
months ended January 31, 2006 from $740,420 for the six months ended January 31,
2005.
Interest and finance charges increased to $19,300,802 for the six
months ended January 31, 2006 from $2,575,118 for the six months ended January
31, 2005. Interest and finance charges for the six months ended January 31, 2006
included a $16 million fee paid on June 23, 2005 for the $160 million standby
equity distribution agreement with Cornell Capital Partners, which was replaced
by a $100 million standby equity distribution agreement on December 30, 2005,
plus related professional fees and interest accretion on our convertible
debentures and preferred shares.
Excluding charges related to our standby equity distribution agreement,
non-cash interest expense for the six months ended January 31, 2006 were
$1,533,945 compared to $2,462,652 during the six months ended January 31, 2005.
Interest Income
Interest income of $135,102 was earned for the six months ended January
31, 2006 as compared to $1,791 for the six months ended January 31, 2005 and was
the result of higher average cash balances during the six months ended January
31, 2006.
Loss on settlement of debt
A loss on the settlement of debt of $214,274 was incurred for the six
months ended January 31, 2006 as compared to nil for the six months ended
January 31, 2005. The loss on settlement of debt represents the aggregate
consideration provided less the face value of the debt. The settlement of debt
is described in greater detail under Item 1-Legal Proceedings.
Foreign exchange loss
A foreign exchange loss of $301,063 was incurred for the six months
ended January 31, 2006 as compared to a foreign exchange gain of $128,989 for
the six months ended January 31, 2005. We are adversely impacted by a lower $US
against the $CDN as a significant portion of our operations are paid in Canadian
dollars. Foreign exchange gains or losses are due to fluctuations in currency
exchange rates and are impossible to predict.
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 our inception. As at January 31, 2006, we had an accumulated deficit
of $96,983,945. Our net loss for the three months ended January 31, 2006 was
$3,640,272 and for the six months ended January 31, 2006 was $21,851,795
compared to $4,103,940 for the three months ended January 31, 2005 and
$6,487,840 for the six months ended January 31, 2005. As of January 31, 2006 our
stockholders' deficiency was $9,144,364 and we had working capital of
$8,105,233.
Our cash position, including short-term investments at January 31, 2006
was $5,577,703 as compared to $10,059,763 at July 31, 2005. This decrease was
due to the net decrease in the use of cash in our operating, financing and
investing activities as described below.
Our net loss of $21,851,795 for the six months ended January 31, 2006
includes non-cash charges of $715,080 for depreciation and amortization, a stock
based compensation recovery of $1,944,175, a loss on settlement of debt of
$214,274 and $17,618,031 for interest and finance charges as disclosed above
under interest and finance charges. Increases in non-cash working capital during
this period amounted to $367,997. Non-cash working capital changes included
increases in accounts receivable, prepaid expenses and accounts payable and
accrued liabilities and a decrease in inventory. The net cash used in operating
activities for the six months ended January 31, 2006 was $4,880,588. Of this
amount, $1,000,000 (including $100,000 of withholding taxes) was paid in
interest expense on our convertible debentures and $228,000 was paid as partial
compensation to settle our dispute with a debenture holder. As it is uncertain
whether we will be able to access our $100 million Standby Equity Distribution
Agreement when required, we may require subsequent financings to meet our
operating cash flow requirements.
During the six months ended January 31, 2006, we also purchased certain
capital assets at an aggregate cost of $115,602.
During the six months ended January 31, 2006, we realized aggregate
gross cash proceeds of $135,800 as follows:
On October 20, 2005, a warrant holder exercised 1,100,000 warrants at
an exercise price of $0.10 for gross proceeds of $110,000.
During the six months ended January 31, 2006, 860,000 stock options
were exercised for gross proceeds of $25,800.
On June 30, 2005, we closed a $30 million securities purchase agreement
with Cornell Capital Partners, Highgate House Funds, Ltd. and LCC Global
Limited. In accordance with the securities purchase agreement, we issued, for a
purchase price of $30 million, (i) a 10% convertible debenture due June 23,
2008, with a principal balance of $20 million, to Cornell Capital Partners, in
trust for LCC Global, (ii) a 10% convertible debenture due June 23, 2008, with a
principal balance of $8 million, to Cornell Capital Partners, in trust for LCC
Global, and (iii) a 10% convertible debenture due June 23, 2008, with a
principal balance of $2 million, to Highgate House Funds, in trust for LCC
Global. We paid to Yorkville Advisors LLC, the general partner of Cornell
Capital Partners, a cash structuring fee of $3 million in connection with this
transaction.
On December 30, 2005, we, Starome Investments Limited, Xentennial
Holdings Limited, Staraim Enterprises Limited, Cornell Capital Partners,
Highgate House Funds and LCC Global entered into Amendment No.1 to the
Securities and Purchase Agreement pursuant to which we amended and restated the
10% convertible debentures in an aggregate principal amount of $30 million. We
amended and restated the 10% convertible debentures to (i) modify the terms of
such 10% convertible debentures, (ii) effect the transfer by (A) Cornell Capital
Partners and LCC Global to Starome Investments, a corporation organized under
the laws of Cyprus, of the 10% convertible debenture with the principal balance
of $20 million, (B) Cornell Capital Partners and LCC Global to Xentennial
Holdings, a corporation organized under the laws of Cyprus, of the 10%
convertible debenture with the principal balance of $8 million and (iii) effect
the transfer by Highgate House Funds and LCC Global to Staraim Enterprises, a
corporation organized under the laws of Cyprus, of the 10% convertible debenture
with the principal balance of $2 million ((i), (ii) and (iii) above being
referred to as the "restructuring"). The following material amendments were made
to each of the 10% convertible debentures in connection with the
"restructuring":
o The olders of the 10% convertible debentures agreed to eliminate our
obligation to make recurring payments in cash of principal and interest
during the term of the 10% convertible debentures. Such holders may
convert outstanding principal and accrued and unpaid interest under the
10% convertible debentures at any time into shares of our common stock,
subject to a 4.9% beneficial ownership limitation, which may be waived
provided the holders of 10% convertible debentures provide us with 65
days notice. On June 23, 2008, any outstanding principal and accrued
and unpaid interest under the 10% convertible debentures must be
converted by the holders of the 10% convertible debentures into shares
of our common stock; provided, however, that to the extent such
conversion would cause any holder to exceed the 4.9% beneficial
ownership limitation, we must pay such excess amount in cash. Holders
of the 10% convertible debentures are not entitled to receive cash
payments of interest during their term.
o We agreed to change the conversion price of the outstanding principal
under the 10% convertible debentures from a fixed price of $0.1125 to a
price equal to the lesser of (i) $0.1125 (subject to adjustment) and
(ii) 95.5% of the lowest closing bid price of our common stock during
the five trading days immediately preceding the conversion.
o The conversion price of accrued and unpaid interest under the 10%
convertible debentures is 95.5% of the average of the closing bid
prices of our common stock for the five trading days immediately
preceding the conversion of any such interest by a holder into shares
of our common stock.
o The holders of the 10% convertible debentures agreed to permit us to
redeem at any time all or any portion of the outstanding principal and
accrued interest under the 10% convertible debentures provided that the
closing bid price of our stock is less than $0.1125. We must pay a 20%
redemption premium on any amounts being redeemed and must issue to the
holder of the 10% convertible debenture being redeemed a five-year
warrant to purchase $1 million shares of our common stock for every
$100,000 redeemed. The "redemption warrant" will be exercisable on a
cash basis at an exercise price of 110% of the closing bid price of our
common stock on the date we provide notice of our intent to redeem.
On December 30, 2005, we and Cornell Capital Partners terminated the $160
million Standby Equity Distribution Agreement, originally entered into on June
23, 2005, and replaced it with a new $100 million Standby Equity Distribution
Agreement (the "$100 million Standby Equity Distribution Agreement"). We may not
request advances under the $100 million Standby Equity Distribution Agreement
until the underlying shares of our common stock are registered with the SEC, it
is unlikely that we will register such underlying shares until all of the
outstanding principal and accrued and unpaid interest on the amended and
restated 10% convertible debentures have been either converted by the holders or
redeemed or paid in full by us, which must occur on or before July 23, 2008. The
term of the $100 million Standby Equity Distribution Agreement will commence on
the date a registration statement covering the underlying shares becomes
effective and will expire five years after such date. Under the old $160 million
Standby Equity Distribution Agreement, Cornell Capital Partners was entitled to
retain 5% of each advance requested by us. In consideration for the reduction of
the amount available to us under the new $100 Standby Equity Distribution
Agreement, Cornell Capital Partners agreed to reduce this 5% advance fee to 2.5%
of each advance.
We may request advances under the $100 million Standby Equity Distribution
Agreement once the underlying shares are registered with the SEC. Once the
registration statement covering the underlying shares of common stock becomes
effective, we may request an advance every five trading days. The amount of each
advance is subject to a maximum amount of $3 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. We may continue
to request advances until Cornell Capital Partners has advanced $100 million or
5 years have elapsed from the date a registration statement covering the
underlying shares of common stock becomes effective.
Under the $100 million Standby Equity Distribution Agreement, Cornell
Capital Partners and its affiliates 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 $100 million Standby Equity Distribution Agreement.
The following conditions must be satisfied before Cornell Capital Partners
is obligated to purchase any common shares under any draw down notice that we
may deliver from time to time under the $100 million Standby Equity Distribution
Agreement:
o a registration statement for the shares must be declared effective by
the SEC and must remain effective and available as of the draw down
settlement date for making re-sales of the common shares purchased by
Cornell Capital Partners;
o there must be no statute, rule, regulation, executive order, decree,
ruling or injunction which would prohibit the consummation of any of
the transactions contemplated by the $100 million Standby Equity
Distribution Agreement;
o there must be no material action, suit or proceeding before any
arbitrator or any governmental authority against us or any of our
subsidiaries, or against any of the officers, directors or affiliates
of our company or any of our subsidiaries, in respect of the $100
million Standby Equity Distribution Agreement or in respect of the
transactions contemplated by the $100 million Standby Equity
Distribution Agreement;
o trading in our common stock must not have been suspended by the SEC or
by the regulators of the principal market for our common stock
(currently the OTC Bulletin Board); and
o the principal market for our common stock must not have instituted, or
otherwise been made subject to, a general suspension or limitation on
the trading of securities through its facilities at any time prior to
delivery of our draw down notice.
During the term of the $100 million Standby Equity Distribution Agreement,
we may request advances of up to $3 million upon giving notice of not less than
five trading days. We may request such advances every five trading days until
the advances aggregate to $100 million.
During the term of the $100 million Standby Equity Distribution Agreement,
subject to certain exceptions for issuances resulting from prior commitments, we
cannot, without the prior consent of Cornell Capital Partners:
o issue or sell any common stock or preferred stock with or without
consideration;
o issue or sell any preferred stock, warrant, option, right, contract,
call, or other security or instrument granting the holder thereof the
right to acquire common stock with or without consideration,
o enter into any security instrument granting the holder a security
interest in any of our assets; or
o file any registration statements on Form S-8.
Provided we give Cornell Capital Partners two days prior written notice,
the foregoing restrictions will exclude options, warrants or other securities
convertible or exchangeable into shares of our common stock that were
outstanding prior to December 30, 2005.
Cornell Capital Partners, and each of its directors, officers, partners,
employees and agents, is entitled to customary indemnification from us for any
losses or liabilities suffered by any such person based upon material
misstatements or omissions from the $100 million Standby Equity Distribution
Agreement, registration statement and the prospectus, except as they relate to
information supplied by Cornell Capital Partners to us for inclusion in the
registration statement and prospectus.
With respect to the $1.5 million 5% convertible debenture due May 20, 2006
issued to Cornell Capital Partners, principal will be due and payable in 12
equal installments. The installments of principal were due and payable
commencing on October 1, 2005 and subsequent installments were due and payable
on the first day of each calendar month thereafter until the outstanding
principal balance is paid in full. However, Cornell Capital Partners granted us
an extension to April 1, 2006 to commence making these principal and interest
payments. Interest on the outstanding principal balance is due and payable
monthly, in arrears, commencing on August 1, 2005 and will continue to be
payable on the first day of each calendar month thereafter that any amounts
under the convertible debenture remain payable.
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.
At January 31, 2006, we had cash and short-term investments of
approximately $5.5 million. We may require up to $3.3 million in financing
through the next twelve months in order to continue in business as a going
concern because our management projects that we will require $4.3 million to
$9.8 million to fund our debt repayment, ongoing operating expenses, working
capital requirements through January 31, 2007, as detailed below.
Estimated Range
Marketing $ 1,700,000 $ 2,000,000
Engineering, research and development 2,000,000 2,500,000
General and administrative 2,200,000 3,000,000
Capital Purchases 100,000 300,000
Debt repayments (1) 300,000 1,600,000
General Working Capital (2) (2,200,000) (600,000)
----------- -----------
TOTAL $ 4,300,000 $ 8,800,000
=========== ===========
(1) Principal payments on all of our outstanding debt and interest payable
under our 10% convertible debentures is convertible into shares of our common
stock.
(2) Our working capital requirements are impacted by our inventory requirements.
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.
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.
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 January 31, 2006, we had an accumulated deficit of $96,983,945.
We have incurred recurring operating losses, and our net loss for the six months
ended January 31, 2006 was $21,851,795. During the six months ended January 31,
2006, we used cash of $4,880,588 in operating activities. As of January 31,
2006, we had a stockholders' deficiency of $9,144,364 and we had working capital
of $8,105,233.
During the six months ended January 31, 2006, we realized gross cash
proceeds of $135,800 from financing activities. There can be no assurance that
we can draw down amounts under the restructured $100 million equity line of
credit, as draw downs are subject to an effective Registration Statement filed
with the SEC and it is uncertain when the we will be permitted to submit a
registration statement to register our $100 million Standby Equity Line of
Credit during the period that the outstanding principal and accrued and unpaid
interest under the 10% convertible dentures remain outstanding as drawdowns are
subject to an effective Registration statement. 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 our 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 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
determinable.
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.
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 OEMs. 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, undiscounted at an appropriate rate. Our 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. Although we expect
to generate cash flow from sales to the OEM marketplace, it is possible that we
will not generate cash flow from sales to the OEM marketplace in excess of net
book value, or that we will generate cash flow from sales to the OEM market in
future years after the other assets have been fully amortized.
Off-Balance Sheet Arrangements
We have not entered into any transaction, agreement or other
contractual arrangement with an entity unconsolidated with us under which we
have:
o an obligation under a guarantee contract;
o a retained or contingent interest in assets transferred to the
unconsolidated entity or similar arrangement that serves as credit,
liquidity or market risk support to such entity for such assets;
o an obligation, including a contingent obligation, under a contract that
would be accounted for as a derivative instrument; or
o an obligation, including a contingent obligation, arising out of a variable
interest in an unconsolidated entity that is held by, and material to, us
where such entity provides financing, liquidity, market risk or credit risk
support to, or engages in leasing, hedging, or research and development
services with us.
ITEM 3. CONTROLS AND PROCEDURES
Disclosure controls and procedures are controls 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.
As required by Rule 13a-15(e) under the Securities Exchange Act of
1934, as amended, as of the end of the period covered by this quarterly report,
being January 31, 2006, we have carried out an evaluation of the effectiveness
of the design and operation of our disclosure controls and procedures. This
evaluation was carried out under the supervision and with the participation of
our 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 disclosure
controls and procedures are effective. There have been no changes in our
internal controls during our quarter ended January 31, 2006 that have materially
affected or are reasonably likely to affect our internal controls over financial
reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 21, 2005, Bristol Investment Fund, Ltd., a holder of our
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 sought an order compelling us to pay $4,393,360 plus
interest from April 25, 2005 for damages and attorneys fees.
On January 5, 2006, we entered into a Settlement Agreement and Mutual
Release with Bristol Investment Fund, Ltd. In connection with the Agreement and
Mutual Release, we issued (i) a bank check in the amount of $228,000 payable to
"Bristol Investment Fund, Ltd. representing $250,000, less $22,000 in Canadian
withholding taxes"; (ii) 2,000,000 shares of our common stock (the "Bristol
Shares") in certificates of 1,000,000 shares each; and (iii) an executed
Stipulation of Discontinuance with prejudice. Bristol Investment Fund, Ltd.
further agreed that no sale of the Bristol Shares will be made before January
16, 2006 and that no more than 1,000,000 of the Bristol Shares may be sold
before February 16, 2006. Bristol Investment Fund, Ltd. further acknowledged
that the discounted debenture has been paid in full and no further sums are due
thereunder.
For accounting purposes, we recorded a loss on settlement of debt of
$214,274, which represents the aggregate consideration provided less the face
value of the debt.
On January 30, 2006, Travel Technology Innovations LLC ("TTI") provided
us with a demand for arbitration. TTI alleges we have breached our sales and
distribution agreement by seeking to prematurely terminate the agreement in
violation of its terms, thereby damaging TTI through lost profits and has put
forth a claim of $1 million. In light of the status of the case, which is in its
initial phases, we cannot determine the likely outcome of this action or whether
the arbitrators will grant TTI's claim.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following change in our securities occurred during the three months
ended January 31, 2006:
o On January 5, 2006, we issued 2,000,000 shares of our common stock to
Bristol Investment Fund Ltd. pursuant to a settlement agreement and
mutual release pursuant to Rule 506 of Regulation D under the
Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Item 1 above.
We have received an extension until April 1, 2006 to pay the principal
monthly repayments of $125,000 on our 5% $1,500,000 convertible debentures.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual and special meeting of our shareholders was held in
Vancouver, Canada on December 9, 2005. A total of 162 shareholders attended the
annual and special meeting in person or by proxy, representing a total of
223,687,521 (or 81.03%) of the 283,709,549 shares of our common stock issued and
outstanding as at the close of business October 21, 2005, the record date for
the meeting.
The following proposals were adopted by our shareholders by ordinary
resolution: (1) to appoint KPMG LLP, Chartered Accountants, of Vancouver,
British Columbia, as the auditor of our company to hold office for the ensuing
year; (2) to authorize our Board of Directors to fix the remuneration to be paid
to the auditor; (3) to set the number of our directors, between the minimum and
maximum number of directors prescribed by our company's articles of continuance,
at four; (4) to elect WILLIAM CRONIN, MARTIN GANNON, JOHNNY CHRISTIANSEN and
ROBERT RUDMAN as directors of our company, to hold office until the next annual
meeting of shareholders, or until their successors are appointed; and (5) to
approve an additional formal stock incentive plan providing for the granting of
stock-based incentives to those eligible employees, directors, officers and
consultants of our company, or of any of our subsidiaries, who are resident in
the United States and/or subject to taxation in the United States, provided that
a maximum of 10,000,000 shares of common stock of our company shall be issuable
pursuant to all awards granted under the plan.
Of the 223,687,521 shares represented at the meeting, 12,500 shares
were held by shareholders attending in person, and 223,675,021 shares were held
by shareholders attending by proxy. The number of shares cast by way of proxy
for, against and withheld, as well as the number of abstentions and broker
non-votes as to each of these matters are as follows:
BROKER
PROPOSAL SHARES FOR SHARES AGAINST WITHHELD NOT VOTED NON-VOTES
1. To appoint KPMG 223,038,690 0 648,831 0 0
LLP as auditor
2. To authorize 222,874,123 621,348 192,050 0 0
the directors
to fix auditor
remuneration
3. To set the 221,553,527 989,989 1,144,005 0 0
number of
directors at
four
4. To elect the
following
directors:
a. Robert Rudman 221,039,605 0 2,647,916 0 0
b. Martin Gannon 223,234,765 0 452,756 0 0
c. Johnny 223,232,005 0 455,516 0 0
Christiansen
d. William Cronin 223,253,220 0 434,301 0 0
5. To approve the 16,808,732 4,243,305 363,353 202,272,131 0
2005 stock
incentive plan
for United
States residents
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit
Number Description
10.1 Agreement for Electronic Manufacturing Services, dated November 16,
2005, between Vansco Electronics LP and SmarTire Systems Inc. (1)
10.2 Settlement Agreement and Mutual Release, dated January 6, 2006, between
Bristol Investment Fund and SmarTire Systems Inc. (2)
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 Form SB-2/A filed
with the Securities and Exchange Commission on February 27, 2006.
(2) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2 filed
with the Securities and Exchange Commission on January 11, 2006.
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/ Al Kozak
- ---------------------
Al Kozak
President and Chief Executive Officer
(On behalf of the Registrant and as Principal Executive Officer)
Date: March 17, 2006
/s/ Jeff Finkelstein
- ---------------------
Jeff Finkelstein
Chief Financial Officer
(On behalf of the Registrant and as Principal Financial Officer
and Principal Accounting Officer)
Date: March 17, 2006
Consolidated Financial Statements
Unaudited
(Expressed in United States dollars)
In accordance with United States Generally Accepted Accounting Principles
SMARTIRE SYSTEMS INC.
Periods ended January 31, 2006 and 2005
SMARTIRE SYSTEMS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
- ----------------------------------------------------------------------------------------------------------------------
January 31, 2006 July 31, 2005
- ----------------------------------------------------------------------------------------------------------------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 2,278,619 $ 10,059,763
Short term investments (note 2(a)) 3,299,084 -
Receivables, net of allowance for doubtful accounts
of $63,400 (July 31, 2005 - $50,750) 553,319 275,789
Inventory 2,674,351 2,798,747
Prepaid expenses 465,946 158,188
- ----------------------------------------------------------------------------------------------------------------------
9,271,319 13,292,487
Capital assets 775,017 716,763
Deferred financing costs (note 3) 1,906,864 18,209,280
Other assets 521,076 1,066,013
- ----------------------------------------------------------------------------------------------------------------------
$ 12,474,276 $ 33,284,543
======================================================================================================================
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities:
Accounts payable and accrued liabilities $ 855,126 $ 915,334
Current portion of convertible debentures 310,960 4,866,584
- ----------------------------------------------------------------------------------------------------------------------
1,166,086 5,781,918
Convertible debentures, net of equity portion of $8,787,252
(July 31, 2005 - $10,111,082) (note 4) 19,693,610 17,118,667
Accrued interest on convertible debentures 756,164 --
Preferred shares, net of equity portion of $3,997,220, subject to
mandatory redemption (July 31, 2005 - $3,999,999) 2,780 1
Stockholders' equity (deficiency):
Share capital (note 6)
Common shares, without par value:
Unlimited shares authorized
289,646,656 shares issued and outstanding 67,303,418 66,695,717
(July 31, 2005 - 278,562,884)
Additional paid-in capital 19,709,309 18,691,497
Deficit (96,983,945) (75,132,150)
Accumulated other comprehensive income 826,854 128,893
- ----------------------------------------------------------------------------------------------------------------------
(9,144,364) 10,383,957
- ----------------------------------------------------------------------------------------------------------------------
$ 12,474,276 33,284,543
======================================================================================================================
Subsequent event (note 11)
See accompanying notes to consolidated financial statements.
Approved on behalf of the Board.
/s/ Robert Rudman /s/ Martin Gannon
- ----------------------- -----------------------
Robert Rudman, Director Martin Gannon, 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 Six Months Ended
January 31, January 31, January 31, January 31,
2006 2005 2006 2005
- --------------------------------------------------------------------------------------------------------------------------
Revenue $ 839,615 $ 390,909 $ 1,432,481 $ 692,078
Cost of goods sold (including January 31, 2005
inventory write-down of $200,000) 638,847 489,819 1,062,535 710,255
- --------------------------------------------------------------------------------------------------------------------------
200,768 (98,910) 369,946 (18,177)
Expenses:
Depreciation and amortization 343,252 380,283 715,080 740,420
Engineering, research and development (note 2(b)(ii)) 550,863 495,665 517,418 997,350
General and administrative (note 2(b)(ii)) 686,370 800,911 526,803 1,380,042
Marketing (note 2(b)(ii)) 365,195 410,726 781,403 907,513
- --------------------------------------------------------------------------------------------------------------------------
1,945,680 2,087,585 2,540,704 4,025,325
- --------------------------------------------------------------------------------------------------------------------------
Loss from operations $ (1,744,912) $ (2,186,495) $ (2,170,758) $ (4,043,502)
Other earnings (expenses):
Interest income 61,656 1,307 135,102 1,791
Net interest and financing expense (note 3) (1,669,366) (1,990,097) (19,300,802) (2,575,118)
Loss on settlement of debt (note 8) (214,274) -- (214,274) --
Foreign exchange gain (loss) (73,376) 71,345 (301,063) 128,989
- --------------------------------------------------------------------------------------------------------------------------
$ (1,895,360) $ (1,917,445) $ (19,681,037) $ (2,444,338)
- --------------------------------------------------------------------------------------------------------------------------
Loss for the period (3,640,272) (4,103,940) (21,851,795) (6,487,840)
==========================================================================================================================
Basic and diluted loss per share $ (0.01) $ (0.02) $ (0.08) $ (0.03)
Weighted average number of common shares used in
the computation of basic and diluted loss per share 288,516,221 226,846,422 285,575,110 189,875,936
==========================================================================================================================
See accompanying notes to consolidated financial statements.
2
SMARTIRE SYSTEMS INC.
Consolidated Statement of Stockholders' Equity
(Deficiency) and Comprehensive Income (Loss)
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
Six months ended January 31, 2006 (unaudited) and year ended July 31, 2005
- ----------------------------------------------------------------------------------------------------------------------------------
Common Shares Additional Deficit
-------------------------
Shares Amount paid-in
capital
- ----------------------------------------------------------------------------------------------------------------------------------
$ $ $
Balance as at July 31, 2004 103,130,761 58,368,020 4,417,323 (59,018,256)
- ----------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options for cash 6,059,998 787,800 (606,000) --
Conversion of convertible debentures and accrued interest to common
shares allocated pro-rata between additional paid-in-capital and common
shares 51,340,389 2,147,293 (648,644) --
Intrinsic value of beneficial conversion feature of convertible debt -- -- 11,005,243 --
Settlement of convertible debt -- -- (677,966) (1,822,033)
Intrinsic value of beneficial conversion feature of preferred shares -- -- 3,999,999 --
Financing cost related to preferred shares -- -- (145,000) --
Financing cost related to convertible debentures -- -- (1,038,037) --
Exercise of warrants for cash, net of issuance costs of $46,872 18,940,560 1,588,643 (1,017,299) --
Cash-less exercise of warrants 13,364,073 1,026,617 (1,026,617) --
Shares issued upon draw downs on equity line, net of issuance costs of
$515,170 78,887,710 2,505,766 410,420 --
Shares issued as placement fees on equity line of credit 75,188 10,000 -- --
Shares issued as compensation for services 6,764,205 261,578 -- --
Compensation expense -- -- 4,018,075 --
Loss for the period -- -- -- (14,291,861)
Translation adjustment -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Balance as at July 31, 2005 278,562,884 66,695,717 18,691,497 (75,132,150)
- ----------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options for cash 860,000 111,800 (86,000) --
Exercise of warrants for cash 1,100,000 110,000 -- --
Conversion of convertible debentures and accrued interest to
common shares allocated pro-rata between additional paid-in
capital and common shares 7,123,772 306,352 (92,286) --
Settlement of convertible debentures 2,000,000 79,549 (41,895) --
Modification of convertible debenture (note 4(c)) -- -- 3,000,000 --
Stock-based compensation recovery (note 2(b)(ii)) -- -- (1,944,175) --
Amortization of financing fees -- -- 182,168 --
Loss for the period -- -- -- (21,851,795)
Translation adjustment -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Balance as at January 31, 2006 289,646,656 67,303,418 19,709,309 (96,983,945)
- ----------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Accumulated Stockholders' Comprehensive
other equity loss
comprehensive (deficiency)
income (loss)
- ------------------------------------------------------------------------------------------------------------------------
$ $ $
Balance as at July 31, 2004 (300,871) 3,466,216 (10,719,543)
- ------------------------------------------------------------------------------------------------------------------------
Exercise of stock options for cash -- 181,800 --
Conversion of convertible debentures and accrued interest to common
shares allocated pro-rata between additional paid-in-capital and common
shares -- 1,498,649 --
Intrinsic value of beneficial conversion feature of convertible debt -- 11,005,243 --
Settlement of convertible debt -- (2,499,999) --
Intrinsic value of beneficial conversion feature of preferred shares -- 3,999,999 --
Financing cost related to preferred shares -- (145,000) --
Financing cost related to convertible debentures -- (1,038,037) --
Exercise of warrants for cash, net of issuance costs of $46,872 -- 571,344 --
Cash-less exercise of warrants -- -- --
Shares issued upon draw downs on equity line, net of issuance costs of
$515,170 -- 2,916,186 --
Shares issued as placement fees on equity line of credit -- 10,000 --
Shares issued as compensation for services -- 261,578 --
Compensation expense -- 4,018,075 --
Loss for the period -- (14,291,861) (14,291,861)
Translation adjustment 429,764 429,764 429,764
- ------------------------------------------------------------------------------------------------------------------------
Balance as at July 31, 2005 128,893 10,383,957 (13,862,097)
- ------------------------------------------------------------------------------------------------------------------------
Exercise of stock options for cash -- 25,800 --
Exercise of warrants for cash -- 110,000 --
Conversion of convertible debentures and accrued interest to
common shares allocated pro-rata between additional paid-in
capital and common shares -- 214,066 --
Settlement of convertible debentures -- 37,654 --
Modification of convertible debenture (note 4(c)) -- 3,000,000 --
Stock-based compensation recovery (note 2(b)(ii)) -- (1,944,175) --
Amortization of financing fees -- 182,168 --
Loss for the period -- (21,851,795) (21,851,795)
Translation adjustment 697,961 697,961 697,961
- ------------------------------------------------------------------------------------------------------------------------
Balance as at January 31, 2006 826,854 (9,144,364) (21,153,834)
- ------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
3
SMARTIRE SYSTEMS INC.
Consolidated Statement of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
Six months ended January 31, 2006 and 2005
(Unaudited)
- -----------------------------------------------------------------------------------------------
2006 2005
- -----------------------------------------------------------------------------------------------
Cash provided (used for):
Operating activities:
Loss for the period $(21,851,795) $ (6,487,840)
Items not affecting cash:
Depreciation and amortization 715,080 740,420
Stock-based compensation expense (recovery) (1,944,175) 172,588
Inventory write-down -- 200,000
Loss on settlement of debt 214,274
Non-cash interest and finance charges 17,618,031 2,462,652
Change in non-cash working capital:
Receivables (251,005) (2,055)
Inventory 290,384 (136,839)
Prepaid expenses (290,283) (66,314)
Accounts payable and accrued liabilities 618,901 (582,618)
- -----------------------------------------------------------------------------------------------
Net cash used in operating activities (4,880,588) (3,700,006)
Investing activities:
Purchase of capital assets (115,602) (25,510)
Purchase of short-term investments (3,299,084) --
- -----------------------------------------------------------------------------------------------
Net cash used in investing activities (3,414,686) (25,510)
Financing activities:
Cash received on exercise of stock options 25,800 --
Cash received on exercise of warrants 110,000 546,788
Proceeds from equity line of credit -- 2,725,000
Proceeds from promissory notes -- 525,000
Proceeds from convertible debentures -- 2,695,000
Settlement of convertible debentures (228,000) --
Financing costs -- 515,478
Repayment of promissory notes -- (2,025,000)
- -----------------------------------------------------------------------------------------------
Net cash provided by financing activities (92,200) 4,982,266
Effect of exchange rate difference on cash and cash equivalents 606,330 (91,085)
- -----------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (7,781,144) 134,709
Cash and cash equivalents, beginning of year 10,059,763 112,951
- -----------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 2,278,619 $ 247,660
===============================================================================================
Supplementary information:
Interest and finance charges paid $ 1,041,071 $ 96,330
Non-cash investing and financing activities:
Conversion of convertible debentures to common shares 400,554 857,388
Shares issued for services -- 172,588
===============================================================================================
See accompanying notes to consolidated financial statements.
4
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
1. Interim financial statements:
The consolidated financial statements include the accounts of the parent
company and our subsidiaries after elimination of all inter-company
balances and transactions. All subsidiaries are 100% owned.
The unaudited consolidated financial statements included herein have been
prepared in accordance with accounting principles generally accepted in
the United States (generally accepted accounting principles) for interim
financial information and with the instructions for Form 10-QSB and
Article 10 of Regulation S-X. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. In the opinion of management all
adjustments, including normal recurring adjustments, necessary for a fair
presentation of the interim periods presented have been included. The
interim results are not necessarily indicative of the operating results
expected for the full fiscal year ending on July 31, 2006.
Our consolidated financial statements have been prepared on the assumption
that the Company will continue as a going concern, which contemplates the
realization of assets and liquidation of liabilities in the normal course
of business. The Report of the Independent Registered Public Accounting
Firm on the financial statements of the Company as of and for the fiscal
year ended July 31, 2005 included in Form 10-KSB contained an explanatory
paragraph that expresses substantial doubt about our ability to continue
as a going concern. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability
and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
As of January 31, 2006, the Company had an accumulated deficit of
$96,983,945 and incurred a net loss of $21,851,795 for the six-month
period ended January 31, 2006. As of January 31, 2006 the Company had cash
and cash equivalents and short-term investments of $5,577,703, working
capital of $8,105,233, a current ratio of 8.0, total assets of
$12,474,276, total liabilities of $21,618,640, and a stockholders'
deficiency of $9,144,364.
Although the Company has a $100 million Standby Equity Distribution
Agreement with Cornell Capital Partners, it is uncertain when the Company
will be permitted to draw down on the Standby Equity Distribution
Agreement during the period that the outstanding principal and accrued and
unpaid interest under the 10% convertible dentures remain outstanding as
drawdowns are subject to an effective Registration statement. As a result,
the Company may require additional financing to fund its operations. 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. Interim unaudited financial results should be
read in conjunction with the audited financial statements included in the
SEC Report on Form 10-KSB, for the period ended July 31, 2005.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
2. Significant accounting policies:
(a) Short-term investments:
Short-term investments are comprised of term deposits with varying
maturities from 91 days to 12 months. All short-term investments are
classified as held-to-maturity and are recorded at cost including
accrued interest, which approximates fair market value, with changes
going to the statement of operations.
(b) Stock-based compensation:
i. 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 for fixed
plan awards. 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.
In accordance with FAS 148, the following table illustrates
the effect on net loss and net loss per share as if the
Company had applied the fair value recognition provisions of
FAS 123. Because options vest over several years and
additional option grants are expected to be made in future
years, the pro forma results are not representative of the pro
forma results for future periods.
- ------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
--------------------------- ---------------------------
January 31, January 31, January 31, January 31,
2006 2005 2006 2005
- ------------------------------------------------------------------------------------------------------
Net loss:
As reported $ (3,640,272) $ (4,103,940) $(21,851,795) $ (6,487,840)
Stock-based compensation recovery
recognized using intrinsic value
method (310,200) -- (1,944,175) --
Stock-based compensation expense
determined under fair value based
method for all awards (199,704) (1,076,635) (217,855) (1,083,012)
- ------------------------------------------------------------------------------------------------------
Pro forma $ (4,150,176) $ (5,180,575) $(24,013,825) $ (7,570,852)
- ------------------------------------------------------------------------------------------------------
Basic and diluted loss per share:
As reported (0.01) (0.02) (0.08) (0.03)
Pro forma (0.01) (0.02) (0.08) (0.04)
- ------------------------------------------------------------------------------------------------------
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
2. Significant accounting policies (continued):
The Company recognizes compensation expense on a straight-line basis
over the vesting period beginning on the date the stock option is
granted.
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.
----------------------------------------------------------------
January 31, January 31,
2006 2005
----------------------------------------------------------------
Expected dividend yield 0% 0%
Expected stock price volatility 144% 143%
Risk-free interest rate 3.50% 3.60%
Expected life options and warrants 5 years 5 years
----------------------------------------------------------------
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.
ii. During the six months ended January 31, 2006, the Company recorded a
$1,944,175 (2005 - nil) recovery of stock compensation expense for
variable awards which reduced engineering, research and development
expenses by $760,122 (2005 - nil), general and administrative
expenses by $1,134,077 (2005 - nil) and marketing expenses by
$49,976 (2004 - nil).
(c) Recent accounting pronouncements:
In December 2004, the FASB issued FASB Statement No. 123 (revised 2004),
Share-Based Payment, which addresses the accounting for transactions in
which an entity exchanges its equity instruments for goods or services,
with a primary focus on transactions in which an entity obtains employee
services in share-based payment transactions. This Statement is a revision
to Statement 123 and supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees, and its related implementation guidance. The Company
has not yet determined the effect that the adoption of this new statement
will have on the Company's historical financial position or results of
operations. This statement will be effective for the Company as of August
1, 2006.
In September 2005, the Emerging Issues Task Force ("EITF") issued EITF
No.05-7, "Accounting for modifications to conversion options embedded in
debt instruments and related issues." EITF 05-7 requires the Company to
consider the change in the fair value of the embedded conversion option
for any modified convertible debt when determining whether a substantial
modification has occurred under the provisions of EITF 96-19. The
provisions of EITF 05-7 are effective for the first interim or annual
reporting period beginning after December 15,2005. The Company has adopted
the provisions of EITF 05-7 effective August 1,2006.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
3. Deferred financing costs:
As at July 31, 2005, the Company had deferred $16,084,086 of financing
costs relating to its $160.0 million equity line of credit. As described
in note 5, on September 23, 2005 the Company withdrew the Registration
Statement previously filed on July 22, 2005 with the SEC. As a result of
the withdrawal of the Registration Statement the Company did not have the
ability to draw down on the $160.0 million equity line of credit. As
further disclosed in note 5, it is currently not determinable when the
Company will be able to draw down on the amended $100.0 million equity
line of credit. For the six months ended January 31, 2006, the Company has
charged $16,084,086 (2005 - nil) to the statement of operations as
interest and financing expense.
4. Convertible debentures:
---------------------------------------------------------------------------------------------------------------
Redemption Balance to be
value of debt Debt component accreted to debt
---------------------------------------------------------------------------------------------------------------
Balance as at July 31, 2005 $ 32,096,333 $ 21,985,251 $ 10,111,082
---------------------------------------------------------------------------------------------------------------
Conversions:
8% convertible debenture (note 4(b)) (115,000) (115,000) --
Discounted convertible debentures (note 4(b)) (189,511) (189,511) --
Modification
10% convertible debentures (note 4(c)) -- (3,000,000) --
Interest accretion:
10% convertible debentures (note 4(c)) -- 1,304,693 (1,304,693)
5% convertible debenture -- 19,137 (19,137)
---------------------------------------------------------------------------------------------------------------
Balance as at January 31, 2006 $ 31,791,822 $ 20,004,570 $ 8,787,252
Less: Current portion of convertible debentures 1,791,822 310,960 1,480,862
---------------------------------------------------------------------------------------------------------------
$ 30,000,000 $ 19,693,610 $ 7,306,390
---------------------------------------------------------------------------------------------------------------
As at January 31, 2006 the following convertible debentures with respective
redemption values were outstanding:
i. $96,822 of the convertible debentures issued at a 22% original
discount from the face principal amount on December 24, 2003;
ii. $195,000 of the 5% convertible debenture issued on December 15,
2004;
iii. $1,500,000 of the 5% convertible debenture issued on May 20, 2005;
iv. $30,000,000 of the 10% convertible debentures issued on June 23,
2005.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
4. Convertible debentures (continued):
(a) As at January 31, 2006, the Company was in arrears on payments of
principal and interest under its 5% convertible debenture issued on
May 20, 2005 in the amount of $500,000 and $54,343 in principal and
interest respectively. The Company has obtained an extension from
the principal holder to defer all principal and interest payments
under this convertible debenture until April 1, 2006.
(b) During the six months ended January 31, 2006, holders of the 8%
convertible debentures converted the remaining $115,000 of principal
and $19,627 of accrued interest into 4,286,665 common shares of the
Company and holders of the discounted convertible debentures
converted $171,165 of principal and $18,346 of accrued interest into
4,837,107 common shares of the Company.
(c) On December 30, 2005, the Company amended certain of its terms and
conditions relating to the $30,000,000, 10% convertible debentures
entered into on June 23, 2005. Terms and conditions have been
amended as follows:
i. Principal and interest payments due in cash are eliminated
during the term of the debentures;
ii. Debentures are convertible into shares of Common Stock at the
option of the Holder at the lesser of $0.1125 and a 4.5%
discount to market. Market is based on the lowest Closing Bid
Price of the Common Stock for the five (5) trading days
immediately preceding the date the conversion notice is
provided;
iii. If at the end of the three year term, the debentures are not
fully converted, the debenture holders must convert the
balance due into shares of the Company up to their beneficial
ownership limitation of 4.9%, which may be waived provided the
debenture holders provide the Company with 65 days notice. The
remaining balance is due in cash by the Company;
iv. Interest is payable in shares of the Company's Common Stock
and is calculated as ninety-five and one-half percent (95.5%)
of the 5 day average of the Closing Bid Price of the Common
Stock for the five (5) trading days immediately preceding the
date the interest conversion is made;
v. The Company has the right to redeem all or any portion of the
outstanding principal and accrued interest under the
convertible debentures at a 20% premium prior to the Maturity
Date provided that our Closing Bid Price as reported by
Bloomberg, LP, is less than the Fixed Conversion Price at the
time of the Redemption Notice. The Debenture holder shall
receive a warrant to purchase one million (1,000,000) shares
of the Company's Common Stock for every One Hundred Thousand
Dollars ($100,000) redeemed, pro rata (the "Warrant"). The
Warrant shall be exercisable on a "cash basis" and have an
exercise price of one hundred ten percent (110%) of the
Closing Bid Price of our Common Stock on the date the Company
provides the Redemption Notice.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
4. Convertible debentures (continued):
The Company filed a Registration Statement on Form SB-2 on January 11,
2006 and subsequently an amended Registration Statement on Form SB-2/A on
February 27, 2006 to register the underlying securities. As of the date of
these financial statements this Registration Statement has not yet been
declared effective by the SEC. Previously, the Company had been in
violation of certain terms of its original debentures due to the
withdrawal of the Registration Statement on Form SB-2 on September 23,
2005 which was filed on July 22, 2005 to register the underlying
securities under the terms of the original debentures.
For accounting purposes, the Company has accounted for the modification of
the terms of its debentures by reducing the carrying amount of the
original debt instrument by the change in the fair value of the embedded
conversion option as required under EITF 05-7. The change in the fair
value of the embedded conversion option has been recorded as additional
paid-in capital.
For the six months ended January 31, 2006 the Company has recorded
$1,304,693 of interest expense relating to interest accretion on the
convertible debentures. The Company has charged the interest expense to
the statement of operations.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
5. Standby equity distribution agreements:
On June 23, 2005, the Company entered into a $160.0 million equity line of
credit with Cornell Capital. On September 23, 2005, the Company formally
requested that the Registration Statement on Form SB-2 previously filed
with the SEC on July 22, 2005 be withdrawn. The Registration Statement was
not previously declared effective by the SEC and no securities were sold
pursuant to the Registration Statement.
On December 30, 2005, the Company entered into an agreement to terminate
its $160.0 million Standby Equity Distribution Agreement ("SEDA") and
enter into a new $100.0 million SEDA with Cornell Capital. Terms of the
agreement are the same as the previous agreement except for the following:
i. Term of the agreement is five years from the date of
effectiveness;
ii. Fees on draw downs reduced to 2.5% from 5%;
iii. The registration statement to be filed on a date mutually
agreed to by the Company and the Investor.
The Company has not registered the equity line of credit. The Company may
not request advances under the $100.0 million equity line of credit until
the underlying shares of its common stock are registered with the SEC and
it is uncertain whether it will register such underlying shares until all
of the outstanding principal and accrued and unpaid interest on the 10%
convertible debentures have been either converted by the holders or paid
in full by the Company, which must occur on or before July 23, 2008. The
term of the $100.0 million SEDA is to commence on the date a registration
statement covering the underlying shares becomes effective and will expire
five years after such date. Due to the uncertainty as to when the Company
will be able to access its equity line, it has expensed fees related to
the $160.0 million equity line of credit.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
6. Share capital:
Authorized:
Unlimited number of common shares with no par value
100,000 preferred shares, issuable in series
Common shares issued and fully paid:
------------------------------------------------------------------------------------------
Number of
shares Amount
------------------------------------------------------------------------------------------
Balance at July 31, 2005 278,562,884 66,695,717
Common shares issued upon conversion of convertible debentures 7,123,772 306,352
Common shares issued upon settlement of convertible debentures 2,000,000 79,549
Common shares issued upon exercise of warrants 1,100,000 110,000
Common shares issued on exercise of employee stock options 860,000 111,800
------------------------------------------------------------------------------------------
Balance at January 31,2006 289,646,656 $67,303,418
------------------------------------------------------------------------------------------
7. Segmented information:
The Company operates in the wireless vehicle 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 Six months ended
------------------------------------------------------------------------------------------
January 31,2006 January 31,2005 January 31,2006 January 31,2005
------------------------------------------------------------------------------------------
United States $ 489,256 $ 139,187 $ 762,275 $ 252,542
United Kingdom 266,344 191,254 490,633 349,693
Other 84,015 60,468 179,573 89,843
------------------------------------------------------------------------------------------
$ 839,615 $ 390,909 $ 1,432,481 $ 692,078
------------------------------------------------------------------------------------------
As at January 31, 2006, 83% (July 31, 2005-52%) of the Company's fixed
assets were in Canada, 17% (July 31, 2005 - 18%) were in Europe and nil
were in Korea (July 31, 2005 - 30%).
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
7. Segmented information (continued):
Major customers, representing 10% or more of total sales, include:
--------------------------------------------------------------------------------------
Three months ended Six months ended
------------------------------------------------------------------------
January 31,2006 January 31,2005 January 31,2006 January 31,2005
--------------------------------------------------------------------------------------
Customer A $ 366,292 $ -- $ 524,466 $ --
Customer B 258,168 154,925 452,294 289,352
Customer C 101,796 55,735 165,101 108,563
--------------------------------------------------------------------------------------
8. Loss on settlement of debentures:
On December 24, 2005, the Company signed a Settlement Agreement and Mutual
Release with a convertible debenture holder that had previously provided
the Company with notice of a summons with the Supreme Court of the State
of New York. The holder had alleged the Company had refused to honor its
request to convert the value of the debt of $91,726 into 9,268,875 common
shares of the Company.
Consideration consisted of 2,000,000 common shares of the Company,
representing a partial exercise of the debenture at the set conversion
price of $0.028 per share plus $250,000 (less withholding taxes of
$22,000) payable to the holder of the debenture, representing payment of
the balance of the debenture and other good and valuable consideration.
For accounting purposes, the Company has recorded a loss on settlement of
debt of $214,274, which represents the aggregate consideration provided
less the face value of the debt.
The holder was previously seeking $4,393,360 plus interest from April 25,
2005 and attorneys fees.
9. Related party transactions:
(a) During the six months ended January 31, 2006, the Company paid
$900,000 (net of $100,000 of withholding taxes) in interest payments
to Cornell Capital for interest due on the $30,000,000 convertible
debentures. Cornell Capital is considered a related party from a
financial perspective due to the number and size of the financial
transactions that have been entered into with the Company. Cornell
Capital does not have influence over the Company's operating or
investing activities.
(b) During the six months ended January 31, 2006, the Company paid
$120,000 (2005 - nil) in consulting fees to the Company's Chairman
pursuant to a consulting agreement entered into on June 30, 2005.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
10. Contingency:
On January 30, 2006 the Company was served with a demand for arbitration
by Travel Technology Innovations LLC ("TTI"). The demand for arbitration
resulted from the Company's January 1, 2006 termination of the Sales and
Distribution agreement signed with TTI on March 12, 2005 and seeks damages
for potential lost profits of $1,000,000. As of January 31, 2006 it is not
possible to determine the outcome of the arbitration and no amount has
been recorded in the financial statements as a potential liability.
11. Subsequent event:
Subsequent to quarter-end, the Company received a Notice of Conversion
from the sole remaining holder of the discounted convertible debenture to
convert the remaining outstanding principal of $96,822 into 3,474,857
common shares of the Company.
12. 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.
(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.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
12. Differences between Canadian and United States Generally Accepted
Accounting Principles and Practices (continued):
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 Six Months Ended
---------------------------- ----------------------------
January 31, January 31, January 31, January 31,
2006 2005 2006 2005
---------------------------------------------------------------------------------------------------------------
Net loss:
In accordance with Canadian GAAP (note 12(d)) $ (3,915,358) $ (4,898,266) $(23,536,967) $ (6,870,276)
Stock-based com pensation expense
included in reported net loss 199,704 1,074,986 217,855 1,084,774
Stock-based com pensation expense
determined under fair value based
method for all awards (199,704) (1,076,635) (217,855) (1,083,012)
---------------------------------------------------------------------------------------------------------------
Pro forma $ (3,915,358) $ (4,899,915) $(23,536,967) $ (6,868,514)
---------------------------------------------------------------------------------------------------------------
Basic and diluted loss per share:
As reported (0.01) (0.02) (0.08) (0.03)
Pro forma (0.01) (0.02) (0.08) (0.04)
---------------------------------------------------------------------------------------------------------------
(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.
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)
Six months ended January 31, 2006 and 2005
- --------------------------------------------------------------------------------
12. Differences between Canadian and United States Generally Accepted
Accounting Principles and Practices (continued):
(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) Under U.S. GAAP the modification of the terms of the $30 million
convertible debentures reduces the carrying value of the original
debentures by an amount equal to the change in the fair value of the
embedded conversion option. Under Canadian GAAP, as the modification
of the terms of the debentures does not represent a settlement but a
renegotiation of the debt instrument, no adjustment has been made
to the carrying value of the $30 million convertible debentures.
-----------------------------------------------------------------------------------------
January 31,2006 July 31,2005
-----------------------------------------------------
Canadian U.S. Canadian U.S.
Consolidated balance sheets GAAP GAAP GAAP GAAP
-----------------------------------------------------------------------------------------
Current assets $ 9,271,319 $ 9,271,319 $ 13,292,487 $13,292,487
Capital assets 775,017 775,017 716,763 716,763
Deferred financing costs 109,700 1,906,864 16,206,086 18,209,280
Other assets 521,076 521,076 1,066,013 1,066,013
Current liabilities 1,166,086 1,166,086 1,649,690 5,781,918
Long term convertible debentures 2,994,144 20,449,774 1,272,123 17,118,667
Preferred shares subject to
mandatory redemption 2,780 2,780 1 1
Stockholders' equity (deficiency) 6,514,102 9,144,364 28,359,535 10,383,957
-----------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
-----------------------------------------------------------
January 31, January 31, January 31, January 31,
Consolidated statement of operations and deficit: 2006 2005 2006 2005
--------------------------------------------------------------------------------------------------------------------------
Net loss in accordance with U.S. GAAP $ (3,640,272) $ (4,103,940) $(21,851,795) $ (6,487,840)
Effects of difference in accounting for:
Stock based compensation recovery under US. GAAP (b) (310,200) -- (1,944,175) --
Stock based compensation expense under Canadian GAAP (b) (199,704) (1,074,986) (217,854) (1,084,774)
lnterest accretion and amortization of debenture finance
costs recorded under U.S. GAAP (b)(d) 1,669,366 1,529,505 19,300,802 2,081,921
Interest accretion and amortization of debenture finance
costs under Canadian GAAP (d) (1,434,548) (1,248,845) (18,823,945) (1,379,583)
--------------------------------------------------------------------------------------------------------------------------
Net loss in accordance with Canadian GAAP (3,915,358) (4,898,266) (23,536,967) (6,870,276)
Beginning deficit in accordance with Canadian GAAP (84,686,310) (54,337,248) (65,064,401) (51,971,332)
Interest on convertible debentures and amortization of
finance charges -- (299,314) -- (693,220)
--------------------------------------------------------------------------------------------------------------------------
Ending deficit in accordance with Canadian GAAP (88,601,368) (59,534,828) (88,601,368) (59,534,828)
--------------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per share
(in accordance with Canadian GAAP) $ (0.01) $ (0.02) $ (0.08) $ (0.04)
--------------------------------------------------------------------------------------------------------------------------
16