UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended July 31, 2006
|_| TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission file number: 0 - 32093
HIENERGY TECHNOLOGIES, INC.
---------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 91-2022980
-------- ----------
State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization
1601B Alton Parkway, Irvine, California 92606
(Address of principal executive offices)
(949) 757-0855
--------------
(Issuer's telephone number)
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
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 issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes |X| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of October 12, 2006, the issuer
had 68,838,751 shares of Common Stock, par value $0.001 per share, 219.64 shares
of Series B Convertible Preferred Stock, par value $0.001, issued and
outstanding.
Transitional Small Business Disclosure Format (Check one): Yes |_| No |X|
HIENERGY TECHNOLOGIES, INC.
Index to
Quarterly Report on Form 10-QSB
For the Period Ended July 31, 2006
PART I - FINANCIAL INFORMATION
Page
----
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets as of July 31, 2006 (unaudited) and
April 30, 2006 3
Consolidated Statements of Operations for the Three Months Ended
July 31, 2006 and 2005 (unaudited) and for the Period from
August 21, 1995 (Inception) to July 31, 2006 (unaudited) 4
Consolidated Statements of Cash Flows for the Three Months Ended
July 31, 2006 and 2005 (unaudited) and for the Period from
August 21, 1995 (Inception) to July 31, 2006 (unaudited) 5
Notes to the Consolidated Financial Statements (unaudited) 8
Item 2 Management's Discussion and Analysis and Plan of Operation 39
Item 3 Controls and Procedures 71
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 72
Item 2 Changes in Securities 75
Item 3 Default Upon Senior Securities 77
Item 4 Submission of Matters to a Vote to Security Holders 77
Item 5 Other Information 77
Item 6 Exhibits and Reports on Form 8-K 78
SIGNATURES 88
2
HIENERGY TECHNOLOGIES, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE COMPANIES)
CONSOLIDATED BALANCE SHEET
FOR THE THREE MONTHS ENDED JULY 31, 2006 AND YEAR ENDED APRIL 30, 2006
July 31 April 30
2006 2006
(Unaudited)
------------- -------------
CURRENT ASSETS
Cash and cash equivalents $ 556,497 $ 51,281
Accounts receivable 200,000 37,398
Inventory, net 822,218 875,218
Other current assets 213,305 22,992
------------- -------------
Total current assets 1,792,019 986,889
------------- -------------
PROPERTY AND EQUIPMENT, net 723,908 788,722
------------- -------------
TOTAL ASSETS $ 2,515,927 $ 1,775,611
============= =============
CURRENT LIABILITIES
Cash advances -- 22,453
Accounts payable 1,982,138 2,090,182
Accrued expenses 137,017 629,383
Accrued payroll and payroll taxes 174,551 258,262
Accrued interest 92,924 78,487
Capital lease obligations 11,736 8,455
Notes payable 196,666 7,125
Notes payable - related parties 85,000 85,000
Convertible notes payable 534,201 583,019
Convertible notes payable - related parties 40,853
Other current liabilities 1,026,024 703,105
------------- -------------
Total current liabilities 4,240,257 4,506,323
LONG-TERM CAPITAL LEASE OBLIGATIONS 2,082 8,106
Total liabilities 4,242,339 4,514,429
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' DEFICIT
Preferred stock, $0.001 par value 20,000,000 shares authorized
211.64 shares authorized and outstanding -- --
Common stock. $0.001 par value 100,000,000 shares
authorized 67,668,751 and 64,202,668 shares issued and outstanding 67,852 64,203
Additional paid-in capital 39,758,092 35,802,969
Committed common stock, 1,788,480 and 3,964,635 shares, respectively 687,443 1,826,598
Deficit accumulated during the development stage (42,239,799) (40,432,588)
------------- -------------
Total shareholders' deficit (1,726,411) (2,738,818)
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 2,515,927 $ 1,775,611
============= =============
3
HIENERGY TECHNOLOGIES, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE COMPANIES)
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JULY 31, 2006 AND 2005 AND
FOR THE PERIOD FROM AUGUST 21, 1995 (INCEPTION) TO JULY 31, 2006
- --------------------------------------------------------------------------------
For the
Period from
August 21,
For the Three Months Ended 1995
---------------------------------- (Inception) to
July 31, July 31, July 31,
2006 2005 2006
(unaudited) (unaudited) (unaudited)
--------------- --------------- ---------------
OPERATING EXPENSES
General and administrative $ 784,793 $ 1,095,739 $ 25,721,055
Research and development 390,341 418,016 5,632,033
--------------- --------------- ---------------
TOTAL OPERATING EXPENSES 1,175,134 1,513,755 31,353,088
LOSS FROM OPERATIONS (1,175,134) (1,513,755) (31,353,088)
--------------- --------------- ---------------
OTHER INCOME (EXPENSE)
Interest income -- 19 10,123
Other income -- 480 19,434
Interest expense (575,313) (29,848) (2,359,122)
Induced Conversion Expense -- -- (733,460)
Financing expense -- -- (223,710)
Loss on Disposal of Equipment (2,614) (26,093) (2,614)
Loss on foreign currency transaction (3,487) -- (13,589)
Penalty expense on issuance of
convertible promissory notes
as a penalty for late registration -- (12,000) (63,000)
Penalty expense on issuance of
common stock and warrants
as a penalty for late registration (50,663) (472,108) (6,076,756)
--------------- --------------- ---------------
Total other expense, net (632,077) (539,550) (9,442,694)
--------------- --------------- ---------------
LOSS BEFORE PROVISION FOR INCOME TAXES (1,807,211) (2,053,305) (40,795,782)
PROVISION FOR INCOME TAXES -- -- 14,983
--------------- --------------- ---------------
NET LOSS (1,807,211) (2,053,305) (40,810,765)
BENEFICIAL CONVERSION FEATURE GRANTED
ON PREFERRED STOCK (512,742) -- (1,280,173)
PREFERRED STOCK DIVIDEND (597,397) -- (1,259,000)
--------------- --------------- ---------------
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS $ (2,917,350) $ (2,053,305) $ (43,349,938)
=============== =============== ===============
Net loss per share $ (0.04) $ (0.04)
=============== ===============
BASIC AND DILUTED LOSS AVAILABLE TO
COMMON SHAREHOLDERS PER SHARE $ (0.04) $ (0.04)
=============== ===============
BASIC AND DILUTED WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING 68,917,466 50,052,579
=============== ===============
4
HIENERGY TECHNOLOGIES, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE COMPANIES)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED JULY 31, 2006 AND 2005 AND
FOR THE PERIOD FROM AUGUST 21, 1995 (INCEPTION) TO JULY 31, 2006
- --------------------------------------------------------------------------------
For the
Period from
August 21,
For the Three Months Ended 1995
---------------------------------- (Inception) to
July 31, July 31, July 31,
2006 2005 2006
(unaudited) (unaudited) (unaudited)
--------------- --------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,807,211) $ (2,053,305) $ (40,810,766)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities
Depreciation 63,844 66,574 834,563
Loss on inventory impairment 11,000 37,000 52,898
Loss on disposal of property and equipment 2,614 26,093 167,196
Gain on payroll tax settlement (344,947)
Issuance or committed issuance of common stock
for services rendered 33,600 165,011 5,696,234
Issuance or committed issuance of common stock
for contribution 16,250
Common stock issued for legal settlement 13,440
Issuance of common stock as compensation expense --
for services rendered from minority shareholders 18,923
Warrants issued or committed for services rendered 5,507 25,373 1,023,904
Financing expense in connection with the --
issuance of warrants 957,170
Expensing of stock options for services rendered 99,988 32,000 2,480,434
Additional compensation to officer in the form of --
convertible note payable - related party 42,171
Amortization of deferred compensation 1,646,192
Amortization of debt discount on convertible --
notes payable 542,794 2,002,216
Issuance of convertible notes payable as a penalty for the
delayed registration of the underlying common stock 12,000 63,000
Issuance or committed issuance of common stock as a penalty
for the delayed registration of shares of common stock 13,830 166,652 3,783,111
Issuance or commitment to issue warrants as a penalty for the
delayed registration of the underlying common stock 36,832 305,455 2,293,159
(Increase) decrease in
Accounts receivable (162,602) 275,957 (200,002)
Inventory 64,000 (293,668) (1,018,484)
Other current assets (127,313) (12,757) (180,265)
Increase (decrease) in
Accounts payable (130,496) 1,303,476 2,850,156
Accrued expenses (145,366) 131,773 484,017
Accrued payroll and payroll taxes (83,711) 44,266 941,251
Accrued interest 17,385 28,030 306,105
Other current liabilities 322,919 8,524 1,026,024
--------------- --------------- ---------------
Net cash (used in) provided by operating activities $ (1,264,386) $ 268,454 $ (15,856,050)
--------------- --------------- ---------------
5
HIENERGY TECHNOLOGIES, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE COMPANIES)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED JULY 31, 2006 AND 2005 AND
FOR THE PERIOD FROM AUGUST 21, 1995 (INCEPTION) TO JULY 31, 2006
- --------------------------------------------------------------------------------
For the
Period from
August 21,
For the Three Months Ended 1995
---------------------------------- (Inception) to
July 31, July 31, July 31,
2006 2005 2006
(unaudited) (unaudited) (unaudited)
--------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment $ (1,644) $ (1,164,746) $ (1,543,804)
Sales of property and equipment -- 21,250 21,250
--------------- --------------- ---------------
Net cash used in investing activities (1,644) (1,143,496) (1,522,554)
--------------- --------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock in
private placement $ -- $ -- $ 3,547,406
Offering costs on issuance of common stock in
private placement (196,793)
Proceeds from issuance or committed issuance of common stock 1,040,000 6,315,424
Offering costs on issuance of common stock (12,000) (262,148)
Proceeds from the issuance of preferred stock 1,413,750 2,393,051
Offering costs on issuance of preferred stock (222,267) (401,169)
Proceeds from issuance of common stock subject
to rescission rights 1,355,000
Proceeds from issuance of common stock subject to buy-back 250,518
Proceeds from collection of subscription receivable for net
sales of common stock subject to buy-back 443,482
Recapitalization of reverse merger 14
Proceeds from exercise of stock options in subsidiary 7,164
Proceeds from issuance of common stock upon exercise
of warrants 1,663,509
Proceeds from notes payable 197,505 256,505
Payment on capital lease obligations (2,743) (9,504)
Payment on notes payable (478) (39,447)
Proceeds from issuance of notes payable - related parties 947,853
Payments on notes payable - related parties (807,265)
Proceeds from convertible notes payable 385,000 1,385,000
Payments on convertible notes (100,000)
Proceeds from convertible notes payable - related parties 111,900
Payments on convertible notes payable - related parties (35,400)
Proceeds from convertible notes payable
subject to rescission rights 685,000
Proceeds from collection of subscription receivable for
sale of convertible note payable sold subject to rescission rights 425,000
--------------- --------------- ---------------
Net cash provided by financing activities 1,771,245 1,027,522 17,935,100
--------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents 505,215 152,480 556,496
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 51,281 18,452 --
--------------- --------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 556,496 $ 170,932 $ 556,496
=============== =============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid $ 7,963 $ 15,076 $ 36,307
=============== =============== ===============
Income taxes paid $ -- $ 800 $ 14,983
=============== =============== ===============
6
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the three months ended July 31, 2006 and 2005 and the period from August
21, 1995 (inception) to July 31, 2006, the Company issued or committed to issue
361,281, 313,359 and 14,810,464 shares of common stock, respectively, for
services rendered or to be rendered. The shares of common stock were valued at
$149,100, $220,391, and $5,811,733, respectively.
During the three months ended July 31, 2006 and 2005 and the period from August
21, 1995 (inception) to July 31, 2006, the Company issued or committed to issue
warrants to purchase 0, 127,179, and 1,435,408 shares of common stock,
respectively, for services rendered or to be rendered. The warrants were valued
at $0, $33,900, and $1,435,408, respectively.
Of the 361,281 common shares issued or committed to be issued during the three
months ended July 31, 2006, 89,286 common shares off-set accounts payable in the
amount of $37,500.
Of the shares valued at $75,600 for services rendered or to be rendered during
the three months ended July 31, 2006, $63,000 remained capitalized as prepaid
filing fees as of July 31, 2006.
During the three months ended July 31, 2006 and 2005 and the period from August
21, 1995 (inception) to July 31, 2006, the Company expensed $13,831, $166,652,
and $3,783,141, respectively, for the issuance or committed issuance of 36,396,
236,946 and 3,680,490 shares of common stock, respectively, as a penalty for the
late registration of common stock.
During the three months ended July 31, 2006 and 2005 and the period from August
21, 1995 (inception) to July 31, 2006, the Company expensed $41,889, $305,455,
and $2,298,666, respectively, for the issuance or committed issuance of warrants
to purchase 568,122, 1,067,838, and 6,959,445 shares of common stock,
respectively, as a penalty for the late registration of the common shares
underlying investor warrants.
During the three months ended July 31, 2006, the Company issued 55.3 shares of
convertible preferred stock and warrants to purchase 921,088 shares of common
stock, in connection with the exchange of certain outstanding convertible notes
payable in the amount of $491,500 and accrued interest of $10,912.
During the three months ended July 31, 2006, the Company recorded debt discounts
totaling $152,760 upon issuance of notes and convertible notes payable in the
face amount of $385,000 with detachable warrants to purchase 390,000 common
shares.
During the three months ended July 31, 2006 and 2005, the Company issued or
committed to issue 547,378 and 106,667 shares of common stock as offering costs,
respectively.
During three months ended July 31, 2006, the Company issued 775,000 unregistered
shares of common stock for the settlement of litigation valued at the fair
market of the common stock issued of $294,500.
The accompanying notes are an integral part of these consolidated financial
statements
7
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
NOTE 1 - ORGANIZATION AND LINE OF BUSINESS
General
HiEnergy Technologies, Inc. ("HiEnergy", together with its subsidiaries, the
"Company") is a nuclear technologies-based company that can effectively decipher
chemical formulas or compositions of unknown substances, without human
intervention. The Company's Atometer(TM) detectors incorporate a proprietary
interrogation process that activates a selected target with high energy
neutrons, causing the contents to emit gamma rays of varying energies, which are
then decoded, with the use of proprietary algorithms, to determine with a high
level of confidence, the chemical composition of the targeted substance.
Since inception, the Company has primarily focused on the research, development
and commercialization of Atometer(TM) explosives detectors for the homeland
security and defense markets. The Company is currently marketing to governmental
and private entities, including the transit sector and military, as well as
negotiating licenses for the distribution of, the following Atometer(TM)
detectors:
o SIEGMA(TM) 3E3 and 3M3 - portable, suitcase-borne systems for the
remote detection and confirmation of home-made bombs, also known as
Improvised Explosive Devices or "IEDs" and uniquely addressing the
significant problems posed by unattended or suspicious packages.
o CarBomb Finder(TM) 3C4 - vehicle-borne system for the detection and
confirmation of car bombs, in which the sensors are deployed from
the vehicle at the end of a mechanical arm and placed in proximity
to the target.
o CarBomb Finder(TM) 3C5 - in-ground vehicle screening system for the
detection and identification of car bombs at checkpoints and
chokepoints, developed in response to the high demand for critical
infrastructure protection and improved perimeter defense.
o STARRAY(TM) - all-terrain robot-borne detector for the stand-off
detection of unexploded ordnance, landmines and IEDs, which can also
be configured and integrated in various robotic and remote-vehicle
platforms.
To date, the Company has yet to generate meaningful revenues from the sale of
its products or the licensing of its technologies and has devoted the bulk of
its efforts and resources to the research, design, testing and development of
its proprietary "stoichiometric" sensor devices and underlying technologies.
The Company expects to continue the research and development of applications of
its technologies and their further exploitation both internally and through
collaboration with third parties in order to advance its detector system designs
to provide more rapid and precise detection and analytical capabilities and
improve their reliability in the field and capitalize on the commercial
opportunities that have been identified. Although the Company has developed
prototypes in programs with the U.S. Department of Defense and the Department of
Homeland Security and expects to continue to pursue and receive additional
research and development funds through these agencies, most of the Company's
research related work has been funded internally in order to capture full
intellectual property rights from any inventions or processes that may arise.
Prior to January 2005, HiEnergy also had one majority-owned subsidiary, HiEnergy
Microdevices, Inc., which was incorporated in Delaware on August 21, 1995 and
was the vehicle through which "Atometry" was initially developed by the
Company's former Chairman, Dr. Bogdan Maglich ("Microdevices"). As a result of a
short-form merger, which became effective on January 25, 2005, the Company
assumed all of Microdevices' assets and liabilities and Microdevices ceased to
exist as a separate entity as of that date.
RECAPITALIZATION BETWEEN HIENERGY AND SHAREHOLDERS OF MICRODEVICES
On April 25, 2002, SLW, which was then a "public shell company", was taken over
by the stockholders of Microdevices in a transaction commonly referred to as a
"reverse takeover". Under this transaction, which was structured as a voluntary
exchange of shares, the stockholders of Microdevices, including the Company's
former Chairman, Dr. Bogdan Maglich, obtained the right to receive up to 64%
percent of the outstanding shares of SLW. The stockholders of SLW prior to the
voluntary share exchange retained, collectively, 36% of SLW. The reverse
takeover was accounted for as a re-capitalization of Microdevices for accounting
purposes, in a manner similar to a pooling of interests, with Microdevices as
the accounting acquirer (reverse acquisition). Since the Company (formerly SLW)
was a "public shell company", with limited assets and liabilities at the date of
the acquisition and no significant operations prior to the acquisition, no pro
forma information has been presented. As a result of the reverse takeover,
Microdevices became the Company's majority-owned subsidiary, and was later
merged with the Company in January 2005 in a short-form merger through which the
Company committed to issue 452,029 shares of common stock to the remaining
stockholders of HiEnergy Microdevices on the basis of 22.3524 HiEnergy shares
for 1 share of Microdevices (the same ratio that was used in the original
voluntary share exchange). Additionally, we may be required to issue up to
704,190 shares of the Company's common stock to former holders of options and
warrants of Microdevices who hold rights to purchase HiEnergy shares at $0.156
per share. These rights survived the merger and may be exercised any time before
April 25, 2007, subject to the payment of promissory notes representing the
purchase price.
8
NOTE 2 - GOING CONCERN
The accompanying unaudited consolidated financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America, which contemplate continuation of the Company as a going concern.
During the three months ended July 31, 2006 and the period from August 21, 1995
(inception) to July 31, 2006, the Company incurred net losses available to
common shareholders of approximately $1,807,180, $2,053,305, and $43,835,103,
respectively, and had negative cash flows from operations of approximately
$15,848,085 for the period from August 21, 1995 (inception) to July 31, 2006. In
addition, the Company had an accumulated deficit of $42,239,799 and was in the
development stage as of July 31, 2006. These factors raise substantial doubt
about the Company's ability to continue as a going concern.
Recovery of the Company's assets is dependent upon future events, the outcome of
which is indeterminable. Successful completion of the Company's development
program and its transition to the attainment of profitable operations is
dependent upon the Company achieving a level of sales adequate to support its
cost structure. In addition, realization of a major portion of the assets on the
accompanying balance sheets is dependent upon the Company's ability to meet its
financing requirements and the success of its plans to develop and sell its
products. The accompanying unaudited consolidated financial statements do not
include any adjustments relating to the recoverability and classification of
recorded asset amounts nor amounts and classification of liabilities that might
be necessary should the Company be unable to continue in existence.
In addition to the capital raised as of July 31, 2006 through private
placements, the Company is currently attempting to raise additional capital
through private placement offerings. Unless the Company raises additional funds,
either by debt or equity issuances, management believes that its current cash on
hand will be insufficient to cover its working capital needs, unless and until
the Company's generates sales at a sufficient level to cover operating expenses.
The Company is also involved in various litigation matters. Although the effect
of such litigation on the Company's financial statements is indeterminable at
this time, in certain cases the Company has entered into various settlement
agreements pursuant to which it must make cash payments within certain
deadlines. If the Company does not have sufficient cash on hand to meet its
obligations under these settlement agreements, it may be subject to judgments
which could adversely affect the Company's ability to continue as a going
concern.
Historically, the Company has been able to raise capital through self-managed
private placements of our equity to accredited and institutional investors. From
October 2005 to August 2006, the Company received through private placements a
total of approximately $3.7 million in proceeds from financing activities,
including $856,500 from the sale of convertible notes payable, $1.6 million from
the exercise of warrants through its special warrant offer, as well as net
proceeds of $1.3 million from the sale of the Company's Series B Convertible
Preferred stock as part of a private placement of up to $5 million of Series B
Convertible Preferred Shares, as further discussed in Note 17.
Until such time as the Company can (i) generate sufficient sales revenues to
fund its operations and research and development costs; and/or (ii) leverage its
financial and developmental capabilities through strategic partnerships which
provide financial support; and/or (iii) receive significant governmental grants,
cooperative funding or purchase contracts, the Company will be required to raise
an additional $3 to $4 million through the sale of securities to cover estimated
expenditures for the remainder of fiscal 2007, subject to the successful
implementation of its plan and the reduction of operating expenses. While the
Company believes it will be able to obtain the additional financing, there can
be no assurance that such financing will be available on acceptable terms and
conditions, or at all. Furthermore, there can be no assurance that the Company
will be successful in implementing its plan.
9
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Development Stage Enterprise
The Company is a development stage company as defined in Statement of Financial
Accounting Standards ("SFAS") No. 7, "Accounting and Reporting by Development
Stage Enterprises." All losses accumulated since inception have been considered
as part of the Company's development stage activities.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with instructions for Form 10-QSB and Item 310 of
Regulation S-B. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for a complete
set of annual financial statements. The Company believes its disclosures are
adequate so that the information presented is not misleading. These consolidated
financial statements should be read with the annual audited financial statements
and the notes thereto included in the Company's Annual Report on Form 10-KSB for
the year ended April 30, 2006, and other reports filed with the SEC. In the
opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation of results of the
financial position and operations of the Company have been included in the
accompanying consolidated financial statements.
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period, and actual results could
differ from those estimates. Results of operations for the three months ended
July 31, 2006 are not necessarily indicative of the results that may be expected
for the fiscal year ending April 30, 2007, or for any other period.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
HiEnergy and its wholly-owned subsidiaries, HiEnergy Defense Inc., HiEnergy
Europe Ltd., HiEnergy Mfg Company, HiEnergy International Co., HiEnergy Leasing
Co., and its former majority-owned subsidiary, HiEnergy Microdevices, Inc. All
significant inter-company accounts and transactions have been eliminated.
Reclassifications
For comparative purposes, prior periods' consolidated financial statements have
been reclassified to conform with report classifications of the current period.
Accounts Receivable
Accounts receivable consist of amounts due from a customer for services under a
purchase agreement due in 30 to 60 days.
Inventories
The Company values its inventory at the lower of cost or market with cost being
determined using the first-in, first-out method. The Company evaluates the
carrying value of its inventory and reserves for potentially excess and obsolete
inventories based on estimated demand quantities on hand, physical condition and
technical functionality. Unfavorable changes in estimates of excess and obsolete
inventory would result in an increase in cost of revenue and a decrease in gross
profit. Inventory used for research and development is expensed with appropriate
state use tax accrued in the period such inventory is used. Total inventory held
at July 31, 2006 was $822,218, and consisted entirely of components acquired in
anticipation of future assembly and sale, and is stated net of allowances for
excess and obsolete inventory.
10
Other Current Assets
Other current assets consist primarily of capitalized insurance premiums,
prepaid consulting and services, and deposits. Insurance premiums and prepaid
consulting and services are capitalized and amortized over the estimated period
for which such services are provided.
Property and Equipment
Property and equipment, including leasehold improvements, are capitalized at
cost and stated net of depreciation and amortization. Depreciation and
amortization are computed using the straight-line method over the useful life of
the property and equipment and over the lease term for leasehold improvements.
Expenditures for additions and major improvements are capitalized. Repair and
maintenance costs are expensed as incurred. When property and equipment are
retired or otherwise disposed of, the related cost and accumulated depreciation
are removed from the accounts and offsetting gains or losses are recorded as
other income or loss.
Useful lives for property and equipment are as follows:
Prototype Equipment 5 years
Laboratory Equipment 5 years
Furniture and Fixtures 5 years
Website Development 5 years
Leasehold Improvements 20 months
Long-Lived Assets
The Company evaluates the carrying value of long-lived assets for potential
impairment whenever events or changes in circumstances indicate that the
carrying value of such assets may not be recoverable. Measurement of the
impairment loss is determined when the fair value of the asset subsequent to the
impairing event or circumstance is less than the carrying value of that asset.
Fair value is generally determined using valuation techniques such as the
present value of expected future cash flows. Impairment losses are recognized in
accordance with Statement of Financial Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets".
Intangible Property
The Company has filed several patent applications within the United States and
internationally. The outcome is indeterminable. Patent costs consist mainly of
legal expenses which are expensed as incurred.
Fair Value of Financial Instruments
The carrying value of cash, accounts receivable and accounts payable approximate
their fair values because of the short term maturity of these instruments.
The fair value of the Company's debt, which consists of notes payable, notes
payable - related parties, convertible notes payable - related parties and
convertible notes payable, is estimated on the quoted market prices for the same
or similar issues or on the current rates offered to the Company for debt of the
same remaining maturities. Such fair value approximates the respective carrying
values of its debt.
Convertible Notes Payable with Beneficial Conversion Features
The Company accounts for convertible notes payable ("CNP") with non-detachable
conversion options that are in-the-money ("beneficial conversion features"), at
the commitment date, in accordance with EITF Issue No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios" and EITF Issue No. 00-27, "Application of Issue
No. 98-5 to Certain Convertible Instruments".
The Company has issued convertible notes payable with beneficial conversion
features, with and without detachable warrants. Where the Company has issued
convertible notes payable with beneficial conversion features without detachable
warrants the difference between the conversion price and the fair value of the
common stock, at the commitment date, is recorded as a debt discount and is
amortized to interest expense over the redemption period of the convertible note
payable, in accordance with EITF No.'s 98-5 and 00-27. The redemption period is
the shorter of the period to maturity, conversion, or other event which requires
the Company to rescind the convertible note payable.
11
Where the Company has issued convertible notes payable with beneficial
conversion features with detachable warrants, the Company allocates the proceeds
between the convertible note payable and the warrants using the relative fair
value of the individual elements at the time of issuance. The difference between
the conversion price, adjusted for the relative fair value of the convertible
notes payable, and the fair value of the common stock, which is limited to the
relative fair value of the convertible note payable, is recorded as a debt
discount. The relative fair value of the warrants is also recorded as a debt
discount. The total debt discount is amortized to interest expense over the
redemption period of the convertible note payable.
Penalties Associated with Late Registration of Common Stock
The Company has entered into Stock Purchase Agreements ("SPA") and Convertible
Note Purchase Agreements ("CNPA") that include provisions that require the
Company to register, as freely trading, the shares of common stock and the
shares of common stock issuable upon exercise of warrants or conversion of
convertible notes payable within certain deadlines, in a Registration Statement
on Form SB-2. Furthermore, if such shares of common stock are not registered
within certain deadlines, a penalty becomes payable or accruable in like
securities. The common stock, warrants and convertible notes payable (the
"penalty securities") issued for late registration are described in Notes 18 and
19, and the commitment to issue such penalty securities is described in Notes 17
and 21.
The Company accounts for penalty securities issued as a penalty for late
registration as a penalty expense, which is recognized in the period the penalty
securities are earned. The fair value of the penalty securities is determined as
follows: common stock is valued at the fair value of the common stock on the
date earned; warrants have been valued using the Black-Scholes option-pricing
valuation model on the date earned; and convertible notes payable are valued at
the face value of the note on the date earned.
Warrants
Noncash Exercise of Warrants - The Company will issue on occasion warrants to
purchase common stock where the holder is entitled to exercise the warrant,
utilizing a non-cash transaction, when the exercise price is less than the fair
value of the common stock. The Company accounts for the issuance of common stock
on the non-cash exercise of warrants as a cost of capital.
Warrants Issued As Financing and Offering Costs - The Company issues common
stock with detachable warrants to investors. The company will also issue
warrants to shareholders who identify and arrange for successful third party
investors in the Company's common stock. These warrants are recorded as a cost
of capital.
Stock-Based Compensation
As of May 1, 2006, the Company adopted SFAS No. 123(R), "Share-Based Payment"
("SFAS 123(R)"), which requires the measurement and recognition of compensation
expense for all share-based payment awards made to employees and directors
including employee stock options based on estimated fair values, ratably over
the requisite service period of the award. SFAS 123(R) supersedes the Company's
previous accounting under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") for periods beginning in
fiscal 2005.
In March 2005, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 ("SAB 107") relating to SFAS 123(R). The Company applied the
provisions of SAB 107 in its adoption of SFAS 123(R). The Company adopted SFAS
123(R) using the modified prospective transition method, which requires the
application of the accounting standard as of May 1, 2006, the first day of the
Company's fiscal year ending April 30, 2007. The Company's Consolidated
Financial Statements as of and for the three months ended July 31, 2006 reflect
the impact of SFAS 123(R). In accordance with the modified prospective
transition method, the Company's Consolidated Financial Statements for periods
prior to May 1, 2006 have not been restated to reflect, and do not include, the
impact of SFAS 123(R).
Prior to the adoption of SFAS 123(R), the Company accounted for stock-based
awards to employees and directors using the intrinsic value method in accordance
with APB 25 as allowed under Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"). Generally, no
compensation expense was recognized by the Company in its financial statements
in connection with the awarding of stock option grants to employees provided
that, as of the grant date, all terms associated with the award are fixed and
the fair value of our stock, as of the grant date, is equal to or less than the
amount an employee must pay to acquire the stock. The Company had recognized
compensation expense in situations where the fair value of our common stock on
the grant date was greater than the amount an employee must pay to acquire the
stock.
12
Stock-based compensation expense recognized under SFAS 123(R) consisted of
share-based payment awards made to employees and directors including employee
stock options based on estimated fair values. Stock-based compensation expense
recognized in the Company's Consolidated Statement of Operations for the three
months ended July 31, 2006 includes compensation expense for share-based payment
awards granted prior to, but not yet vested as of April 30, 2006, based on the
grant date fair value estimated in accordance with the pro forma provisions of
SFAS 123 and compensation expense for the share-based payment awards granted
subsequent to May 1, 2006 based on the grant date fair value estimated in
accordance with the provisions of SFAS 123(R). As stock-based compensation
expense recognized in the Consolidated Statement of Operations for the three
months ended July 31, 2006 is based on awards ultimately expected to vest, it
has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to
be estimated at the time of grant and revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates. In the Company's pro
forma information required under SFAS 123 for the periods prior to fiscal 2006,
the Company accounted for forfeitures as they occurred.
The Company uses the Black-Scholes option-pricing model to recognize the value
of stock-based compensation expense for all share-based payment awards.
Determining the appropriate fair-value model and calculating the fair value of
stock-based awards at the grant date requires considerable judgment, including
estimating stock price volatility, expected option life and forfeiture rates.
The Company develops estimates based on historical data and market information,
which can change significantly over time. A small change in the estimates used
can have a relatively large change in the estimated valuation, and consequently,
a material effect of the results of operations. The weighted average fair value
of stock options granted during the three months ended July 31, 2006 was $0.17.
For stock options granted during the three months ended July 31, 2006, the
weighted average assumptions for grants were a risk free interest rate of 5.1%
an expected life of 3 years, volatility of 87.5% and dividend yield of 0%.
The following table presents net loss attributable to common stockholders and
loss per share for the three month period ended July 31, 2005, as reported, to
the pro forma amounts that were recorded based on the fair value on the grant
dates consistent with the method of SFAS No. 123, prior to the adoption of SFAS
123(R) on May 1, 2006:
Three Months Ended
July 31,
------------------
2005
------------------
Net loss attributable to common stockholders $ (2,053,305)
Stock-based employee compensation included in
reported net income 32,000
Total stock-based employee compensation expense
determined under fair value based methods for
all awards, net of related tax effects (465,313)
------------------
Pro forma net loss attributable to common
stockholders $ (2,486,618)
Basic loss per share:
As reported (0.04)
Pro forma (0.05)
13
The following table represents the employee stock option activity during the
period for the three months ended July 31, 2006:
Wt Ave
Wt Ave Aggregate Remaining
Number of Exercise Instrinsic Contractual
Shares Price Value Term (yrs.)
---------- -------- ---------- ----------
Outstanding Options @ 4/30/06 7,678,439 $ 0.66
Granted 422,500 $ 0.34
Exercised 0 $ --
Canceled (1,225,000) $ 0.57
----------
Options Outstanding @7/31/06 6,875,939 $ 0.66 $437,134 3.6
Options Exercisable @7/31/06 6,185,939 $ 0.69 $436,834 4.0
The weighted average fair value at date of grant for options granted was
estimated using the Black-Scholes option-pricing model. Assumptions used by the
Company related to the three months ended July 31, 2006 were:
Dividend Yield: 0%
Expected stock price volatilty: 87.5%
Risk Free Interest Rate Range: 4.92% thru 5.22%
Expected Life of Options: 3 years
The number of shares available for future stock grants to employees and
directors was zero at July 31, 2006. No options were exercised in the three
months period ended July 31, 2006.
The following table summarizes our non-vested stock option activity for the
three month period ended July 31, 2006.
Wt Ave Approximate
Number Fair Fair
of Shares Value Value
--------- ------ -----------
Non-vested stock options @ 4/30/06 770,000 $0.36
Vested (325,000) $0.35 $112,779
Cancelled (177,500) $0.24
Granted 422,500 $0.17
--------
Non-vested stock options @ 7/31/06 690,000 $0.25
======== ======
During the three months ended July 31, 2006, the Company recognized $99,988 in
compensation expense which has been classified to general and administrative
expense. The approximate fair value of the unvested stock options outstanding at
July 31, 2006, totaled $213,083. The Company expects to recognize this expense
as follows:
Remaining this FY'07 $177,403
FY'08 35,680
--------
Total $213,083
========
Stock options and warrants issued to non-employees are accounted for in
accordance with SFAS No. 123(R) and EITF Issue No. 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services", and related interpretations.
Comprehensive Income
The Company presents comprehensive income in accordance with SFAS No. 130,
"Reporting Comprehensive Income." This statement establishes standards for
reporting comprehensive income and its components in a financial statement.
Comprehensive income as defined includes all changes in equity (net assets)
during a period from non-owner sources. Comprehensive income is not presented in
the Company's consolidated financial statements since it did not have any of the
components of comprehensive income in any period presented.
14
Research and Development Costs
The Company accounts for research and development costs in accordance with SFAS
No. 2, "Accounting for Research and Development Costs". Research and development
costs are charged to operations as incurred. As described in section 3.50 of the
Government Contract Audit Guide for Fixed-Price Best-Efforts Cost Sharing
Arrangements, amounts earned under the Company's grants and development
agreements with the U.S. Department of Defense and U.S. Department of Homeland
Security have been offset against research and development costs, in accordance
with the provisions of that section.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," which requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in the financial statements or tax returns. Under this
method, deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be realized.
The provision for income taxes represents the tax payable for the period and the
change during the period in deferred tax assets and liabilities.
Net Loss per Share
The Company calculates net loss per share in accordance with SFAS No. 128,
"Earnings per Share." Basic loss per share is computed by dividing the net loss
available to common shareholders by the weighted-average common shares
outstanding. Diluted loss per share is computed similar to basic loss per share
except that the denominator is increased to include the number of additional
common shares that would have been outstanding if the potential common shares
had been issued and if the additional common shares were dilutive. Because the
Company has incurred net losses, basic and diluted loss per share is the same.
The following potential shares of common stock have been excluded from the
computation of diluted net loss per share for the periods presented because the
effect would have been anti-dilutive.
As of July 31,
-----------------------
2006 2005
---------- ----------
Stock Options 9,534,844 8,600,655
Warrants 19,715,019 28,557,982
Convertible notes payable and accrued interest -
related Parties -- 802,060
Convertible notes payable and accrued interest 1,066,792 649,512
Shares of common stock deemed subject to rescission
rights -- 68,546
Shares held by Company to be issued upon
payment of outstanding promissory notes -- 704,190
---------- ----------
Total 30,316,655 39,382,945
---------- ----------
15
Recently Issued Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An Amendment
of ARB No. 43, Chapter 4" ("SFAS 151"). SFAS 151 amends the guidance in ARB No.
43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts
of idle facility expense, freight, handling costs, and wasted material
(spoilage). Among other provisions, the new rule requires that items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs
be recognized as current-period charges regardless of whether they meet the
criterion of "so abnormal" as stated in ARB No. 43. Additionally, SFAS 151
requires that the allocation of fixed production overhead to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
151 is effective for fiscal years beginning after June 15, 2005 and is required
to be adopted beginning on January 1, 2006. The Company has recently commenced
acquiring inventory and has no sales or cost of goods and the adoption of SFAS
151 did not have a material impact on the Company's consolidated results of
operations and financial condition.
In December 2004, the FASB issued SFAS No. 152 "Accounting for Real Estate
Time-Sharing Transactions - An Amendment of FASB statements No. 66 and 67"
("SFAS 152"). SFAS 152 amends SFAS 66 and 67 to reference the financial
accounting and reporting guidance for real estate time-sharing transactions that
is provided in AICPA Statement of Position (SOP) 04-2, Accounting for Real
Estate Time-Sharing Transactions. SFAS 152 is effective for financial statement
for fiscal years beginning after June 15, 2005. The adoption of SFAS 152 did not
have a material impact on the Company's consolidated results of operations and
financial condition.
In December 2004, the FASB issued SFAS No. 153 "Exchanges of Non-monetary Assets
- - An Amendment of APB opinion No. 29" ("SFAS 153"). SFAS 153 clarifies that
exchanges of non-monetary assets should be measured based on the fair value of
the assets exchanged, with a general exception for exchanges that have no
commercial substance. SFAS 153 is effective for non-monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS
153 did not have a material impact on the Company's consolidated results of
operations and financial condition.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154") which replaces Accounting Principles Board Opinions
No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in
Interim Financial Statements-An Amendment of APB Opinion No. 28." SFAS 154
provides guidance on the accounting for and reporting of accounting changes and
error corrections. It establishes retrospective application as the required
method for reporting a change in accounting principle and the reporting of a
correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years which begin after December 15, 2005.
The adoption of SFAS 151 did not have a material impact on the Company's
consolidated results of operations and financial condition.
In November 2005, FASB issued FASB Staff Position (FSP) Nos. FAS 115-1 and FAS
124-1, "The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments." FSP Nos. FAS 115-1 and FAS 124-1 amend SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", SFAS No.
124, "Accounting for Certain Investments Held by Not-for-Profit Organizations",
as well as APB Opinion No. 18, "The Equity Method of Accounting for Investments
in Common Stock." This guidance nullifies certain requirements of EITF 03-1,
"The Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments." FSP Nos. FAS 115-1 and FAS 124-1 include guidance for evaluating
and recording impairment losses on debt and equity investments, as well as new
disclosure requirements for investments that are deemed to not be
other-than-temporarily impaired. FSP Nos. FAS 115-1 and FAS 124-1 also require
other-than-temporary impaired debt securities to be written down to their
impaired value, which becomes the new cost basis. FSP Nos. FAS 115-1 and FAS
124-1 are effective for fiscal periods beginning after December 15, 2005. The
adoption did not have a material impact on the Company's consolidated results of
operations and financial condition.
In February 2006, the FASB issued SFAS No. 155 ("SFAS 155"), "Accounting for
Certain Hybrid Financial Instruments -- an amendment of FASB Statements No. 133
and 140." SFAS 155 permits fair value measurement for any hybrid financial
instrument that contains an embedded derivative that otherwise would require
bifurcation. This statement is effective for all financial instruments acquired
or issued after the beginning of an entity's first fiscal year that begins after
September 15, 2006. The Company is still evaluating the statement but does not
expect the adoption of SFAS 155 to have a material impact on the Company's
consolidated financial statements.
In March 2006, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 156, "Accounting for Servicing of Financial Assets" ("SFAS 156").
SFAS 156 provides relief for entities that use derivatives to economically hedge
fluctuations in the fair value of their servicing rights and changes how gains
and losses are computed in certain transfers or securitizations. SFAS 156 is
effective as of the beginning of the first fiscal year that begins after
September 15, 2006. The Company is still evaluating the statement but does not
expect the adoption of SFAS 156 to have a material impact on the Company's
consolidated financial statements.
16
In June 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes," which is an interpretation of SFAS No. 109
("SFAS 109"), "Accounting for Income Taxes." FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise's financial statements
in accordance with SFAS 109 and prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. FIN 48 is effective
for fiscal years beginning after December 15, 2006. The Company is currently
evaluating the effect that the adoption of FIN 48 may have on its financial
position or results of operations.
NOTE 4 - CASH CONCENTRATION
A cash concentration risk arises when the Company has more cash in one financial
institution then is covered by insurance. At July 31, 2006, the Company had
cash in banks in excess of FDIC insured amounts totaling $ 514,845.
NOTE 5 - OTHER CURRENT ASSETS
Other current assets consisted of the following as of the periods ended:
July 31, 2006 April 30, 2006
------------- --------------
Prepaid professional services $ 73,000 $ --
Insurance premiums 131,600 13,287
Other 8,705 9,705
-------- -------
Total $213,305 $22,992
======== =======
NOTE 6 - INVENTORY
Total net inventory as of July 31, 2006 was $822,218. The Company values its
inventory at the lower of cost or market. The Company performs quality control
reviews of its components to ensure that each component meets the quality and
design standards required for final assembly of finished goods. For components
identified as possibly defective or of not meeting the specific design
requirements for finished goods, the company records an inventory reserve for
components of uncertain use in product assembly or records an impairment charge
for components which require additional work to bring them to the quality and
standard of product design or written off if determined that the component is
obsolete and virtually incompatible with the design and standard of finished
goods. At July 31, 2006, included in net inventory is a $26,000 inventory
reserve for components owned by the Company which were being repaired at July
31, 2006. In addition, included in operating loss for the three months ended
July 31, 2006 is $14,826 for restocking fees on the return of inventory
previously purchased by the Company.
SFAS 2, "Accounting for Research and Development Costs", allows an enterprise to
draw from its normal inventory and convert the inventory for research and
development purposes as a capital asset. During the three months July 31, 2006,
the Company did not convert any of its inventory to research and development
equipment.
17
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of the periods ended:
July 31, 2006 April 30, 2006
------------- --------------
Equipment $1,194,373 $1,196,786
Furniture and fixtures 85,903 85,903
Leasehold improvements 51,150 51,150
---------- ----------
1,331,426 1,333,839
Less accumulated depreciation 607,518 545,117
---------- ----------
Total $ 723,908 $ 788,722
========== ==========
Depreciation and amortization expense for the three months ended July 31, 2006
and 2005 and the period from August 21, 1995 (inception) to July 31, 2006, was
$63,844, $66,574, and $834,563 respectively.
NOTE 8 - ACCRUED PAYROLL AND PAYROLL TAXES
At April 30, 2004, the Company's former subsidiary, Microdevices, recorded a
payroll tax liability of approximately $386,000 for potential payroll taxes due
for unknowlingly filing incomplete payroll tax returns or not filing payroll tax
returns with respect to the issuance of shares of Microdevices common stock to
officers, employees, directors, legal advisors and consultants for services
rendered prior to April 30, 2002. Prior to April 30, 2006, we amended previously
filed payroll tax returns and filed missing tax returns to ensure that the
Microdevices payroll tax returns were in compliance with payroll tax regulations
for the payroll tax period of 1998 through June 30, 2002 and allowed the taxing
authorities to determine and assess the payroll tax, penalties and interest due
for these periods. As result, the Company paid approximately $25,000 in payroll
taxes, penalties and interest during the 2006 fiscal year and entered into an
installment agreement with the Internal Revenue Service to make $2,000 monthly
payments on tax only principal due of $44,317. As of April 30, 2006, based on
this IRS assessment, we reduced the $386,000 estimated payroll tax accrual to
the actual IRS assessment and recorded the approximate $345,000 adjustment to
operating expenses. At July 31, 2006, the balance of the Microdevices liability
assessed by the Internal Revenue Service for 1998 through June 30, 2002 was
$49,279 for the installment note and related penalties and interest due.
Excluding the payroll tax liability mentioned above, the Company had accrued
payroll and payroll taxes of $125,272 as of July 31, 2006. This amount includes
$27,410 in accrued payroll and payroll tax, $39,167 of deferred salary, as well
as $51,591 for earned vacation of employees
NOTE 9 - CAPITAL LEASE OBLIGATIONS
Capital lease obligations consisted of the following as of the periods ended:
July 31, 2006 April 30, 2006
------------- --------------
Capital lease for equipment, secured by the equipment with an effective
interest rate of 17.205% per annum through October 2007, with monthly
payments in the amount of $237. $ 2989 $ 3,556
Capital lease for equipment, secured by the equipment, with an effective
interest rate of 8.99% per annum through October 2007, with monthly
payments in the amount of $817.64. 10,829 13,005
------- -------
13,818 16,561
Less current portion 11,736 8,455
------- -------
Long-term portion $ 2,082 $ 8,106
======= =======
18
NOTE 10 - NOTES PAYABLE
Notes payable consisted of the following as of the periods ended:
July 31, 2006 April 30, 2006
------------- --------------
Notes payable to former employees for deferred
compensation, unsecured and bearing interest at 5% per
annum. $ 7,125 $7,125
-------- ------
Notes payable to former consultant due in connection with
settlement agreement, bearing interest at 5% per annum
and due December 2006. 189,541 --
-------- ------
196,666 7,125
Less current portion 196,666 7,125
-------- ------
Long-term portion $ -- $ --
======== ======
NOTE 11 - NOTES PAYABLE - RELATED PARTIES
Notes payable - related parties consisted of the following as of the periods
ended:
July 31, 2006 April 30, 2006
------------- --------------
Notes payable to a shareholder of the Company, unsecured,
bearing interest at 10.5% per annum, or 15% per annum
upon default, and due on demand. $40,000 $40,000
Note payable to a shareholder of the Company, unsecured,
bearing interest at 10.5% per annum, and due on demand 45,000 45,000
------- -------
85,000 85,000
Less current portion 85,000 85,000
------- -------
Long-term portion $ -- $ --
======= =======
NOTE 12 - CONVERTIBLE NOTES PAYABLE - RELATED PARTIES
Convertible notes payable - related parties consisted of the following as of the
periods ended:
July 31, 2006 April 30, 2006
------------- --------------
Convertible notes payable ("CNP") to two board members,
unsecured, bearing interest of 10% per annum, and, coupled
with the debt discount attributable to the beneficial
conversion feature and detachable warrants estimated
effective annual interest rates in the range of 27% to 52%,
due in March and April 2007. The CNP were issued with
detachable warrants to purchase 22,600 shares of common
stock at $0.60 per share with a three year term. The face
value of the CNP is $56,500, the recording of which reflects
an unamortized debt discount of $15,647 for the relative
values of the beneficial conversion feature and detachable
warrants. The note holders have the option to convert the
principal and accrued interest into shares of common stock
at $0.60 per share at any time until the later of the
prepayment date or the maturity date. Any outstanding
balance of the CNP, plus any unpaid interest, will be
automatically exchanged into the next financing secured by
the Company in the amount of $2,000,000 or above, at a 10%
discount. In June 2006, the CNP together with accrued
interest were automatically exchanged into shares of the
Company's Series B Convertible Preferred Stock. $-- $40,853
--- -------
-- 40,853
Less current portion -- 40,853
--- -------
Long-term portion $-- $ --
=== =======
19
NOTE 13 - CONVERTIBLE NOTES PAYABLE
April 30, 2006 April 30, 2006
-------------- --------------
Convertible notes payable ("CNP") to various investors,
unsecured, bearing interest of 10% per annum, and, coupled
with the debt discount attributable to the beneficial
conversion feature and detachable warrants, estimated
effective annual interest rates in the range of 31% to 74%,
due in October and November 2006. The CNP were issued with
detachable warrants to purchase 400,000 shares of common
stock at $0.80 per share with a three year term. The face
value of the CNP is $500,000, the recording of which
reflects an unamortized debt discount of $65,799 for the
relative values of the beneficial conversion feature and
detachable warrants. The note holders have the option to
convert the principal and accrued interest into shares of
common stock at $0.60 per share at any time until the later
of the prepayment date or the maturity date. Any outstanding
balance of the CNP, plus any unpaid interest, will be
automatically exchanged into the next financing secured by
the Company in the amount of $2,500,000 or above, at a 10%
discount. During the Company's special warrant offer,
360,000 shares of common stock were purchased upon exercise
of the detachable warrants at a reduced exercise price of
$0.20 per share, with the remaining warrants forfeited. See
"Note 17 - Commitments and Contingencies, Convertible Notes
Payable," for more information $434,201 $365,343
Convertible notes payable ("CNP") to an investor, unsecured,
bearing interest of 10% per annum, and, coupled with the
debt discount attributable to the beneficial conversion
feature and detachable warrants, estimated effective annual
interest rates in the range of 58% to 79%, due in September
and October 2006. The CNP were issued with detachable
warrants to purchase 120,000 shares of common stock at $0.60
per share with a three year term. The face value of the CNP
is $300,000, the recording of which reflects an unamortized
debt discount of $82,324 for the relative values of the
beneficial conversion feature and detachable warrants. The
note holders have the option to convert the principal and
accrued interest into shares of common stock at $0.30 per
share at any time until the later of the prepayment date or
the maturity date. Any outstanding balance of the CNP, plus
any unpaid interest, will be automatically exchanged into
the next financing secured by the Company in the amount of
$2,000,000 or above, at a 10% discount. In June 2006, the
CNP together with accrued interest were automatically
exchanged into shares of the Company's Series B Convertible
Preferred Stock. -- 217,676
Convertible notes payable ("CNP") to an investor, unsecured,
bearing interest of 10% per annum, and, coupled with the
debt discount attributable to the detachable warrants,
estimated effective annual interest rates in the range of
52% due May 2007. The CNP were issued with detachable
warrants to purchase 100,000 shares of common stock at $0.45
per share with a three year term. The face value of the CNP
is $100,000. The note holders have the option to convert the
principal and accrued interest into shares of common stock
at $0.30 per share at any time until the later of the
prepayment date or the maturity date. In August 2006, the
Company repaid the investor $100,000 CNP together with
accrued interest of $2,383. The related debt discount has
been fully amortized to interest expense at July 31, 2006. 100,000 --
-------- --------
534,201 583,019
-------- --------
Less current portion $534,201 $583,019
-------- --------
Long-term portion $ $ --
======== ========
20
In accordance with EITF No. 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" and
EITF No. 00-27, "Application of Issue No. 98-5 to Certain Convertible
Instruments", the Company has evaluated its sale of the above convertible notes
payable with detachable warrants for the beneficial conversion features. The
Company has allocated the proceeds from the placement of the debt to the
warrants and the debt based on their relative pro-rated values.
NOTE 14 - OTHER ACCRUED LIABILITIES
As of July 31, 2006, the Company had other current liabilities of $1,026,000 as
compared to $703,100 for the year ended April 30, 2006. Of this amount, $903,100
represents deposits made against the purchase of our devices and services with
customers. This amount is expected to remain as unearned revenue until the
applicable revenue recognition criteria are met the timing for which remains
uncertain to the Company.
NOTE 15 -RESEARCH AND DEVELOPMENT COSTS
To date, the Company has devoted the bulk of its efforts and resources to the
research, design, testing and development of sensor systems incorporating its
proprietary "stoichiometric" technologies for numerous governmental and
commercial applications and markets. The Company's technologies have the ability
to determine automatically, in a matter of tens of seconds and with a high
degree of accuracy, whether an object or container carries dangerous substances,
such as explosives, illicit drugs or biological agents, by deciphering the
chemical composition of select substances. Aside from its current applications,
management believes that its technologies have numerous other applications.
21
The Company's research and development expenses consist primarily of salaries
and benefits, facilities, depreciation, consulting services, supplies and
travel. The Company accounts for research and development costs in accordance
with SFAS No. 2, "Accounting for Research and Development Costs". Research and
development costs are charged to operations as incurred. As described in section
3.50 of the Government Contract Audit Guide for Fixed-Price Best-Efforts Cost
Sharing Arrangements, amounts earned under the Company's grants and development
agreements with the U.S. Department of Defense ("DoD") and U.S. Department of
Homeland Security (DHS) have been offset against research and development costs,
in accordance with the provisions of that section, in all periods presented.
Below is a summary of research and development costs for the following periods:
Period from
Three August 21, 1995
Months Ended July 31, (Inception) to
--------------------- ---------------
2006 2005 July 31, 2006
-------- -------- -------------
Research and development costs $390,341 $479,122 $ 7,406,027
Grant proceeds earned -- (61,106) (1,773,994)
-------- -------- -----------
Net research and development costs $390,341 $418,016 $ 5,632,033
-------- -------- -----------
NOTE 16 - RETIREMENT PLAN
In July 2005, the Company's Board of Directors approved a SIMPLE IRA Plan (the
"Plan"). Participation in the Plan is automatic for those employees who meet
eligibility requirements unless they decline participation. Under the Plan, the
Company provides matching contributions of up to 3% of each participating
employee's annual eligible compensation. The maximum employee contribution is
subject to regulatory limitations. The Company contributed $2,565 and 0 to the
Plan on behalf of its employees during the three months ended July 31, 2006 and
2005, respectively.
NOTE 17 - COMMITMENTS AND CONTINGENCIES
Series B Convertible Preferred Financing
In June and August 2006, the Company entered into Series B Convertible Preferred
Stock Purchase Agreements (the "Agreements") with select accredited investors
(the "Investors") for the sale of Series B Convertible Preferred Stock, par
value $0.001 per share (the "Series B Preferred Shares") and Series B-1 Warrants
and Series B-2 Warrants (collectively, the "Warrants"). As of July 31, 2006,
Investors subscribed a total of $2,116,403 of the offering, and the Company has
issued 211.64 of Series B Preferred Shares, Series B-1 Warrants for the purchase
of up to 2,116,403 shares of common stock and Series B-2 Warrants for the
purchase of up to 1,410,935 shares of common stock. Less commission and
financing expenses, and including the automatic exchange of certain outstanding
convertible notes payable plus accrued interest in the amount of $552,653, the
Company received a total of $1,262,617 in net proceeds.
The Series B Preferred Shares are convertible into shares of common stock of the
Company at $0.30 per share (the "Conversion Price"). The Conversion Price is
subject to downward adjustments in the event the Company issues or sells more
common stock, however, the Company is not required to make any adjustment to the
Conversion Price upon (i) issuances of any additional shares of common stock and
warrants therefore in connection with a merger, acquisition or consolidation,
(ii) issuances of additional shares of common stock pursuant to a bona fide firm
underwritten public offering of securities, (iii) any issuances of warrants to
purchase shares of common stock issued pursuant to the Agreement, (iv) issuances
of securities pursuant to the conversion or exercise of convertible or
exercisable securities issued or outstanding on or prior to the date hereof or
issued pursuant to the Agreement, (v) issuances of warrants to the placement
agent for the transactions contemplated by the Agreement or in connection with
other financial services rendered to the Company, (vi) the payments of any
dividends on the Series B Preferred Stock, (vii) issuances of additional shares
of common stock in connection with license agreements, joint ventures and other
strategic partnering arrangements so long as such issuances are not for the
primary purpose of raising capital, and (viii) issuances of common stock or the
issuance or grants of options to purchase common stock pursuant to the Company's
stock option plans and employee stock purchase plans outstanding on the date
hereof.
22
The Series B Preferred Shares have a liquidation preference of $10,000 per
share. The Series B Holders are entitled to receive, out of any assets at the
time legally available thereof and as declared by the Board of Directors,
dividends at the rate of 8% per share per annum until January 1, 2007, at which
time this rate will increase to 10%. If the Company has an effective
registration statement for the sale of the common shares to be received in
conversion of the Series B Preferred Shares and the closing bid price of the
Company's traded shares exceeds $1.00 for a period of 20 consecutive trading
days, the Series B Preferred Shares will automatically convert into shares of
common stock of the Company. The Series B-1 Warrants and Series B-2 Warrants are
exercisable until June 30, 2011 and have exercise prices of $0.45 and $0.60,
respectively the "Warrant Prices"). The Warrants provide the Investors with
ratchet rights, whereby the exercise price of the Warrants will be reduced to
equal the price of any new shares (or common share equivalents) sold below the
Warrant Prices. Further, commencing one (1) year following the date of issuance,
if (i) the traded market price of the shares of common stock of the Company is
greater than the Warrant Price and (ii) a registration statement under the
Securities Act provided for the resale of the shares underlying the Warrants is
not then in effect, the Investors may exercise the Warrants by cashless
exercise.
Until approximately December 31, 2007, the Investors have a right of first
refusal to participate in certain subsequent financings of the Company. This
right of first refusal is not triggered by issuances of shares of common stock
in connection with mergers, strategic partnering arrangements, or in bona fide
firm underwritten public offerings of our securities.
In connection with this Agreement, on June 30, 2006, the Company also entered
into a Registration Rights Agreement with the Investors. Under the Registration
Rights Agreement, the Company has committed to file, within 45 days following
the closing date, a "resale" registration statement covering all the shares of
common stock issuable upon conversion of the Series B Preferred Shares and any
dividends payable thereon and the shares of common stock issuable upon exercise
of Warrants and use its best efforts to have the registration statement declared
effective within 120 days following the closing date. If the Company fails to
register all shares issuable pursuant to this transaction within the required
time, the Company must pay the Investors 2.0% for the first calendar month and
1.0% per calendar month thereafter (and not to exceed 10% in the aggregate) of
the Investor's initial investment in the Preferred Stock until cured.
Under the Agreement, the Company is initially required to reserve a number of
shares of its common stock sufficient to effect the conversion of all the Series
B Preferred Shares and exercise of the outstanding Warrants. However, the
Agreement requires the Company to obtain shareholder approval by October 31,
2006 for the filing of an amendment to its Certificate of Incorporation to
increase the number of the Company's authorized shares of common stock
sufficient for it to reserve a number of shares of common stock equal to 120% of
the number of shares necessary to effect the conversion of the Series B
Preferred Shares and the exercise of the Warrants. In the event the Company has
not obtained the approval of its stockholders at such annual meeting, the
Company must pay the Investors 2.0% for the first calendar month and 1.0% per
calendar month thereafter (and not to exceed 10% in the aggregate) of the
Investor's initial investment in the Preferred Stock until cured.
The Company has evaluated the above for derivative liability accounting per SFAS
No. 133 and EITF 00-21, due to the anti-dilutive provisions in both the
convertible preferred stock and detachable warrants and deemed it not to apply
for the following reasons: (i) the Series B Preferred Shares and Warrants do not
have any contingencies due in stock on the inability to register the required
amount of shares of which the results are indeterminable; (ii) the Series B
Preferred Shares and Warrants include anti-dilutive clauses which are based on
the subsequent issuance of new equity or debt over which the Company has control
as to value and pricing and thus control as to whether or not the subsequent
issuance would be dilutive and result in an additional liability; such issuance
having no effect unless issued for less than the existing values, or if issued
for less than the existing values, would be only determinable at the point it is
issued; and (iii) the conversion or execution price of the Series B Preferred
Shares and Warrants is not based or determinable on any external factor and is
explicit in the terms of the agreement.
Consultancy Agreements and Contracts
In August 2004, the Company entered into a Retention Agreement with the
Company's current securities counsel, for legal services which include the
preparation and review of the Company's annual and quarterly reports, regulatory
filings and other assistance with corporate and contract needs as the Company
may request from time to time.
23
In April 2005, the Company entered into a subcontract with a global maintenance
and services company, in which the subcontractor as Exclusive Service Provider
will provide the Company with product support and aftermarket servicing,
including the installation, repair and preventative maintenance for all products
to be sold and deployed by the Company in the United States. Pursuant to the
subcontract, the Company will pay the contractor on an hourly basis for labor,
plus travel and expenses, and supply all necessary parts and technical support
to allow contractor to fulfill its obligations.
In June 2005, the Company entered into a contract with a consultant to provide
public media relations on a guaranteed placement basis. Under the contract, the
Company agrees to pay the consultant pursuant to a fixed fee schedule for
successful placements and media coverage incorporating the Company's products
and technologies.
In September 2005, the Company entered into a contract with a consultant to
provide investor relations. Under the contract, the Company agrees to pay the
consultant $2,000 per month and make timely reimbursements for any approved
expenses incurred.
In November 2005, the Company entered into an engagement letter with an attorney
to act as special counsel to the Company on discovery and litigation matters
related to the arbitration between HWH Enterprises and the Company. Pursuant to
the agreement, the Company will pay the attorney $200 per hour and agrees to
reimburse the attorney for any pre-approved expenses.
In January 2006, the Company entered into a new contract with a consultant to
provide engineering services and production planning for a six month-month
period. Major terms of the agreement are as follows:
o The Company will pay the consultant cash remuneration of $4,000 and
issue him restricted shares in the amount of $15,000 for each month
of services performed under the engagement.
o The Company will reimburse consultant for any pre-approved expenses
during the engagement.
o In the event the Company files a registration statement on S-8, the
Company will include restricted shares issued to the consultant for
resale and the Company has the option to prepay the consultant's
services with S-8 stock.
In January 2006, the Company entered into a reseller agreement with a
service-disabled veteran-owned small business (SDVO) related to the right to
market and resell the Company's products and services to federal agencies and
customers. The Company agreed to work with no other qualified SDVOSB in the
sales and marketing of its products and services. The reseller agreement and
related pricing expires in one year unless extended by mutual agreements.
In February 2006, the Company engaged a research physicist as a scientific
advisor and consultant to the Company to pursue funded cooperative research and
development with NATO, IAEA, EU and local governments and certain marketing
activities. Pursuant to the letter agreement, prior to commencing any work, the
Company will be required to pay the consultant a retainer of $40,000 in the form
of stock of the Company and reimburse any pre-approved expenses. Either party
may terminate the agreement at any time upon 60 days written notice to the
other.
In February 2006, the Company executed an engagement letter with an independent
contractor to provide radiation licensing, certification, training and auditing
services. Major terms of the agreement are as follows:
o The Company agrees to pay $150 for each hour invoiced by the
consultant during the engagement in cash and/or stock of the
Company.
o The Company has the option to prepay the consultant's services with
stock with an obligation to file any shares issued for services on a
registration statement.
o The Company will reimburse consultant for any pre-approved expenses.
In March 2006, the Company entered into a consultancy agreement with a senior
research scientist to provide software engineering, software documentation and
architecture for a six month-month period. Major terms of the agreement are as
follows:
o The Company will pay $60 for each hour invoiced by the consultant
during the engagement in cash and/or stock of the Company.
o The Company has the option to prepay the consultant's services with
stock with an obligation to file any shares issued for services on a
registration statement.
o The Company will reimburse consultant for any pre-approved expenses
during the engagement.
24
In April 2006, the Company entered into an agreement with a leading technology
solutions sales and distribution company related to non-exclusive rights to
market and resell the Company's products and services to governmental customers
in Singapore and China and exclusive rights to market and resell the Company's
products and services to the Beijing 2008 Summer Olympic Games.
In May 2006, the Company entered into a reseller agreement with a leading
governmental sales organization related to non-exclusive rights to market and
resell the Company's products and services to federal customers, including the
U.S. Department of Energy, which provides a reseller discount of up to 15%. The
reseller agreement expires in one year.
In June 2006, the Company entered into a contract with a consultant for Edgar
filing services in which it prepays one year of services with 180,000 restricted
shares of its common stock. Pursuant to the agreement, the Company issued the
service provider a three year warrant to purchase 50,000 shares of its common
stock with an exercise price of $0.60 per share, as the shares had not been
filed for registration on or before August 1, 2006.
In June 2006, the Company entered into a letter agreement with a sales
consultant to provide advisory services as to business strategy, new
product/innovation development, and sales and marketing. The Company will pay
the consultant a number of shares of common stock of the Company equal to $5,000
per month. With respect to any sales revenue received by the Company as a result
of the direct efforts of the consultant, the Company will pay the consultant a
sales commission of 15%, payable in the form of cash or shares of common stock
of the Company. The agreement may be terminated by any party with 30 days
written notice to the other.
In July 2006, the Company entered into a retention agreement with legal counsel,
in connection with the litigation of employment matters and other claims alleged
by the Company's former chief executive officer, including enforcement of
confidentiality agreements and other contract matters as the Company may request
from time to time. A deposit in the amount of $10,000 was made against future
services to be rendered.
In July 2006, the Company executed a professional services agreement with a
professional legal and financial staffing corporation. Two accounting
professionals and one legal professional are currently providing consulting
services to us from this corporation. Pursuant to the agreement we are to pay
the staffing corporation hourly payments for services in the amount of $70 to
$130 per hour, plus overtime, to be invoiced and paid on a weekly basis for the
duration of the assignment. Any balances due for services rendered and remaining
outstanding after thirty (30) days of the invoice date shall incur late charges
at the greater of (i) 1 1/2% per month or (ii) the highest rate allowable by
law.
In July 2006, the Company entered into a reseller agreement with a leading
reseller related to non-exclusive rights to market and resell the Company's
products and services to local, state and federal customers, as well as private
security companies, and provides for a sales commission of 10%. The reseller
agreement expires in one year.
Placement Agency Agreements
In September 2005, the Company entered into an exclusive agreement with a
placement agent to arrange for the sale of debt or equity securities. Major
terms of the agreement are as follows:
o The term of the agreement will be for one year or in the event the
placement agent has not completed financing of at least $2 million
in the first 30 days, the Company may cancel at any time with 5
days' written notice of cancellation.
o The Company will pay a retainer in the amount of $10,000 to be
deducted from any fees due under the agreement.
o The Company will pay a success fee equal to 10% of any of the gross
proceeds received by the Company derived from the efforts of the
placement agent for any amounts up to $3 million and 7% for that
amount in excess of $3 million, plus reimbursable expenses not to
exceed $10,000 without written approval of the Company.
o In connection with advisory services related to strategic
transactions, the Company shall pay the placement agent a cash fee
of 3% of the aggregate value/consideration received.
o The Company will issue the placement agent warrants to purchase 8%
of the amounts of securities placed with investors through the
efforts of the placement agent. The exercise price of the warrants
will be equal to the price at which the securities were placed. The
warrants vest immediately, expire four years from the date of grant,
and include "piggyback" registration rights.
o As part of the agreement, the Company executed a separate letter
indemnifying the agent and its related parties for services provided
under the engagement letter.
25
Employment Agreements
In January 2005, the Company entered into an employment agreement for the
employment of Roger W.A. Spillmann as Secretary and Vice President. This
agreement is still in effect; however Mr. Spillmann now serves as the company's
President and CEO. Major commitments in the agreement are as follows:
o The Company must pay him an annual base salary of $200,000, of which
$140,000 will be payable in cash, and the remainder in deferred
compensation.
o The Company granted him a stock option to purchase 500,000 shares of
common stock at $0.72 per share, and vesting on December 31, 2005.
o If terminated by the Company without cause, the Company must pay him
on the termination date, severance pay in an amount equal to six (6)
months of the minimum annual base salary.
o The Company will provide him with four (4) weeks paid vacation as
well as comprehensive family medical and dental healthcare benefits.
In January 2006, the Company entered into an employment agreement with a senior
scientist in which the Company committed to pay the scientist an annual base
salary of $120,000 and, after six months of continuous employment, employee
stock options to purchase 35,000 shares of common stock per year at the market
price on the issuance date, with equal vesting on a bi-annual basis. Pursuant to
the employment agreement, upon sixty days of employment the scientist will
receive standard medical and dental healthcare benefits.
In December 2005, the Company entered into an employment agreement with a
software engineer in which the Company committed to pay the employee an annual
base salary of $75,000 and, after six months of continuous employment, employee
stock options to purchase 37,500 shares of common stock per year at the market
price on the issuance date, with equal vesting on a bi-annual basis. Pursuant to
the employment agreement, upon sixty days of employment the engineer will
receive standard medical and dental healthcare benefits and upon ninety days
qualify for enrollment in the Company's IRA plan.
In April 2006, the Company entered into an employment agreement with its Chief
Scientist. Major commitments included in the agreement are as follows:
o The Company must pay him an annual base salary of $120,000 per year
effective May 1, 2006. of which $20,000 will be accrued as deferred
compensation and payable in equal installments on a quarterly basis.
o The Company has the option to prepay him with common shares having a
value equivalent to six (6) months of the above stated salary in the
event the Company files a registration statement on S-8.
o The Company will grant him a stock option to purchase 80,000 shares
of common stock at the market price on the issuance date with equal
vesting on a bi-annual basis.
o On each anniversary of his original hire date of July 19, 2004, the
Company will grant him a stock option to purchase 30,000 shares of
common stock per year at the market price on the issuance date, with
equal vesting on a bi-annual basis.
o The Company will provide him with three (3) weeks paid vacation as
well as comprehensive family medical and dental healthcare benefits.
In June 2006, the Company entered into an employment agreement with its CAD
Manager. Major commitments included in the agreement are as follows:
o The Company must pay him an annual base salary of $50,000 per year
effective July 1, 2006.
o The Company will grant him an employee stock option to purchase
25,000 shares of common stock upon acceptance of the agreement, and
on each anniversary thereafter, at the market price on each issuance
date with equal vesting on a bi-annual basis.
o The Company will provide him with two (2) weeks paid vacation as
well as comprehensive family medical and dental healthcare benefits.
Purchase and Sales Agreements
In April and May 2004, the Company issued a purchase order for neutron
generators at a total cost of approximately (euros) 678,000, approximately
$813,600. The Company had the option to lease these units from the vendor for up
to 12 months but has returned all units prior to the 12 month period due to
performance issues under the lease.
26
In May 2004, the Company ordered gamma radiation detectors, electronic cooling
systems and other components for a total cost of $1,368,000. The Company began
receiving the detectors and components in May 2004 and continued to receive
units at varying intervals. Due to its decision to better balance inventory, the
Company halted delivery and in February 2006 the Company returned 13 of the
electronic cooling units for a credit against payables due the vendor and
incurred a restocking fee of 20%. In the event the Company receives orders
sufficient to justify adding detectors, the vendor has agreed to extend the
Company a purchasing discount of 10% so as to recover a portion of the
restocking fee.
In November 2004, the Company issued a purchase order for two advanced neutron
generators at a total cost of approximately $335,000 for use in research and
development related to the Company's SuperSenszor(TM) program and the Company's
cooperative research agreement with the TSA. As of April 30, 2006, the Company
has paid for and received one of the generators and has made a non-refundable
deposit of $92,997 against the remaining unit with the balance due upon
acceptance following delivery which to date has been delayed due to technical
issues.
In January 2005, the Company received an order for one SIEGMA(TM) system, along
with a down payment in the amount of $75,000, and a guarantee of the balance
upon delivery, from a company located in Tenerife, Canary Islands, Spain.
Payment of the balance in the amount of $227,000 is due upon testing and
acceptance of the unit. As of July 31, 2006, the payments have been included in
other accrued liabilities and are expected to remain recognized as unearned
revenue until the applicable revenue recognition criteria are met.
In May 2005, the Company entered into an Equipment Sales Agreement with a major
transit authority in connection with the purchase of two SIEGMA(TM) systems for
an aggregate sum of $603,104. Accordingly, on June 10, 2005, the Company
received Purchase Order No. 4500233769 from the Commonwealth of Pennsylvania in
the amount of $603,104. In September 2005, the Company received a down payment
in the amount of $375,581 and in January 2006, the Company received the balance
of the purchase order. Pursuant to the agreement, the Company will provide one
year of maintenance and service, and radiation safety consulting, as well as
software and hardware upgrades for a period of six months. As of July 31, 2006,
the payments have been included in other accrued liabilities and are expected to
remain recognized as unearned revenue until the applicable revenue recognition
criteria are met.
In May 2006, the Company entered into an Equipment Sales Agreement with a major
transit authority in connection with the purchase of a four-year maintenance and
support services program for an aggregate sum of $200,000. During the first
year, the Company will provide the buyer with any upgrades made to the hardware
and software delivered as part of its cooperative sales program. Accordingly,
the Company received Purchase Order No. 4500327526 from the Commonwealth of
Pennsylvania in the amount of $200,000 and then full payment in August 2006. As
of July 31, 2006, the payments have been included in other accrued liabilities
and are expected to remain recognized as unearned revenue until the applicable
revenue recognition criteria are met.
Finance Agreements
In June 2006, in connection with the renewal of its Directors and Officers
insurance policy, the Company entered into a finance agreement for the payment
of $105,302 in insurance premiums over a 10 month period in equal installments
of $9,110. Total remaining payments under the finance agreement as of July 31,
2006 are $81,986.
In June 2006, in connection with the renewal of its commercial general liability
policy, the Company entered into a finance agreement for the payment of $14,062
in insurance premiums. As of July 31, 2006, total remaining payments under the
finance agreement are $9,324, payable over 8 months in equal installments of
$1,165.
In June 2006, in connection with the renewal of its workman's compensation
policy, the Company entered into a finance agreement for the payment of $32,128
in insurance premiums. As of July 31, 2006, total remaining payments under the
finance agreement are $22,500, payable over 9 months in equal installments of
over 8 month period in equal installments of $2,843.
Lease Agreement
In October 2002, the Company entered into a three-year operating lease agreement
with one of its directors at that time for its corporate offices in Irvine,
California. In October 2005, the Company extended the lease for an additional
year adding 2,265 square feet of space within the same building, bringing the
total building space to 13,262. The new space is being used for additional
offices, inventory storage, with space set aside for some product assembly. The
Company also has an option for additional space if needed for expanded assembly
or manufacturing. The Company also leases 2,400 feet of outdoor testing space
which is included in the monthly rent under the terms of the addendum. The
addendum for one additional year provides for monthly rent of $17,591. The
addendum to the lease expires in October 2006 and as of July 31, 2006, the
aggregate future minimum payment under the lease agreement was $52,773.
27
Settlement Agreement
On June 9, 2006, the Company entered into a Confidential Settlement Agreement
and Mutual Release with a former consultant, Yeffet Security Consultants, Inc.
("YSCI"), which provides for a mutual reconciliation of disputes. As part of the
Settlement Agreement, YSCI released the Company from all claims to recover the
$449,540 being sought and forfeited its options to purchase up to 1,000,000
shares of our common stock. Pursuant to the Settlement Agreement, the Company
made a cash payment of $27,000 and is obligated to make additional cash payments
in the amount of $36,541 representing accrued and unpaid services and expenses
incurred in 2003, and $153,000. The remaining cash payments are due 150 days
following the execution of the Settlement Agreement together with simple
interest of 8% per annum on any unpaid balance accruing from the execution of
the Settlement Agreement until full payment, provided that the Company has an
additional thirty-day cure period to pay this debt if needed. Pursuant to the
Settlement Agreement, the Company issued 775,000 shares (the "Settlement
Shares") of its common stock to YSCI. In the event, the Company breaches its
obligations of the Settlement Agreement relating to the payment of money or the
issuance of shares, YSCI, after providing written notice and five business days
to cure any such breach, may have the arbitrator enter a judgment for the unpaid
balance of the cash payments plus the cash value of any undelivered stock. In
connection with the Settlement Shares issued, the Company recorded an expense of
$249,500 based on the fair value of the common stock on the date of the
settlement.
In December 2005, a claim was filed against the Company with the County Court of
Dallas County by Lockwood Greene Engineers Inc. ("LGE") (Cause No.
cc-05-12059-b), in which LGE sought collection of a fee in the amount of
$44,707.50 allegedly owed to it for engineering and construction services
purported to have been provided to us during the fiscal year ended 2005. On July
20, 2006, the Company entered into a Confidential Settlement Agreement (the
"Settlement Agreement") with CH2M Hill Lockwood Greene as the successor to LGE.
As part of the Settlement Agreement, LGE agreed to immediately cause the lawsuit
to be dismissed and both parties released each other from any and all other
claims each party might have against the other. Pursuant to the terms of the
Settlement Agreement, the Company is required to pay LGE an aggregate of $40,000
in four installments of $10,000, due respectively on July 21, 2006, October 20,
2006, January 19, 2007 and April 20, 2007. In the event the Company fails to
make an installment payment by the required date, it has a ten-day period to
cure. In the event the Company does not make the payment within the cure period,
LGE would be entitled to refile the lawsuit seeking payment for the unpaid
amounts due under the Settlement Agreement, plus any accrued legal fees and
interest as allowed by law from the date the unpaid installment was due.
Litigation
In May 2003, Barry Alter brought a lawsuit against the Company in the New Castle
County Court of Chancery in Delaware to recover the advancement of expenses in
the amount of $24,000 he allegedly incurred in response to an SEC investigation
which mirrored the Company's investigation by the SEC, and for which Mr. Alter
obtained separate legal counsel to represent him. That action was identified as
Civil Action No. 20320NC. On June 17, 2003, Mr. Alter notified the Company that
this action had been voluntarily dismissed without prejudice. However, to date,
there has been no settlement with Mr. Alter, and there can be no assurance that
the claims he asserted against the Company will not be resuscitated at some time
in the future.
In January 2005, the Company was served with a Summons and Class Action
Complaint For Violations of Federal Securities Laws, which was filed on October
18, 2004, in the Federal District Court for the Southern District of California
under case number SACV04-1226 GLT. The Complaint filed named the Company and its
former Chairman, Bogdan C. Maglich, among other named defendants, on behalf of a
class of persons who acquired the stock of the Company during the period from
February 22, 2002 through July 8, 2004. In February 2005, plaintiff's counsel
filed a First Amended Complaint entitled and styled, "In re: HiEnergy
Technologies, Inc. Securities Litigation," Master File No. 8:04-CV-01226-DOC
(JTLx), alleging various violations of the Federal securities laws, generally
asserting the same claims involving Philip Gurian, Barry Alter, and the
Company's failure to disclose their various securities violations including,
without limitation, allegations of fraud. The First Amended Complaint seeks,
among other things, monetary damages, attorney's fees, costs, and declaratory
relief. The Company engaged two legal firms to vigorously defend itself in this
matter and assess the impact of the pending lawsuit. On Friday, March 25, 2005,
the Company timely filed responsive pleadings as well as Motions to Dismiss the
Plaintiffs' First Amended Complaint arguing that the Complaint failed to state a
claim upon which relief can be granted. On June 17, 2005, the Court issued an
Order Granting the Motions to Dismiss (the "Order"), finding that the Plaintiffs
failed in the First Amended Complaint to allege causation of loss resulting from
any alleged omissions and/or misrepresentations of the Company or Dr. Maglich,
to sustain a cause of action for securities fraud under Section 10(b) of the
Exchange Act and Rule 10b-5 of the SEC, that the Plaintiffs had failed to plead
actual reliance on any allegedly false or misleading filings of the Company to
sustain a claim under Section 18 of the Exchange Act, and that the Plaintiffs
had failed to allege a primary violation of any securities laws to sustain a
claim for a violation of Section 20(a) of the Exchange Act. On July 5, 2005, the
Plaintiffs filed a Second Amended Complaint in compliance with the Court's
Order. On October 24, 2005, the Court issued a Minute Order granting in part and
denying in part Motions to Dismiss filed by the Company, finding that the
Plaintiffs failed in the Second Amended Complaint to sustain a cause of action
for securities fraud under Section 10(b) of the Exchange Act and Rule 10b-5 of
the SEC against Dr. Maglich and for claims that the Company filed false and
misleading financial statements and executed suspicious stock sales. On November
14, 2005, the Court held a scheduling conference at which the Plaintiff informed
the Company that it would not file a Third Amended Complaint. In accordance with
the Scheduling Order from the Court, class representative motions are to be
filed within 90 to 120 days and pre-trial conference has been scheduled for
September 11, 2007. Company counsel will respond to any motions with appropriate
challenges to its legal sufficiency to state a claim upon which relief may be
granted. As of date, the costs to defend the class action have been substantial
and it is unable to predict an exact amount, or even a meaningful estimate, of
the aggregate costs that may be incurred, at this time.
28
In April 2005, a claim was filed against the Company with the 101st Judicial
District Court, Dallas County, Texas by Data Discovery Inc., ("DDI") (Civil
Action No. 3-05-CV-0949-M). DDI, representing one party of a dissolved
partnership, is seeking the collection on behalf of the partnership of $107,300
allegedly owed to it for services purported to have been fully-provided to the
Company. The Company engaged local counsel and filed, on May 10, 2005, a Notice
of Removal to move the case to federal court, and a Motion for Dismissal. In
July 2005, the District Court delivered a Memorandum Opinion and Order granting
the Company's Motion for Dismissal and ordered that within twenty days DDI amend
its suit to the satisfaction of the District Court, or the order will become a
dismissal with prejudice, which would bar DDI from filing any other suit against
the Company related to the subject matter of its current claim. In August 2005,
DDI filed a new lawsuit on behalf of the partnership which is expected to go
before the Court following an appropriate period for discovery. In August 2006,
the Company entered into settlement discussions with DDI and in September 2006,
DDI caused the lawsuit to be dismissed without prejudice. There can be no
assurance that the claims DDI asserted against the Company will not be
resuscitated at some time in the future.
In October 2005, a claim was filed against the Company with the Supreme Court of
the County of New York, New York by HWH Enterprises ("HWH") (Index No.
603438/05). HWH is seeking collection of $101,621.18 allegedly owed to it for
its public relations services purported to have been provided to the Company
during the prior fiscal year. The Company engaged local counsel and intends to
defend itself and counsel will respond with appropriate challenges. As of this
date, the Company and its legal counsel have made no other determination as to
the merits of, or possible defenses to, the claim, and are unable to predict a
meaningful estimate of the costs of defending against the claim at this time.
In November 2005, a claim was filed against the Company with the District Court
of Orange County, California by SBI-USA ("SBI"). SBI is seeking collection of a
fee in the amount $50,000 allegedly owed to it for financial advisory services
purported to have been provided to the Company during the fiscal year ended
2003. In July 2006, we agreed to mediation and entered into settlement
discussions to avoid further litigation costs and in September 2006, the Company
and SBI entered into a settlement agreement which provides for a mutual
reconciliation of disputes and a dismissal of the claim.
In December 2005, a claim was filed against the Company with the County Court of
Dallas County by Lockwood Greene Engineers Inc. ("LGE") (Cause No.
cc-05-12059-b). LGE is seeking collection of a fee in the amount of $35,039
allegedly owed to it for engineering and construction services purported to have
been provided to the Company during the fiscal year ended 2005. In July 2006,
the Company and LGE entered into a Confidential Settlement Agreement and Mutual
Release which provides for a mutual reconciliation of disputes.
Potential Legal Actions
In December 2005, the Company received a letter from EADS North America, Inc.
("EADS") alleging breaches by the Company of a lease agreement between the
Company and EADS, dated April 29, 2004 (the "Lease"). Pursuant to the terms of
the Lease, EADS was to deliver ten neutron generators on a fixed schedule agreed
upon by both parties. The Company received four of the ten neutron generators
with significant delays due to production and support issues and ceased payments
pending resolution. Prior to the end of the Lease, the Company returned the four
generators it had received due to non-performance by EADS and sought termination
of the contract. The letter from EADS alleges that the Company failed to meet
its payment obligations, demands early termination payments, cancellation of
discounts and other charges unrecognized by the Company, and threatens
litigation in the event the Company fails to cure immediately. The Company has
recorded $239,017 for lease payments in accordance with terms of the lease while
it attempts to resolve the matter. In June 2006, the Company received a
supplemental letter from EADS detailing additional charges for premature
cancellation and return of equipment in an amount equal to $280,415. The Company
disputes these additiona charges as of this date, no legal action has been filed
by either party and the Company intends to defend itself against any legal
proceeding that may be brought by EADS on the basis indicated in this letter.
The Company is unable to predict a meaningful estimate of the costs of defending
itself against any possible legal action, should one be filed in the future. The
Company currently sources neutron generators from other trusted vendors and its
ability to manufacture its products has not been materially impacted by this
dispute.
29
Minority Shareholders
On January 25, 2005, Microdevices was effectively merged into the Company
through a short form merger effected by the Company and certified by the
Secretary of the State of Delaware, whereupon the Company assumed all assets and
liabilities of Microdevices. Under the terms of the merger, the Company issued
452,029 shares of common stock to the remaining stockholders of HiEnergy
Microdevices on the basis of 22.3524 HiEnergy shares for 1 share of HiEnergy
Microdevices (the same ratio that was used in the original voluntary share
exchange). Additionally, we may be required to issue up to 704,190 shares of the
Company's common stock to former holders of options and warrants of Microdevices
who hold rights to purchase HiEnergy shares at $0.156 per share. These rights
survived the merger and may be exercised any time before April 25, 2007, subject
to the payment of promissory notes representing the purchase price.
Convertible Notes Payable
As of July 31, 2006, the Company had outstanding $600,000 of convertible notes
payable ("CNP") issued to investors, which together with accrued interest of
$40,075 are convertible into 2,133,583 shares of common stock. The CNP have been
recorded net a remaining unamortized debt discount of $65,799 for the relative
values of the beneficial conversion feature and detachable warrants. The holders
have the option to convert the principal and accrued interest into shares of
common stock at a conversion price of $0.30 per share at any time until the
later of the prepayment date or the maturity date, and will automatically
exchange into the Company's Series B Convertible Preferred Offering at a 10%
discount pursuant to the terms of the CNP. In August 2006, the Company repaid an
investor $100,000 CNP together with accrued interest of $2,383.
Penalty Securities
After August 2003, the Company entered into certain stock and convertible note
purchase agreements which contain a provision that requires the Company to (i)
register, as freely trading, the shares of common stock and the shares of common
stock issuable upon exercise of warrants or conversion of the convertible notes
payable within certain deadlines, in a Registration Statement on Form SB-2; and
(ii) pay or accrue a penalty in like securities if such shares of common stock
are not registered within the specified deadlines. In accordance with the
relevant registration rights provisions in these agreements, the Company has
paid or accrued penalties due purchasers in these offerings, because the Company
failed to meet the specified deadlines for having a Registration Statement on
Form SB-2 declared and maintained effective.
In December 2005 the Company's Board approved a special warrant offer allowing
investors to exercise their existing warrants at greatly reduced exercise
prices. In conjunction with this offer each participating investor forfeited any
right to receive penalties after November 2005. However, for investors who did
not participate in the special warrant offer, the Company remains obligated to
honor these registration rights and to issue additional securities as a result
of the related penalties, and it will incur additional financial costs or
penalties until such time as all registerable shares under the agreements have
in fact been registered or when the penalties become impermissible as a matter
of law as prescribed in the instrument or can be sold without registration under
Rule 144. The Company and its stockholders are subject to substantial dilution
as a result of the Company's inability to register shares as required by the
Company's agreements.
Government Contract Commitments
On July 18, 2005, the Company executed a Time and Material Subcontract in the
amount of $333,688 with Integrated Concepts & Research Corporation (ICRC), which
was awarded as part of ICRC's Prime Contract Number DAAE07-02-C-L062 with the
United States Army Tank - Automotive and Armaments Command, Warren Michigan
(TACOM). Under the Subcontract, the Company will deliver one CarBomb Finder(TM)
head unit and provide the engineering and technical support necessary for its
integration in the SmarTruck II Multi-Mission Vehicle. In early 2006, ICRC
requested an extension under the subcontract and at present the finished
prototype is expected to be completed and field tested by the U.S. Army and D.C.
Capitol Hill Police by year end. Funding of the program was provided through a
supplemental authorization of the Defense Appropriations Act for Fiscal Year
2005. As of July 31, 2006, the Company has received payment in the amount
of $260,114 for its performance. Funding of the program was provided through a
supplemental authorization of the Defense Appropriations Act for Fiscal Year
2005. ICRC will pay the Company's time and material costs on a periodic basis
during the term of the contract, for which the Company is required to submit
monthly written reports detailing its progress under the subcontract. The
Company recognizes the proceeds from the subcontract as an offset against
research and development expenses following the submission of the monthly
written reports. Pursuant to the subcontract, when the written report is
accepted by ICRC, the Company receives payment in about 30 to 45 days, or no
later than 5 days after payment by the U.S. Army Contracting Officer to ICRC.
30
The Company's entitlement to the above-mentioned funding is conditioned upon its
compliance with the terms and conditions of the respective SBIR contract and
cooperative agreement, as well as applicable federal regulations, including
auditing of the expenditure of the resources for allowable purposes by grantor
agencies of the federal government or their designees. The Company believes that
any commitments or obligations that may arise from cost disallowance or
sanctions as a result of those audits are not expected to be material to its
financial statements.
NOTE 18 - COMMON STOCK
Common Stock Issued or Committed for Cash
During the three months ended July 31, 2006 and 2005 and the period from August
21, 1995 (inception) to July 31, 2006, the Company issued or committed to issue
0, 3,022,225 and 17,316,321 shares of common stock, respectively, in exchange
for cash of $0, $1,040,000 and $8,364,424, respectively.
Common Stock Issued or Committed for Services Rendered or to be Rendered
During the three months ended July 31, 2006 and 2005 and the period from August
21, 1995 (inception) to July 31, 2006, the Company issued or committed to issue
361,281, 313,359 and 14,810,464 shares of common stock, respectively, in
exchange for services rendered or to be rendered, valued at the fair market of
the common stock issued of $149,100, $220,391 and $5,811,733, respectively. Of
the 361,281 common shares issued or committed to be issued during the three
months ended July 31, 2006, 89,286 common shares off-set accounts payable in the
amount of $37,500.
Details of the services performed, in consideration for the common stock, during
the three months ended July 31, 2006, are as follows:
o During the three months ended July 31, 2006, 180,000 unregistered
shares of common stock valued at $75,600 were committed to be issued
for Edgar filing services.
o During the three months ended July 31, 2006, the Company issued or
committed to issue a total of 25,000 unregistered shares of common
stock valued at $11,000 to members of its Board of Directors for
their attendance at scheduled meetings. Each member of the Company's
board received 5,000 shares of un-registered common stock for each
meeting attended.
o During the three months ended July 31, 2006, the Company issued or
committed to issue 125,000 unregistered shares valued at $52,500 to
an engineering consultant as compensation for services provided
during the year.
o During the three months ended July 31, 2006, the Company committed
to issue 31,281 unregistered shares valued at $10,000 to a sales and
marketing consultant as compensation for services provided during
the year.
Common Stock Issued with the Settlement of Litigation
During three months ended July 31, 2006, the Company issued 775,000 unregistered
shares of common stock for the settlement of litigation valued at the fair
market of the common stock issued of $294,500.
Common Stock Issued on the Cashless Exercise of Warrants
During three months ended July 31, 2006 and 2005 and the period from August 21,
1995 (inception) to July 31, 2006, the Company issued 0, 22,463, and 1,895,294
shares of common stock, respectively, on the cashless exercise of warrants.
Common Stock Issued or Committed as a Penalty for Late Registration
During three months ended July 31, 2006 and 2005 and the period from August 21,
1995 (inception) to July 31, 2006, the Company issued or committed to issue
36,396, 236,946, and 3,680,490 shares of common stock, respectively, as penalty
expenses in the amount of $13,831, $166,652 and $3,783,111, respectively, for
the late registration of the Company's common stock. See "Note 17 - Commitments
and Contingencies, Penalty Securities".
31
NOTE 19 - STOCK OPTIONS AND WARRANTS
Stock Options - General
As of May 1, 2006, the Company adopted SFAS No. 123(R), "Share-Based Payment"
("SFAS 123(R)"), which requires the measurement and recognition of compensation
expense for all share-based payment awards made to employees and directors
including employee stock options based on estimated fair values, ratably over
the requisite service period of the award.. SFAS 123(R) supersedes the Company's
previous accounting under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") for periods beginning in
fiscal 2005. Prior to the adoption of SFAS 123(R), the Company accounted for
stock-based awards to employees and directors using the intrinsic value method
in accordance with APB 25 as allowed under Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
Generally, no compensation expense was recognized by the Company in its
financial statements in connection with the awarding of stock option grants to
employees provided that, as of the grant date, all terms associated with the
award are fixed and the fair value of our stock, as of the grant date, is equal
to or less than the amount an employee must pay to acquire the stock. The
Company had recognized compensation expense in situations where the fair value
of our common stock on the grant date was greater than the amount an employee
must pay to acquire the stock.
The Company uses the the Black-Scholes option-pricing model to recognize the
value of stock-based compensation expense for all share-based payment awards.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which do not have vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The following summarizes the stock option and warrant transactions for employees
and other service providers:
Stock
Weighted Options Weighted Weighted
Average And Average Total Average
Stock Exercise Warrants Exercise Options Exercise
Options Price Non- Price And Price
Employee Per Share Employee per Share Warrants per Share
---------- --------- --------- --------- ---------- ---------
Outstanding,
August 21, 1995
(inception) to
April 30, 2006 2,482,011 $0.13 1,051 $0.28 2,483,062 $0.13
Granted 287,653 $0.20 346,373 $0.28 634,026 $0.24
---------- ----- --------- ----- ---------- -----
Outstanding,
April 30, 2002 2,769,664 $0.14 347,424 $0.28 3,117,088 $0.16
========== ===== ========= ===== ========== =====
Granted 3,461,755 $1.24 2,002,726 $2.02 5,464,481 $1.43
Canceled (2,264,208) $1.33 (1,051) $0.28 (2,265,259) $1.33
Outstanding,
April 30, 2003 3,967,211 $0.42 2,349,099 $1.76 6,316,310 $0.84
========== ===== ========= ===== ========== =====
Granted 1,738,221 $1.03 1,029,000 $1.11 2,767,221 $1.01
Canceled (1,058,483) $1.42 (119,705) $0.36 (1,178,188) $1.31
Outstanding
April 30, 2004 4,646,949 $0.42 3,258,394 $1.61 7,905,343 $0.83
---------- ----- --------- ----- ---------- -----
Granted 2,956,980 $0.76 100,000 $0.99 3,056,980 $0.77
Canceled (910,000) $1.08 (876,668) $2.79 (1,786,668) $1.92
---------- ----- --------- ----- ---------- -----
Outstanding
April 30, 2005 6,693,929 $0.70 2,481,726 $1.17 9,175,655 $0.82
---------- ----- --------- ----- ---------- -----
Granted 1,464,510 $0.55 177,179 $0.65 1,641,689 $0.56
Canceled (480,000) $0.77 -- $ -- (480,000) $0.77
Outstanding
April 30, 2006 7,678,439 $0.66 2,658,905 $1.13 10,337,344 $0.78
Exercisable
April 30, 2006 6,908,439 $0.62 2,138,905 $1.17 9,047,344 $0.75
---------- ----- --------- ----- ---------- -----
Granted 422,500 $0.17 -- $ -- 422,500 $0.17
Canceled (1,225,000) $0.57 -- $ -- (1,225,000) $0.57
Outstanding
July 31, 2006 6,875,939 $0.66 2,685,905 $1.13 9,534,844 $0.79
Exercisable
July 31, 2006 6,185,939 $0.69 2,138,905 $1.17 8,324,844 $0.81
---------- ----- --------- ----- ---------- -----
32
The weighted-average remaining contractual life of the options and warrants
outstanding for employees and other service providers at April 30, 2006 was 3.2
years. The exercise prices of the options and warrants outstanding at April 30,
2006 ranged from $0.01 to $2.95 and information relating to these options and
warrants is as follows:
Weighted- Weighted-
Weighted- Average Average
Average Exercise Exercise
Stock Stock Remaining Price of Price of
Range of Options & Options & Contractual Options & Options &
Exercise Warrants Warrants Life Warrants Warrants
Prices Outstanding Exercisable (years) Outstanding Exercisable
- ------------- ----------- ----------- ----------- ----------- -----------
$0.01 - $0.99 6,531,401 5,821,401 3.57 $0.45 $0.45
$1.00 - $1.99 2,069,454 1,589,454 2.63 $1.10 $1.13
$2.00 - $2.95 933,939 933,989 1.48 $2.54 $2.54
--------- ---------
9,534,844 8,324,844
========= =========
33
Warrants Issued or Committed to Investors and Placement Agents in Private
Placements
During three months ended July 31, 2006 and 2005 and the period from August 21,
1995 (inception) to July 31, 2006, the Company issued or committed to issue
warrants to purchase 5,072,829, 7,902,241, and 34,048,743 shares of common stock
to investors and placement agents in private placements.
Warrants Issued or Committed as Penalty for Late Registration
During the three months ended July 31, 2006 and 2005 and the period from August
21, 1995 (inception) to July 31, 2006, the Company issued or committed to issue
warrants to purchase 568,122, 1,067,838, and 6,959,445 shares of common stock,
respectively, as a penalty with a fair value of $41,889, $305,455 and
$2,298,666, respectively, for the late registration of the Company's common
stock. The fair values of the warrants were determined using the Black-Scholes
model. See "Note 17 - Commitments and Contingencies, Penalty Securities".
Warrants with Cashless Rights as Penalty for Late Registration
Due to the Company's inability to file and maintain effective a registration
statement within certain specified deadlines, as of July 31, 2006, outstanding
warrants to purchase up to 5,670,606 may be purchased by cashless exercise. If
the closing price for the Company's shares is greater than the exercise price,
then the holders may exercise the warrant by a cashless exercise. The number of
shares to be received by the holders upon cashless exercise is determined by the
spread between the closing price of the Company's common stock on the exercise
date and the exercise price of the warrant, but would not exceed the number of
the underlying shares to the warrant so exercised. These common shares would be
issued to the holder with no proceeds to the Company.
NOTE 20 - INCOME TAXES
The components of the deferred income tax assets (liabilities) at July 31, 2006
were as follows:
Deferred tax assets
Equity compensation $ 727,000
Net operating loss carry forwards 6,571,000
-----------
Total deferred tax assets 7,298,000
Deferred tax liabilities
Depreciation (125,000)
-----------
7,173,000
Less valuation allowance (7,173,000)
Net deferred tax asset $ --
===========
34
The following table presents the current and deferred income tax provision for
federal and state income taxes for the three months ended July 31, 2006 and the
year ended April 30, 2006:
Three Months Ended Year Ended
July 31, 2006 April 30, 2006
------------------ --------------
Current
Federal $ -- $ --
State
-- 800
----------- -----------
-- 800
----------- -----------
Deferred
Federal 6,062,000 5,100,000
State 1,111,000 935,000
----------- -----------
7,173,000 6,035,000
7,173,000 6,035,800
=========== ===========
Less: valuation allowance (7,173,000) (6,035,000)
----------- -----------
Provision for income tax $ -- 800
=========== ===========
The provision for (benefit from) income taxes differs from the amount that would
result from applying the federal statutory rate for the three months ended July
31, 2006 and the year ended April 30, 2006, as follows:
Three Months Ended Year Ended
July 31, 2006 April 30, 2006
------------------ --------------
Statutory regular federal income benefit
rate 34.00% 34.00%
State taxes 8.84 8.84
Change in valuation allowance (42.85) (42.85)
------ ------
Total (0.01)% (0.01)%
====== ======
As of July 31, 2006, the Company had net operating loss carry forwards for
federal and state income tax purposes of approximately $22,840,000 which starts
expiring in 2010 through 2025. The utilization of net operating loss carry
forwards may be limited due to the ownership change under the provisions of
Internal Revenue Code Section 382 and similar state provisions.
NOTE 21 - SUBSEQUENT EVENTS
Consultancy Agreements and Contracts
In August 2006, the Company entered into an agreement with a Washington, D.C.
based government relations firm to manage our interface with our Government
customers and Congressional funding counterparts, as well as work with us to
identify federal opportunities. Pursuant to the agreement, the Company will pay
a flat monthly fee in the amount of $6,000 from September 1, 2006 through
December 31, 2006, increasing to $7,000 per month from January 1, 2007 through
April 30, 2007, and increasing to $8,000 per month through December 31, 2007,
plus other out-of-pocket expenses. Either party may cancel the agreement at the
end of each month.
In September 2006, the Company executed a professional services agreement with a
professional financial and accounting staffing corporation. One accounting
professional is currently providing consulting services to us from this
corporation. Pursuant to the agreement we are to pay the staffing corporation
hourly payments for services in the amount of $140 per hour, plus overtime, to
be paid upon invoicing for the duration of the assignment.
35
Placement Agency Agreement
In September 2006, the Company entered into an exclusive agreement with a
placement agent to arrange for the sale of debt or equity securities. Major
terms of the agreement are as follows:
o The term of the agreement will be for one year or in the event the
placement agent has not completed financing of at least $2 million
in the first 60 days, however, the Company may cancel at any time
with 5 days' written notice of cancellation.
o The Company will pay a retainer of 2.5 shares of its Series B
Preferred Stock.
o The Company will pay a success fee equal to 10% of any of the gross
proceeds received by the Company derived from the efforts of the
placement agent for any amounts up to $3 million and 8% for that
amount in excess of $3 million, plus reimbursable expenses approved
by the Company.
o The Company will issue the placement agent warrants to purchase 10%
of the amounts of securities placed with investors through the
efforts of the placement agent. The exercise price of the warrants
will be equal to the price at which the securities were placed. The
warrants vest immediately, expire four years from the date of grant,
and include "piggyback" registration rights.
Lease Agreement
In October 2006, the Company extended its lease for an additional year. The
Company also has an option for additional space if needed for expanded assembly
or manufacturing. The Company also leases 2,400 feet of outdoor testing space
which is included in the monthly rent under the terms of the addendum. The
addendum for one additional year provides for monthly rent of $17,850. The
addendum to the lease expires in October 2007, the aggregate future minimum
payment under the lease agreement is $214,200.
Penalty Securities
In August 2006, the Company committed to issue 12,132 shares and warrants to
purchase 191,669 shares at various exercise prices between $0.45 and $1.75, to
various holders of securities with registration rights as a penalty, due to the
Company's inability to file and maintain effective a registration statement
within certain specified deadlines.
In September 2006, the Company committed to issue 12,132 shares and warrants to
purchase 194,488 shares at various exercise prices between $0.45 and $1.75, to
various holders of securities with registration rights as a penalty, due to the
Company's inability to file and maintain effective a registration statement
within certain specified deadlines.
Settlement Agreements
In November 2005, a claim was filed against the Company with the District Court
of Orange County, California by SBI-USA ("SBI"). SBI is seeking collection of a
fee in the amount $50,000 allegedly owed to it for financial advisory services
purported to have been provided to the Company during the fiscal year ended
2003. The $50,000 fee was recorded as a contingent liability in 2004. In July
2006, the Company agreed to mediation and entered into settlement discussions to
avoid further litigation costs. On September 6, 2006, the Company entered into a
Settlement Agreement and Mutual Release with SBI. As part of the Settlement
Agreement, SBI agreed to cause the lawsuit to be dismissed and both parties
agreed to release each other from any and all other claims each party might have
against the other. Pursuant to the terms of the Settlement Agreement, the
Company is required to pay SBI payments in the aggregate of $35,000. As of date,
the Company has paid $8,750 and is required to pay SBI monthly payments of
$2,000 each month with a lump sum payment due by December 29, 2006 in the amount
of $20,250. In the event the Company fails to make an installment payment by the
required date, the Company has a ten-day period to cure. Should the Company not
make the payment within the cure period, SBI would be entitled to an entry of
judgment in its favor and against us in the amount of $60,000. For the year
ended April 30, 2006, to reflect the actual settlement amount, we adjusted the
accrual recorded in the prior year period to $35,000.
In April 2005, a claim was filed against the Company with the 101st Judicial
District Court, Dallas County, Texas by Data Discovery Inc. ("DDI") (Civil
Action No. 3-05-CV-0949-M). DDI, representing one party of a dissolved
partnership, is seeking the collection on behalf of the partnership of $107,300
allegedly owed for services purported to have been fully-provided to the
Company. The Company has engaged local counsel and filed on May 10, 2005, a
Notice of Removal to move the case to federal court, and a Motion for Dismissal.
In July 2005, the District Court delivered a Memorandum Opinion and Order
granting our Motion for Dismissal and ordered that within twenty days DDI amend
its suit to the satisfaction of the District Court, or the order will become a
dismissal with prejudice, which would bar DDI from filing any other suit against
the Company related to the matters within its claim. In August 2005, DDI filed a
new lawsuit on behalf of the partnership which is expected to go before the
Court following an appropriate period for discovery. In August 2006, we entered
into settlement discussions with DDI and in September 2006 DDI caused the
lawsuit to be dismissed without prejudice. There can be no assurance that the
claims DDI asserted against us will not be resuscitated at some time in the
future.
36
Legal Actions
On July 27, 2006, the Company filed a complaint for breach of contract against
its former CEO, Dr. Bogdan C. Maglich with the Orange County Superior Court,
Santa Ana, California, Case No. 06CC08456. The complaint alleged, among other
things, that Dr. Maglich had violated his employee confidentiality agreement.
The Company's complaint sought injunctive relief, unspecified damages according
to proof, interest, and attorneys' fees. On August 1, 2006, the Court granted an
ex parte Temporary Restraining Order and Order to Show Cause Why Preliminary
Injunction Should Not Be Issued ("TRO"). The TRO provided that pending hearing
on the Order to Show Cause, which the court set for August 22, 2006, Dr.
Maglich, his agents, assigns, and all those acting in concert with him were
restrained and enjoined from: (1) "violating the Confidentiality and Assignment
of Inventions Agreement dated October 7, 2003;" and (2) "violating the promise
contained in your letter agreement with plaintiff dated April 12, 2006 that you
'hereby agree to be bound by the Cure Statements' of your then attorney, .
..attached thereto, that 'Dr. Maglich agrees to refrain from disseminating any
information that the Board [of Directors of Plaintiff HiEnergy Technologies,
Inc.] believes may be confidential inside information without the Board's
approval, and agrees to refrain from disseminating any statements about the
Company without the Board's approval." The order continued: "Notwithstanding
anything to the contrary herein, defendant is not restrained from making
private, bona fide complaints to regulators, police, or prosecutors about the
company." As of the date of this report, due to limitations on the removal of
directors by the Board under applicable corporate law, Dr. Maglich currently
continues to serve as a director.
On August 22, 2006, after oral argument of counsel, the court invited the
Company's counsel to submit a proposed preliminary injunction to enjoin
disclosure of specific categories of Company trade secrets/confidential
information. The court declined to issue a preliminary injunction on terms as
broad as set forth in the TRO or based upon Dr. Maglich's letter dated April 12,
2006. On September 29, 2006, the Court granted a Preliminary Injunction which
restrains and enjoins Dr. Maglich, his agents, assigns, and all those acting in
concert with him from violating his confidentiality agreement pending trial.
On August 21, 2006, Dr. Maglich sent to one or more investors of the Company a
copy of a purported complaint, dated August 21, 2006, by Dr. Maglich against the
Company and its CEO, Roger Spillmann. The purported complaint claims, among
other things, that the Orange County, California Superior Court had been asked
by the Company to override federal rules, regulations, or statutes. The
complaint appears to be largely a rehash of Dr. Maglich's prior allegations plus
a new allegation, as stated above, that the state court had been asked to
disregard federal law. The Company denies the allegations and contends that (i)
the state court has been acting lawfully in restraining Dr. Maglich's improper
conduct.; (ii) Dr. Maglich's communications with investors were in violation of
the TRO; (iii) the allegations are frivolous and are brought by a former
disgruntled employee in bad faith; and (iv) Dr. Maglich is involved in a
vendetta against the Company for his own purposes. The Company maintains that is
committed to full compliance with all SEC and other state and federal rules,
regulations, and statutes.
On January 24, 2006, personal legal counsel for the Company's former Chairman,
Dr. Bogdan Maglich, submitted a memorandum to the Company's Board of Directors
alleging that, despite the payment by the Company to Dr. Maglich of salary,
bonuses, expenses and other benefits, some of the provisions of his employment
agreement had not been implemented, resulting in an adverse financial impact to
Dr. Maglich personally. Dr. Maglich's legal counsel proposed to settle this
claim for (i) cash or a demand note in the amount of $66,569, (ii) $188,271
worth of common stock registered for sale, and (iii) $232,785 of restricted
common stock. On January 25, 2006, Dr. Maglich's personal legal counsel met with
the Company's Board during which meeting it was agreed that Dr. Maglich and the
Company would attempt to settle the claims. However, in his cross-complaint, Dr.
Maglich now claims that the memorandum concluded that the Company owed him
$487,000 in unpaid benefits and that the Company "orally agreed" that it owed
him this amount. The Company denies such allegation.
On February 9, 2006, Dr. Maglich's personal legal counsel sent a letter to the
Board stating that the failure to accede to Dr. Maglich's demands and provide
him with certain other requested benefits, could be viewed as a constructive
termination and entitle Dr. Maglich to two years severance pay pursuant to his
employment agreement and "result in other significant effects on the Company."
On February 17, 2006, the Company's Board of Directors removed Dr. Bogdan
Maglich from his position as our Chief Executive Officer and suspended him from
his duties as Chairman of the Board, Treasurer and Chief Scientific Officer.
37
Effective April 18, 2006, the Company terminated Dr. Maglich as its Chairman and
Chief Scientist in accordance with Section 10(a) of his Employment Agreement,
which stated that the Company could terminate his employment at any time upon
gross negligence or willful malfeasance by Dr. Maglich in the material
performance of his duties and responsibilities to the Company under the
agreement. Dr. Maglich claims that his suspension and subsequent termination as
an employee of the Company was the result of age discrimination and national
origin discrimination. Dr. Maglich also claims that he is entitled to $416,000
plus interest in severance payments under his Employment Agreement. However, the
signed original version of the Employment Agreement in the Company's files
stated that Dr. Maglich was entitled to severance pay only in the event of a
termination by us "without cause."
On August 18, 2006, the Company was also served with a cross-complaint by Dr.
Maglich filed on July 27, 2006 with the Superior Court of California, County of
Orange, under case number 06CC084586. The cross-complaint alleges breach of oral
and written contracts, age discrimination and national origin discrimination,
retaliation for age and national origin discrimination, violations of the Ralph
and Bane Civil Rights Act, withholding corporate records from Dr. Maglich and
withholding Dr. Maglich's personal property. Dr. Maglich seeks damages in the
amount of $903,000 plus interest for alleged breach of contracts, a $25,000
civil penalty for alleged civil rights violations, punitive damages, legal
costs, and unspecified cash damages for lost wages and benefits and for damages
resulting form emotional distress, mental anguish and pain and suffering. The
Company believes Dr. Maglich's claims are without merit and intends to assert a
vigorous defense. The costs of defending against the cross-complaint could be
substantial; however the Company is unable to predict an exact amount, or even a
meaningful estimate, at this time.
In August 2006, the Company was served with a Summons and Complaint by a former
employee providing services to an affiliate of the Company's former CEO, filed
on July 3, 2006 in the Superior Court of California, County of Orange. The
Complaint names Dr. Bogdan Maglich, his affiliate, Maglich Family Holdings,
Inc., and HiEnergy Technologies, as defendants, and plaintiff is seeking
compensatory damages, exemplary damages, and punitive damages due to alleged
intentional and negligent infliction of emotional distress for purported false
and defamatory remarks made by Dr. Maglich about the plaintiff in a response to
a request for information by the California Employment Development Department
with regard to a claim for benefits. The Company and its counsel intend to
respond to the allegations in any further pleading with appropriate challenges
to its legal sufficiency to state a claim upon which relief may be granted. The
costs of defending against the Complaint could be substantial; however the
Company is unable to predict an exact amount, or even a meaningful estimate, at
this time.
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATIONS
FORWARD LOOKING STATEMENTS
This quarterly report on Form 10-QSB (the "Report"), the other reports,
statements, and information that we have previously filed or that we may
subsequently file with the Securities and Exchange Commission, and public
announcements that we have previously made or may subsequently make include, may
include, incorporate by reference, or may incorporate by reference, certain
statements that may be deemed to be "forward-looking statements". These
forward-looking statements relate to such matters as, among other things, our
anticipated financial performance, business prospects, technological
developments, new products, future distribution or license rights, international
expansion, possible strategic alternatives, new business concepts, capital
expenditures, consumer trends, and similar matters.
Forward looking statements necessarily involve known and unknown risks,
uncertainties and other factors that may cause our actual results, levels of
activity, performance, or achievements to be materially different from any
future results, levels of activity, performance, or achievement expressed or
implied by such forward-looking statements. Readers are cautioned to review
carefully the discussion concerning these and other risks which can materially
affect our business, operations, financial condition and future prospects, which
is found under the heading Risk Factors at the end of this Item 2.
In some cases, you can identify forward-looking statements by terminology such
as "may," "will," "should," "could," "intend," "expect," "anticipate," "assume",
"hope", "plan," "believe," "seek," "estimate," "predict," "approximate,"
"potential," "continue", or the negative of such terms. Statements including
these words and variations of such words, and other similar expressions, are
forward-looking statements. Although we believe that the expectations reflected
in the forward-looking statements are reasonable based upon our knowledge of our
business, we cannot absolutely predict or guarantee our future results, levels
of activity, performance, or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of such
statements.
We note that a variety of factors could cause our actual results and experience
to differ materially from the anticipated results or other expectations
expressed in our forward-looking statements. The risks and uncertainties that
may affect the operations, performance, development and results of our business
include, but are not limited to, the following: changes in consumer spending
patterns; changes in consumer preferences and overall economic conditions; the
impact of competition and pricing; the financial condition of the suppliers and
manufacturers from whom we source our components; economic and political
instability in foreign countries or restrictive actions by the governments of
foreign countries in which suppliers and manufacturers from whom we source
products are located or in which we may actually conduct or intend to expand our
business; changes in tax laws, or the laws and regulations governing direct or
network marketing organizations; our ability to hire, train and retain a
consistent supply of reliable and effective participants in our direct or
network marketing operation; general economic, business and social conditions in
the United States and in countries from which we may source products, supplies
or customers; the costs of complying with changes in applicable labor laws or
requirements, including without limitation with respect to health care; changes
in interest rates; the cost of insurance, shipping and postage, energy, fuel and
other business utilities; the reliability, longevity and performance of our
licensors and others from whom we derive intellectual property or distribution
rights in our business; the risk of non-payment by, and/or insolvency or
bankruptcy of, customers and others owing indebtedness to us; threats or acts of
terrorism or war; and strikes, work stoppages or slow downs by unions affecting
businesses which have an impact our ability to conduct our own business
operations.
Forward-looking statements that we make, or that are made by others on our
behalf with our knowledge and express permission, are based on knowledge of our
business and the environment in which we operate, but because of the factors
listed above, actual results may differ from those in the forward-looking
statements. Consequently, these cautionary statements qualify all of the
forward-looking statements we make herein. We cannot assure the reader that the
results or developments anticipated by us will be realized or, even if
substantially realized, that those results or developments will result in the
expected consequences for us or affect us, our business or our operations in the
way we expect. We caution readers not to place undue reliance on these
forward-looking statements, which speak only as of their dates, or on any
subsequent written and oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by these
cautionary statements. We do not undertake any obligation to release publicly
any revisions to such forward-looking statements to reflect events or
circumstances after the date hereof or thereof or to reflect the occurrence of
unanticipated events.
39
Readers should also note that the safe harbor for forward-looking statements,
provided by, among other federal regulations, Section 21E of the Exchange Act,
are unavailable to issuers of penny stocks. As we have issued securities at a
price below $5.00 per share, our shares are considered penny stocks and such
safe harbors are therefore unavailable to us.
GENERAL
The following discussion should be read in conjunction with our unaudited
Consolidated Financial Statements and accompanying Notes, included herein.
Certain statements contained herein may constitute forward-looking statements,
as discussed at the beginning of this Item 2 on Form 10-QSB. Our actual results
could differ materially from the results anticipated in these statements as a
result of a variety of factors, including those discussed in our filings with
the Securities and Exchange Commission and as discussed in the sections under
the heading "Risk Factors" in this Report".
Any reference to "we," "us" and "our" herein shall mean HiEnergy Technologies,
Inc., together with its consolidated subsidiaries, HiEnergy Defense, Inc.,
HiEnergy Mfg Company, HiEnergy International, Inc., and HiEnergy Europe, Ltd,
and its former majority-owned subsidiary, HiEnergy Microdevices, Inc.
OVERVIEW OF COMPANY
HiEnergy Technologies, Inc. ("HiEnergy", together with its subsidiaries, the
"Company") is a nuclear technologies-based company and creator of the world's
first "stoichiometric" diagnostic devices that can effectively decipher chemical
compositions of unknown substances, without human intervention. Traditionally,
the practical determination of the chemical formula for a substance could only
be accomplished invasively, through analytic chemistry, where the substance must
be physically subjected to a series of complex tests involving chemicals, test
tubes and a multitude of instruments.
Our Atometer(TM) detectors incorporate a proprietary interrogation process that
activates a selected target with high energy neutrons, causing the contents to
emit gamma rays of varying energies, which are then decoded, with the use of
proprietary algorithms, to determine with a high level of confidence, the
chemical composition of the targeted substance. To our knowledge, our
Atometer(TM) detectors are the only commercially available devices with this
"stoichiometric" capability and therefore we believe are uniquely positioned in
the marketplace.
Since inception, we have primarily focused on the research, development and
commercialization of Atometer(TM) explosives detectors for the homeland security
and defense markets. Our Atometer(TM) explosives detectors can non-invasively
and remotely detect and confirm, through metal or other barriers, the presence
of explosives in an object, with a probability of detection of greater than 97%
and "false positive" and "false negative" rates of approximately 3%. Further,
they have demonstrated the capability to detect hidden explosives, irrespective
of shape or form, solid or liquid. In numerous studies, we have also been able
to detect other select combustibles, biological agents, and illicit substances,
such as narcotics.
We are currently marketing to governmental and private entities, including the
transit sector and military, as well as negotiating licenses for the
distribution of, the following Atometer(TM) detectors:
o SIEGMA(TM) 3E3 and 3M3 - portable, suitcase-borne systems for the
remote detection and confirmation of home-made bombs, also known as
Improvised Explosive Devices or "IEDs" and uniquely addressing the
significant problems posed by unattended or suspicious packages.
o CarBomb Finder(TM) 3C4 - vehicle-borne system for the detection and
confirmation of car bombs, in which the sensors are deployed from
the vehicle at the end of a mechanical arm and placed in proximity
to the target.
o CarBomb Finder(TM) 3C5 - in-ground vehicle screening system for the
detection and identification of car bombs at checkpoints and
chokepoints, developed in response to the high demand for critical
infrastructure protection and improved perimeter defense.
o STARRAY(TM) - all-terrain robot-borne detector for the stand-off
detection of unexploded ordnance, landmines and IEDs, which can also
be configured and integrated in various robotic and remote-vehicle
platforms.
To date, we have yet to generate meaningful revenues from product sales or the
licensing of our technologies and have devoted the bulk of our efforts and
resources to the research, design, testing and development of our proprietary
"stoichiometric" sensor devices and underlying technologies. We expect to
continue the research and development of applications of our technologies and
their further exploitation both internally and through collaboration with third
parties in order to advance our detector system designs for more rapid and
precise detection and analytical capabilities and improve their reliability in
the field and to capitalize on the commercial opportunities that have been
identified. Although we have developed prototypes in programs with the U.S.
Department of Defense and the Department of Homeland Security and expect to
continue to pursue and receive additional research and development funds through
these agencies, most of our research related work has been funded internally in
order to capture full intellectual property rights from any inventions or
processes that may arise.
40
Our mailing address and executive offices are located at 1601-B Alton Parkway,
Irvine, California 92606. Our telephone number is (949) 757-0855. Our corporate
website is www.hienergyinc.com. Information contained on our website is not to
be considered part of this Annual Report on Form 10-KSB.
RECAPITALIZATION BETWEEN HIENERGY AND SHAREHOLDERS OF MICRODEVICES
On April 25, 2002, SLW, which was then a "public shell company", was taken over
by the stockholders of Microdevices in a transaction commonly referred to as a
"reverse takeover". Under this transaction, which was structured as a voluntary
exchange of shares, the stockholders of Microdevices, including the Company's
former Chairman, Dr. Bogdan Maglich, obtained the right to receive up to 64%
percent of the outstanding shares of SLW. The stockholders of SLW prior to the
voluntary share exchange retained, collectively, 36% of SLW. The reverse
takeover was accounted for as a re-capitalization of Microdevices for accounting
purposes, in a manner similar to a pooling of interests, with Microdevices as
the accounting acquirer (reverse acquisition). Since the Company (formerly SLW)
was a "public shell company", with limited assets and liabilities at the date of
the acquisition and no significant operations prior to the acquisition, no pro
forma information has been presented. As a result of the reverse takeover,
Microdevices became the Company's majority-owned subsidiary, and was later
merged with the Company in January 2005 in a short-form merger through which the
Company committed to issue 452,029 shares of common stock to the remaining
stockholders of HiEnergy Microdevices on the basis of 22.3524 HiEnergy shares
for 1 share of Microdevices (the same ratio that was used in the original
voluntary share exchange). Additionally, we may be required to issue up to
704,190 shares of the Company's common stock to former holders of options and
warrants of Microdevices who hold rights to purchase HiEnergy shares at $0.156
per share. These rights survived the merger and may be exercised any time before
April 25, 2007, subject to the payment of promissory notes representing the
purchase price.
BASIS OF PRESENTATION
For accounting purposes, the reverse takeover by Microdevices of HiEnergy was
accounted for as a re-capitalization of Microdevices in a manner similar to a
pooling of interests, with Microdevices as the accounting acquirer (reverse
acquisition). Since HiEnergy (formerly SLW) was a "public shell company", with
no material assets and liabilities at the date of the acquisition and no
significant operations prior to the acquisition, no pro forma information has
been presented.
We have prepared our unaudited Consolidated Financial Statements on a
going-concern basis in accordance with accounting principles generally accepted
in the United States of America. This going-concern basis of presentation
assumes that we will continue operations for the foreseeable future and will be
able to realize our assets and discharge our liabilities and commitments in the
normal course of business. As described in Risk Factors: Risks Related to Our
Business, there is substantial uncertainty about our ability to continue as a
going concern. Our financial statements do not include adjustments that might
result from the outcome of this uncertainty.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations
are based on our unaudited Consolidated Financial Statements and accompanying
Notes and the other financial information appearing elsewhere in this Report,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities and expenses, and related disclosure of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates. We base our estimates on assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis of making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.
Long-lived Assets
Property and equipment are recorded at cost and depreciated using the
straight-line method over an estimated life of five years. Determining the
estimated life of our property and equipment requires judgment and changes to
the estimated life could materially impact the amount of depreciation expense
recognized in the statement of operations and the amount recognized as property
and equipment in the consolidated balance sheet.
41
Stock-based Compensation
As of May 1, 2006, we adopted SFAS No. 123(R), "Share-Based Payment" ("SFAS
123(R)"), which requires the measurement and recognition of compensation expense
for all share-based payment awards made to employees and directors including
employee stock options based on estimated fair values, ratably over the
requisite service period of the award.. SFAS 123(R) supersedes our previous
accounting under Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") for periods beginning in fiscal 2005. We
have applied the provisions of Staff Accounting Bulletin No. 107 ("SAB 107") in
our adoption of SFAS 123(R), using the modified prospective transition method,
which requires the application of the accounting standard as of May 1, 2006, the
first day of our fiscal year ending April 30, 2007. Our Consolidated Financial
Statements as of and for the three months ended July 31, 2006 reflect the impact
of SFAS 123(R). In accordance with the modified prospective transition method,
our Consolidated Financial Statements for periods prior to May 1, 2006 have not
been restated to reflect, and do not include, the impact of SFAS 123(R).
Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to
employees and directors using the intrinsic value method in accordance with APB
25 as allowed under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). Generally, no
compensation expense was recognized by us in our financial statements in
connection with the awarding of stock option grants to employees provided that,
as of the grant date, all terms associated with the award are fixed and the fair
value of our stock, as of the grant date, is equal to or less than the amount an
employee must pay to acquire the stock. We had recognized compensation expense
in situations where the fair value of our common stock on the grant date was
greater than the amount an employee must pay to acquire the stock.
The Company uses the Black-Scholes option-pricing model to recognize the value
of stock-based compensation expense for all share-based payment awards.
Determining the appropriate fair-value model and calculating the fair value of
stock-based awards at the grant date requires considerable judgment, including
estimating stock price volatility, expected option life and forfeiture rates.
The Company develops estimates based on historical data and market information,
which can change significantly over time. A small change in the estimates used
can have a relatively large change in the estimated valuation, and consequently,
a material effect of the results of operations.
We account for stock options and warrants issued to non-employees in accordance
with SFAS No. 123(R) and EITF Issue No. 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services" ("EITF 96-18"), and related
interpretations.
Research and Development Costs
We account for research and development costs in accordance with SFAS No. 2,
"Accounting for Research and Development Costs". Research and development costs
are charged to operations as incurred. As described in section 3.50 of the
Government Contract Audit Guide for Fixed-Price Best-Efforts Cost Sharing
Arrangements, amounts earned under our development contracts with the U.S.
Department of Defense have been offset against research and development costs,
in accordance with the provisions of that section, in all periods presented.
THREE MONTHS ENDED JULY 31, 2006 COMPARED TO THREE MONTHS ENDED JULY 31, 2005
For the three months ended July 31, 2006, we incurred a net loss of $1,807,211,
as compared to a net loss of $2,053,000 for the three months ended July 31,
2005. Included in the losses are equity based expenses of $182,000 and $624,000,
respectively.
42
Operating Expenses
GENERAL AND ADMINISTRATION
General and administration expenses for the three months ended July 31, 2006
were $784,000, which includes $139,000 of equity based compensation, decreasing
$312,000 from the prior year. In lieu of cash, we have often engaged service
providers by offering common stock, warrants, options and convertible notes
payable ("CNP") as compensation. Through various arrangements, these providers
have provided services such as business development, business and financial
consulting, Edgar services, legal and other professional services, and
directorship. Some warrants and options have been issued and expensed, but then
subsequently forfeited causing no dilution to us. The major components of
general and administration expenses, both cash and equity, are as follows:
Three Months Ended July 31, 2006 Three Months Ended July 31, 2005
---------------------------------- -------------------------------------
Cash & Equity Cash & Equity
Accrued Based Accrued Based Increase/
Expenses Compensation Total Expenses Compensation Total (Decrease)
-------- ------------ -------- --------- ------------ ---------- ----------
Salaries and
related $241,000 $100,000 $341,000 $277,000 $ 32,000 $ 309,000 $ 32,000
Consulting 6,000 11,000 17,000 35,000 18,000 53,000 (36,000)
Legal fees 187,000 -- 187,000 157,000 60,000 217,000 (30,000)
Accounting fees 69,000 -- 69,000 121,000 -- 121,000 (52,000)
Investor& public
relations 12,000 -- 12,000 65,000 -- 65,000 (53,000)
Insurance 49,000 -- 49,000 47,000 -- 47,000 2,000
Travel 21,000 -- 21,000 96,000 -- 96,000 (75,000)
Other 60,000 28,000 88,000 167,000 21,000 188,000 (100,000)
-------- -------- -------- -------- -------- ---------- ---------
Total $645,000 $139,000 $784,000 $965,000 $131,000 $1,096,000 $(312,000)
-------- -------- -------- -------- -------- ---------- ---------
For the three months ended July 31, 2006, as compared to the prior year period,
salary and related expense increased $32,000. Equity based compensation expense
increased $68,000 to $100,000, and reflects the additional expense of employee
stock options recognized under SFAS 123(R) based on estimated fair values, which
was adopted on May 1, 2006. Excluding equity based compensation expense of
$100,000, salary and related expense decreased $36,000. This decrease reflects
savings accomplished with personnel reductions commencing in the fourth quarter
ended April 30, 2006, as part of cost-saving measures under our cost-reduction
plan. As of date, an estimated $440,000 in annual salary and benefits expense
has been eliminated with personnel reductions and the resignation of our
controller. The decrease in administrative personnel is expected to have an
effect, although limited, while we pursue greater efficiency and productivity of
the remaining staff and utilize consultants on a opportunistic basis. For the
second quarter of fiscal year 2007, salary and benefits expense is expected to
decrease further, and increase only moderately in the second half of fiscal 2007
with the anticipated hiring of additional administrative personnel to provide
greater support toward our public reporting requirements, internal controls,
sales and marketing activities, and other legal and financial matters related to
our commercialization objectives.
Consulting expenses for the three months ended July 31, 2006, decreased $36,000
from the prior year period. Excluding equity-based compensation, consulting
expenses decreased $29,000 from the prior year period and was primarily
attributable to reduced reliance on outside consultants. The higher amount of
equity-based compensation expense for the prior year period reflects issuances
of common shares for non-recurring business development and consulting services,
while the current year period only includes shares issued to directors for board
attendance. We expect cash consulting fees to increase moderately into fiscal
2007 with the use of accounting and legal consultants to meet our short-term
reporting and disclosure requirements, and total consulting expense, including
equity compensation, to increase thereafter as we accelerate our efforts to
bring our product to market. Generally, we have reduced our reliance on paying
for services with restricted equity instruments because of the significant
discounting required to compensate for their illiquidity; however, we do
anticipate having to offer equity based compensation opportunistically in an
effort to conserve cash.
Legal fees decreased $30,000 for the three months ended July 31 2006 as compared
to the prior year period. Excluding equity-based compensation of $60,000 of
equity-based compensation expense incurred during the prior year period, which
represents the excess cost of having settled certain outstanding accounts
payable to a related party for legal services, legal expenses increased $30,000
over the prior year period. Although we have been able to accomplish savings by
internalizing many corporate and regulatory functions and reducing our reliance
on outside corporate legal services, these savings have been outpaced by an
increase in litigation expense related to our defense of a class action law
suit, multiple claims brought by our former chairman and chief executive
officer, other pending legal matters disclosed in this Report. Although we have
settled four of the claims during the last six months and aim to settle most of
the remaining pending litigation matters, we expect litigation expense to remain
high during fiscal year 2007. Corporate legal expenses are also expected to
remain high as we pursue the filing of registration statements for stock issued
to employees, consultants and investors, and proxy materials associated with our
next shareholders' meeting, and then decrease during fiscal year 2007. We also
anticipate having to offer equity based compensation to settle legal expenses
opportunistically in an effort to conserve cash. Lastly, we are involved with
various appeals and defenses related to patent applications made by us, which
shall require an increase of activity by IP counsel, creating higher patent
filing expense.
43
Accounting fees decreased $52,000 for the three months ended July 31, 2006 as
compared to the prior year period. This decrease was primarily due to a
reduction in accounting activity during the quarter due to the delay in the
filing of our annual report. The accounting costs related to our annual audit,
typically incurred in the first quarter, will be incurred in the second quarter.
Due to the duration of the audit and changes in accounting procedures, we expect
a significant increase in accounting fees in the next quarter, and then decrease
into the second half of fiscal year 2007 with normalized accounting activity. We
expect to increase accounting personnel or use of consultants in order to
further reduce external accounting costs and improve and generate efficiencies
in our financial controls.
Investor and public relations expense decreased $53,000 for the three months
ended July 31, 2006 as compared to the prior year period. During fiscal year
2006, we sought cost-effective solutions to our investor relations and public
relations activities, so we could continue to direct majority of our resources
toward more immediate concerns, such as product development, the funding of
internal operations, and expenditures related to legal and regulatory matters.
In June 2005, we entered into a cost-effective contract with a consultant to
provide public media relations on a success fee basis and in August 2005 engaged
an outside consultant to provide investor relations services at $2,000 per
month. We anticipate investor and public relations expense to remain steady in
the first half of fiscal year 2007 and increase moderately thereafter as we seek
to develop increased awareness among the investor community.
Insurance expense increased by $2,000 for the three months ended July 31, 2006
over the prior year period. The increase reflects an increase in health
insurance costs due to rate increases of $5,000 and a decrease in Directors and
Officers policy premiums which was renewed for an additional year at a lower
cost than that of the prior year period. Due to the elimination of certain
health insurance costs resulting from a reduction of personnel, we expect a
decrease in insurance expense for the remainder of the first half of fiscal year
2007. Thereafter, we expect insurance expense to increase moderately with an
anticipated expansion of operations as well as the need for comprehensive
product liability coverage.
Travel expenses decreased by $75,000 for the three months ended July 31, 2006
over the prior year period. The decrease was primarily due higher than normal
travel expenses incurred during the prior year period with several overseas
demonstrations, and our better administration of costs for offsite
demonstrations. We have improved our administration of costs for offsite
demonstrations and have reduced the personnel requirement for demonstrations to
one or two scientific staff and one or two sales representatives. Further, we
are conducting all demonstrations with our suitcase-borne system which is more
cost effective to ship than our vehicle system, and have placed significant
emphasis on the domestic market and have limited demonstrations overseas as part
of our new capital prioritization policy. We expect that travel expenses for the
remainder of fiscal year 2007 will remain steady as our sales and marketing
personnel continue to attend numerous key industry conferences and trade shows,
management continues to meet with investors, consultants and potential strategic
partners, and general business activity increases in connection with our
commercialization objectives.
Other expenses for the three months ended July 31, 2006 decreased $99,000 as
compared to the prior year period. While equity-based compensation expense for
Edgar filing fees and marketing increased $7,000 over the prior year period,
business development expense decreased by $30,000 and marketing and conference
and exhibition fee expense decreased by $10,000. Inventory impairment expense
and restocking fees decreased by $22,000 and, in aggregate, telephone, supplies
and postage expenses decreased $23,000. Building lease and facility expenses
increased $2,200 over the prior year period, due to a change in the terms of our
lease which requires us to pay electricity costs. Additional savings were
achieved in other areas such as, sponsor/participant fees and contributions to
industry symposiums and related events and licenses and permits. While we do not
anticipate other expenses to increase for the first half of fiscal 2007, we do
expect an increase in the second half of fiscal year 2007 as our general
business activity accelerates in connection with our commercialization
objectives and heightened need for marketing and business development.
44
RESEARCH AND DEVELOPMENT
Net research and development expenses for the three months ended July 31, 2006
were $391,000, decreasing $28,000 over the prior year period. Excluding grant
income, which decreased $61,000 from the prior year period, research and
development expenses decreased $89,000. During the three months ended July 31,
2006, we have issued or contracted to issue, equity-based compensation to
consultants contracted to provide engineering and research services in lieu of
cash. The major components of research and development expenses are as follows:
Three Months Ended July 31, 2006 Three Months Ended July 31, 2005
---------------------------------- -----------------------------------
Cash & Equity Cash & Equity
Accrued Based Accrued Based Increase/
Expenses Compensation Total Expenses Compensation Total (Decrease)
-------- ------------ -------- --------- ------------ -------- ----------
Salaries & related $176,000 $ -- $176,000 $202,000 $ -- $202,000 $(26,000)
Consultants 49,000 15,000 64,000 41,000 21,000 62,000 2,000
Supplies 14,000 -- 14,000 25,000 -- 25,000 (11,000)
Travel 1,000 -- 1,000 -- -- -- 1,000
Depreciation 60,000 -- 60,000 55,000 -- 55,000 5,000
Other 76,000 -- 76,000 136,000 -- 136,000 (60,000)
Grant Income -- -- -- (61,000) -- (61,000) 61,000
-------- ------- -------- -------- ------- -------- --------
Total $376,000 $15,000 $391,000 $398,000 $21,000 $419,000 $(28,000)
-------- ------- -------- -------- ------- -------- --------
Salaries and related for research and development activities decreased $26,000
for the three months ended July 31, 2006 as compared to the prior year period.
This decrease reflects savings accomplished with personnel reductions commencing
in the fourth quarter ended April 30, 2006 as part of cost-saving measures. As
of date, an estimated $360,000 in annual salary and benefits expense has been
eliminated with personnel reductions, including the resignation of several
members of our scientific staff. The decrease is research and development
personnel is expected to have an effect, although limited, as we pursue greater
efficiency and productivity of the remaining staff and utilize consultants on a
opportunistic basis. For the second quarter of fiscal year 2007, salary and
benefits expense is expected to decrease further, reflecting the departure of
two research scientists, and increase only moderately in the second half of
fiscal 2007, including an increase of equity based compensation with anticipated
payments of common stock to certain members of our scientific staff as
incentives.
Consulting expenses for research and development activities for the three months
ended July 31, 2006 increased $2,000 over the prior period from $62,000 to
$64,000. Of this amount, $15,000 represents equity based compensation expense
related to the issuance of shares of our common stock for engineering and
manufacturing services and $30,000 represents accrued expense payable in the
form of stock for the same. The moderate increase was due to the hiring of a
senior research scientist as a consultant with regard research and development
and product design and the continued service of an engineering and manufacturing
consultant. Going forward, we expect consulting fees for the first half of
fiscal 2007 to remain steady and increase moderately into the second half of
fiscal 2007 as we anticipate expanding our use of consultants to meet our
research and development objectives. We also expect to continue to issue
consultants our common stock in lieu of cash in an effort to conserve cash, and
expect equity based compensation to remain high.
Supply expense decreased $11,000 for the three months ended July 31, 2006 as
compared to the prior year due to cost-cutting measures and improved expense
controls, as well as decreased participation in the number of funded research
programs. In the event of an increase in our grant and cooperative development
activity, related supply expense is expected to increase significantly in the
second half of fiscal year 2007. However, we intend to continue to focus on the
completion and advancement of our product commercialization and will direct most
resources toward this objective.
Travel expenses decreased $1,000 for the three months ended July 31, 2006 as
compared to the prior year as our scientists were involved almost entirely in
onsite research and development during the current year period than the prior
year period. We expect travel expenses to remain low during the first half of
fiscal year 2006 and increase moderately thereafter with anticipated grants and
awards, co-development programs and offsite testing.
For the three months ended July 31, 2006, depreciation expense increased by
$5,000 as we have continued to purchase equipment for research and development
activities. Cumulatively, these additions have increased depreciation expense.
In light of our expected increase in research and development activities as we
advance and/or develop prototypes and make technology improvements, we expect
further research and development equipment purchases. Accordingly, depreciation
expense should increase going forward as we continue to expense current
equipment and increase our capital expenditures year over year.
45
Other research and development expenses for the three months ended July 31, 2006
decreased $60,000 to $76,000 from $136,000 for the prior year period. Excluding
equipment lease expense of $83,000 recorded during the prior year period, other
research and development expenses increased $23,000. The increase was primarily
comprised of a $9,000 increase in insurance premiums due to rate increases and
the conversion of one scientific consultant to an employee. Also included in
other expenses are building lease and facility expenses, which increased $15,000
over the prior year period, due to a change in the terms of our lease which
provides an increase in monthly payments with a corresponding increase in both
square footage and cost per square foot, and a requirement to pay electricity
costs. Other expenses also include $19,112 for fees for licensing and
subscriptions which increased $4,000, due to increased licensing and regulatory
costs associated with our equipment, and extraordinary costs of $3,300 related
to maintenance and repair and $4,000 of personal property taxes. Excluding a
decrease in expense with the cancellation of the equipment operating lease and
the anticipated reduction in insurance expense resulting from the departure of
two research scientists and one technician, we expect other research and
development expenses to decrease for the remainder of fiscal year 2007.
Depreciation
Total depreciation expense for the three months ended July 31, 2006 and 2005 was
$64,000 and $67,000, respectively. The decrease in depreciation expense reflects
a decrease of equipment put into service during the proceeding and intervening
period.
Interest Expense and Income
Total interest expense for the three months ended July 31, 2006 increased to
$575,000 from $30,000 for the prior year period. Included in the $575,000 of
total interest expense are $22,000 of interest paid or accrued on CNP issued to
investors bearing interest rates per annum of 10%, $5,000 of interest accrued on
balances due pursuant to certain litigation settlement agreements, $7,000 of
interest accrued or paid on finance agreements and lease purchase agreements,
and $543,000 of debt discount expense associated with the beneficial conversion
feature of CNP and detachable warrants.
Interest income for the three months ended July 31, 2006 was minimal.
Other Expenses
During the three months ended July 31, 2006, we recorded a loss on disposal of
property and equipment of $3,000 and recorded a charge of $3,000 due to foreign
currency exchange loss on payables due a foreign supplier.
Penalties on Debt and Equity Issuances
We have issued as penalties, CNP, common stock, and warrants to certain holders
of CNP, common stock and warrants with registration rights, as a result of our
inability to file and maintain effective a registration statement within certain
specified deadlines. The penalties will stop accruing on all of the instruments
once a registration statement covering the instruments is filed and maintained
effective, or when the penalties become impermissible as a matter of law as
prescribed in the instrument.
In December 2005, our Board of Directors approved a special warrant re-pricing
offer for investors whereby participants were allowed to exercise their existing
warrants at greatly reduced prices under the condition, among others, that they
forfeit any claim to the right for future penalties on all securities, resulting
from our inability to file and maintain an effective registration statement or
otherwise. With the participation of a significant number of warrant holders
under the special warrant offer, we have significantly reduced future penalties
on all securities issued to investors.
During the three months ended July 31, 2006, we issued or committed to issue
36,396 shares of common stock as penalty expenses in the amount of $14,000, as
compared to penalty expenses in the amount of $167,000 on the issuance of
236,946 shares of common stock issued in the prior year period. Although greatly
reduced, certain holders of unregistered common stock who did not participate in
the special warrant offer still may receive or accrue each month, as applicable,
additional shares calculated as a percentage of the original number of shares
purchased.
46
For the three months ended July 31, 2006, we recorded $37,000 as penalty expense
for the issuance or committed issuance of warrants to purchase 566,560 common
shares, as compared to penalty expenses in the amount of $305,000 on the issued
or committed issuance of warrants to purchase 1,067,838 shares of common stock
in the prior year period. The fair value of these warrants was determined using
the Black-Scholes pricing model. Although greatly reduced, certain holders of
warrants who did not participate in the special warrant offer still may accrue
each month, as applicable, increases in the number of shares underlying their
warrants, calculated as a percentage of the original number of the underlying
shares.
For the three months ended July 31, 2006, we recorded no expense against CNP as
penalties as compared to $12,000 of penalty expense incurred in the prior year
period. Since all holders of CNP participated in the special warrant offer, we
no longer accrue these penalties to holders of CNP.
Stock-Based Compensation Expense
On May 1, 2006, we adopted Statement of Financial Accounting Standards No. 123
(revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires the
measurement and recognition of compensation expense for all share-based payment
awards made to employees and directors including employee stock options.
Stock-based compensation expense recognized under SFAS 123(R) for the three
months ended July 31, 2006 was $100,000, which consisted of share-based payment
awards made to employees and directors including employee stock options based on
estimated fair values. Stock-based compensation expense recognized in the
Company's Consolidated Statement of Operations for the three months ended July
31, 2006 includes compensation expense for share-based payment awards granted
prior to, but not yet vested as of April 30, 2006, based on the grant date fair
value estimated in accordance with the pro forma provisions of SFAS 123 and
compensation expense for the share-based payment awards granted subsequent to
May 1, 2006 based on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R). As stock-based compensation expense recognized in the
Consolidated Statement of Operations for the three months ended July 31, 2006 is
based on awards ultimately expected to vest, it has been reduced for estimated
forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates. In the Company's pro forma information required
under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for
forfeitures as they occurred. As of July 31, 2006, the total remaining
unrecognized compensation cost related to unvested stock options amounted to
$213,083, which will be amortized over the weighted-average remaining requisite
service period of 1.5 years.
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 2006, we had cash and cash equivalents of $556,000 and accounts
receivable of $200,000.
Other current assets, as of July 31, 2006 increased to $213,000 from $23,000 as
of prior year end. At July 31, 2006, other current assets consisted primarily of
a security deposit of $8,000 related to our facility lease, $132,000 of prepaid
insurance, $63,000 of prepaid edgar filing services paid with equity, and
$10,000 of prepaid legal services.
During the three months ended July 31, 2006, our sources of cash were as
follows:
Amount
----------
Sales of convertible preferred stock $1,413,750
Sales of convertible notes payable, net 385,000
Offering costs (222,267)
Customer deposits 200,000
----------
$1,776,483
----------
As of July 31, 2006, accounts payable were $1,964,000, as compared to $2,591,000
for the prior year period. Accounts payables primarily consist of balances owed
to vendors in connection with the purchase and lease of R&D equipment, as well
as an increase in accrued and unpaid services from consultants and lawyers. We
intend to settle a portion of the payables due service providers, where
possible, through stock issuances.
47
Because we continue to operate under a tightened cash position, which has
resulted in delays to our making payments to some service providers and vendors,
we have changed our policies related to equipment purchasing and put into place
stricter cash conservation measures as well as a restructured our entire
organization so as to generally reduce operating expenditures. For the remainder
of fiscal year 2007, we foresee accounts payable remaining high until we raise
sufficient capital or generate cash flow to significantly pay down these
balances.
Accrued expenses as of July 31, 2006 were $137,000, decreasing $492,000 from
prior year end. The decrease was due to the reclassification of $471,500 of
expenses recognized in connection with certain settlement agreements entered
into by us with regard to litigation filed against us. We intend to settle a
portion of the accrued expenses due consultants, where possible, through stock
issuances. Of the $137,000, $30,000 was expense related to engineering and
manufacturing services, payment of which may be settled with the issuance of
shares of our common stock.
As of July 31, 2006, we continue to carry an estimated payroll tax liability of
$49,000, related to equity based compensation provided by Microdevices for
services rendered from June 1997 through February 2002 by officers, employees,
directors, legal advisors and consultants. We have been making payments against
this amount under a payment plan with the IRS, which also reduced a significant
amount of the payroll tax liability and penalties accrued in the prior period.
See "Note 8 - Accrued Payroll and Payroll Taxes" to our unaudited Consolidated
Financial Statements. Excluding the payroll tax liability mentioned above, as of
July 31, 2006, we have accrued payroll and payroll taxes of $125,000 as compared
to $253,000 for the prior year end. This amount includes $30,000 in accrued
payroll tax, $40,000 of deferred salaries for its President/CEO, as well as
$52,000 for earned vacation of employees.
As of July 31, 2006, the Company had $1,026,000 of other current liabilities as
compared to $703,100 for the year ended April 30, 2006. Of this amount, $903,100
represents deposits made by customers against purchases of our devices and
services, which increased $200,000 over the prior year end, and $123,000
represents a liability associated with insurance premium payable per a finance
agreement. The $903,100 amount is expected to remain recognized as deposits
until the applicable revenue recognition criteria are met, the timing for which
remains uncertain.
As of July 31, 2006, we had $88,000 of accrued interest, representing an
increase of $9,000 from the prior year end and comprised primarily of interest
accrued on CNP issued to investors.
Convertible Notes
Between September and November, 2005, we sold $600,000 of convertible notes
payable (CNP) to various investors, of which $100,000 was subsequently repaid,
with the investor using the money to purchase common shares upon exercise of
warrants under the special warrant offer. The remaining CNP bear interest at 10%
per annum (except in an event of default in which case they bear interest at the
default rate of 12% per annum from the default date until the date that such
default is cured or waived) and are due in October and November 2006. The
remaining $500,000 of CNP were issued with detachable warrants to purchase
400,000 shares of common stock with a three year term at an exercise price of
$0.80 per share. During our special warrant offer, 360,000 shares of common
stock were purchased upon exercise of these detachable warrants at a reduced
exercise price of $0.20 per share, with the remaining warrants forfeited. The
CNP holders have the option to convert the principal and accrued interest into
shares of our common stock at a conversion price of $0.60 per share at any time
until the later of the prepayment date or the maturity date. The Notes are
senior to all of our existing indebtedness, other than any current or future
accounts receivable financing up to an aggregate face amount of $1,000,000.
Further, the outstanding balance of the remaining CNP, plus any unpaid interest,
will be automatically exchanged into the next financing secured by us in the
amount of $2,500,000 or above, at a 10% discount. See "Note 13 - Convertible
Notes Payable" to our unaudited Consolidated Financial Statements. As of the
date of this Report, investors have subscribed approximately $2,200,000 of
Series B Convertible Preferred Stock in our most recent financing and we will
need to raise approximately an additional $300,000 in order to affect the
exchange of the remaining CNP, or risk default which will result in an increase
to the interest rate to 12%, among other remedies.
48
In May and June 2006, the Company issued convertible notes payable ("CNP") to
various investors in exchange for cash of $180,000, which bear interest at 10%
per annum and are due one year from the date of issuance. The CNP were issued
with detachable warrants to purchase 180,000 shares of common stock with a three
year term at an exercise price of $0.45 per share. The holders have the option
to convert the principal and accrued interest into shares of common stock at a
conversion price of $0.30 per share at any time until the later of the
prepayment date or the maturity date. The CNP were secured against certain
receivables of the Company and is payable upon their receipt. In July 2006, the
Company repaid $80,000 of the CNP together with $657 of accrued interest and in
August 2006, the Company repaid $100,000 of the CNP together with $2,383 of
accrued interest.
In May and June 2006, the Company issued CNP to investors in exchange for cash
of $135,000, which bear interest at 10% per annum and are due in May and June
2007. The CNP were issued with detachable warrants to purchase 60,000 shares of
common stock with a three year term at an exercise price of $0.45 per share. In
June 2006, the CNP were automatically exchanged into the Company's Series B
Convertible Preferred Offering at a 10% discount pursuant to the terms of the
CNP.
In June 2006, the Company issued a promissory note for $150,000 to an investor
in exchange for cash of $150,000, due June 2007. The note was issued with a
detachable warrant to purchase 150,000 shares of common stock with a three year
term at an exercise price of $0.45 per share. In June 2006, the promissory note
was exchanged into the Company's Series B Convertible Preferred Offering.
As of July 31, 2005, we were delinquent on notes payable totaling $85,000 held
by a shareholder and related party, which were issued by HiEnergy Microdevices
and assumed by us upon the reverse takeover affected in April 2002. The notes
have been subject to demand since November 1997; however, to date no demand has
been received.
Settlement Agreement
On June 9, 2006, we entered into a Confidential Settlement Agreement and Mutual
Release with a former consultant, Yeffet Security Consultants, Inc. ("YSCI"),
which provides for a mutual reconciliation of disputes. As part of the
Settlement Agreement, YSCI released us from all claims to recover the $449,540
being sought and forfeited its options to purchase up to 1,000,000 shares of our
common stock. Pursuant to the Settlement Agreement, we made a cash payment of
$27,000 and is obligated to make additional cash payments in the amount of
$36,541 representing accrued and unpaid services and expenses incurred in 2003,
and $153,000. The remaining cash payments are due 150 days following the
execution of the Settlement Agreement together with simple interest of 8% per
annum on any unpaid balance accruing from the execution of the Settlement
Agreement until full payment, provided that we have an additional thirty-day
cure period to pay this debt if needed. Pursuant to the Settlement Agreement, we
also issued 775,000 shares (the "Settlement Shares") of its common stock to
YSCI. In the event, we breach our obligations of the Settlement Agreement
relating to the payment of money or the issuance of shares, YSCI, after
providing written notice and five business days to cure any such breach, may
have the arbitrator enter a judgment for the unpaid balance of the cash payments
plus the cash value of any undelivered stock. If we do not have sufficient cash
on hand to meet our obligations under this and any other settlement agreement,
we may be subject to judgments which could adversely affect the Company's
ability to continue as a going concern.
Additional Liquidity Considerations
As of July 31, 2006, we had total current liabilities of approximately $4
million as compared to $4.5 million at the end of the prior year period. These
liabilities greatly exceed our cash on hand. While we have received to date
payments for the purchase of our products and services in the amounts of
$603,100 and $200,000, respectively, we currently do not have firm order
commitments or receivables of significance. Unless and until income generated
from orders reaches a sufficient level to cover operating expenses and our
liabilities, we are required to continue to sell equity or debt instruments in
order to pay present liabilities and fund on-going operations. If we cannot
attract investment or generate revenues, our ability to grow may be severely
hindered and we may not be able to continue as a going concern.
49
In February 2006, in light of cost cutting measures instituted by us, we have
revised our estimated annual financial requirements for calendar 2006 from a
range of $5 to $10 million to a range of $4 to $6 million. This estimated amount
takes into consideration the need to reconcile outstanding payables. Our
budgeted operating expense for fiscal year 2007 is currently estimated at $4.2
million, which assumes $3.2 million of general operating expense and $1 million
of increased R&D and manufacturing expense. In order to meet our standards of
performance and offer more competitive product, we anticipate additional R&D
costs of approximately $500,000. We also estimate expenses related to the
build-out of a manufacturing site to be about $500,000. Although, operating
expense is projected to decrease from $6.1 million to $3.2 million, if we
greatly expand our marketing and sales activities, general operating expense
could increase significantly and the projected operating expense may be
underestimated.
Although historically we have been able to raise capital through self-managed
private placements of our equity, we currently do not have an institutional
commitment for the additional capital necessary as of the date of this Report.
In September 2005, we engaged a placement agent to provide certain advisory and
placement services in connection with securing financing. From October 2005 to
August 2006, we received through private placements to accredited and
institutional investors a total of approximately $3.7 million in proceeds from
financing activities, including $856,500 from the sale of convertible notes
payable, $1.6 million from the exercise of warrants under our special warrant
offer, as well as net proceeds of $1.3 million from the sale of Series B
Convertible Preferred stock as part of a private placement of up to $5 million
of our Series B Convertible Preferred Shares to accredited and institutional
investors approved by the Board in June 2006.
We plan to continue to apply for several government contracts for future
development projects; however, such contracts may not be obtained. We have
successfully obtained a total of seven government development contracts to date
from the U.S. Department of Defense, U.S. Department of Energy and U.S. Customs
Service to finance our research and development. Contracts may be denied for
reasons that include funding of the program, our financial position and
abilities, or for other reasons. In December 2005, $1 million was appropriated
for "stoichiometric" explosive detection systems with the U.S. Army under
Program Element 0602712A. Although we expect these funds to be released for the
delivery of our robot-borne detector to the U.S. Army, and we have confirmed the
availability of these funds as of the date of this report, we can provide no
assurance when these funds will be released.
As to our commercial activities, from September 2005 to January 2006, we
received payment in the amount of $603,000 against an order of two SIEGMATM
systems from Southeastern Pennsylvania Transportation Authority (SEPTA). In
August 2006, we received full payment from the Commonwealth of Pennsylvania
against a purchase of a four-year maintenance and support services program in
the amount of $200,000, which as deferred revenue will be earned and recorded as
revenue on a straight-line basis over the period of the contracts. We also
currently maintain a deposit against an order by Compania de Aprovisionamiento
Especifico S.L. of Tenerife, Spain for one SIEGMATM system and expect to collect
the balance of $227,000 upon delivery.
Until such time as we can (i) generate sufficient sales revenues to fund
operations and research and development costs; and/or (ii) leverage our
financial and developmental capabilities through strategic partnerships which
provide financial support; and/or (iii) receive significant governmental grants,
cooperative funding or purchase contracts, we will be required to raise an
additional $3 to 4 million through the sale of securities to cover estimated
expenditures for the remainder of fiscal 2007, subject to the successful
implementation of our plan and the reduction of operating expenses.
50
PLAN OF OPERATION
Since February 2006, we have made significant changes to our management and
operations with the objective of transforming our organization in order to make
it scalable for anticipated growth. We have taken immediate and deliberate steps
to enhance our operations, improve cost efficiencies and advance our transition
from a research and development company to a commercial manufacturing and sales
organization. We have instituted new fiscal planning, budgeting and auditing
structures, and have significantly reduced expenses, including personnel and
other operating costs.
We have also instituted new capital prioritization strategies to improve capital
utilization and distribution across the entire organization. We have eliminated
expenditures on non-core activities in order to maximize our ability to exploit
those core industries and geographic markets which offer the most compelling
market and revenue growth opportunities, and for which we believe we have
differentiated technologies and expertise.
Lastly, we have been implementing a new results-driven business plan that aims
to expand our customer base and develop multiple sources of revenue including
(i) equipment sales; (ii) extended multi-year service contracts and warranties;
(iii) radiation safety training, licensing and consulting; (iv) technology
licensing fees and joint venture investment income; (vi) research contracts,
co-development funding and grants; (vii) integration services and reseller fees
from non-proprietary products licensed from third parties, and (viii) lease
financing and equipment rental income.
During the remainder of fiscal year 2007 and going forward, our focus will
remain on the commercialization, marketing and sale of our CarBomb FinderTM,
SIEGMA(TM) and STARRAY(TM) systems, as well as the development of newer
prototypes incorporating our proprietary "stoichiometric" technologies, and
incorporate the following principal objectives:
o Aggressively pursue revenue generation and fund working capital from
pre-sales, sales, additional development grants, government
contracts, as well as the formation of joint ventures;
o Secure strategic partners in our industry who have established
product lines and distribution channels, allowing for more efficient
access to our targeted markets and leveraged sales efforts;
o Maintain a leadership position in nuclear-based diagnostics and
further development of competitive products incorporating our core
technologies and other leading-edge technologies, which provide
vale-added solutions for large and sustainable markets;
o Optimize product design and engineering and allow for the easiest
production, fastest assembly, best quality, highest reliability, and
the shortest time to market of our systems;
o Achieve efficiencies throughout the commercialization process from
prototype development to commercial production and better position
our technology for strategic partnerships and cooperative
developments for other industry applications; and
o Continue to improve operational efficiency, maintain expense
controls and implement the business practices, management
philosophies and technology tools necessary to position ourselves
best for revenue growth and organizational expansion.
Our largest geographical market for our products is within the continental U.S.,
which if segmented by user, comprises state and local police departments / bomb
squads, major airports and mass-transit agencies, as well as border and port
security agencies. Explosive detection is generally governmental in nature and
the majority of these potential customers for our products in the U.S. are
dependent on local, state and federal government funds as well as grants awarded
by the U.S. Department of Homeland Security (DHS), the U.S. Department of
Transportation (DOT), and the U.S. Department of Defense (DoD). Funding for
homeland security is expected to continue to increase in the forthcoming fiscal
year as new legislative measures have been recently proposed and/or enacted
which provide direct appropriations in addition to departmental budgets.
The commercial courier, private transportation, and private security services
sectors also have a demonstrated need for our technology. Private security
companies are responsible for protecting 85% of the majority of the critical
infrastructure within the United States. This infrastructure includes local,
state and federal government facilities, office buildings, commercial centers,
stadiums, recreational sites, and resorts, as well as high risk sites such as
nuclear power plants, petroleum refineries and liquefied natural gas facilities
in the United States.
51
We continue to see potential demand for our explosives identification and
detection products and have correspondingly increased, and directed greater
resources toward, the direct and indirect sales and marketing of our products.
We have also created an organized and centralized sales management and lead
tracking system which provides accurate and credible forecasting to allow our
management to properly align expenses with revenue growth, allocate resources,
and rapidly identify shifts in customer demand, market trends and other industry
developments.
As of the date of this Report, we have developed a strategic sales and marketing
plan and have expanded our relationship with distributors and resellers
specializing in the security and anti-terrorism industry, defense industry
consultants, as well as potential strategic partners in developing some key
geographic markets and verticals. In July 2006, Ingersoll Rand Security
Technologies agreed to list our products on its Series 84 Integrated Security
Schedule with the GSA, a centralized federal procurement and property management
agency created by the U.S. Congress to improve government efficiency and help
federal agencies better serve the public. We intend to jointly market and sell
our SIEGMA(TM) systems to governmental agencies, the military and other
customers in complement to Ingersoll Rand's own security offerings.
In connection with our plan, we are currently focusing our sales and marketing
assets products on the domestic market. Accordingly, we have limited our
overseas activities until such time as we can leverage our financial and
developmental capabilities through strategic partnerships or joint ventures with
foreign sponsors, or can generate sufficient sales revenues to fund foreign
operations. Strategic partnerships and joint ventures are intended to reduce the
capital requirements necessary for us to build and maintain the infrastructure
necessary to manufacture and support our products outside North America and
serve as a complementary platform for sales and distribution into Europe, Asia
and other markets. In April 2006, we entered into an agreement with Byron
Commerce Pte Ltd, a leading technology solutions sales and distribution company,
to market and resell our Atometer(TM) explosive detectors, including the
SIEGMATM, CarBomb Finder(TM) and STARRAY(TM) systems, to governmental customers
in the Asia-Pacific markets. We are also in active discussions with numerous
potential distributors and licensees with interests in reselling our products in
the Middle East region.
For the remainder of fiscal year 2007, we also intend to continue to accelerate
and enhance our pre-market and aftermarket efforts, which address the warranty,
service, maintenance, certification, licensing, export policy, product liability
and customer service elements of our commercialization strategy. We have teaming
agreements in place with a global maintenance company, have engaged outside
specialists involved in certification, inspection, and risk management, and are
seeking coverage of our products under the Safety Act to address product
liability issues.
In December 2005, we launched a new program, the Equipment Technical Assistance
Program (ETAP), an integrated suite of services available to buyers which
includes hands-on equipment and operator training, local equipment support,
including calibration, maintenance and servicing, and radiation safety
certification and licensing. For this purpose, we also formed a strategic
relationship with a specialized service and consultancy organization to provide
ongoing radiation licensing, certification, training and auditing services. We
intend to negotiate and enter into additional outsourcing relationships with the
overall objective of providing a uniform and uncompromising package of product
and customer support.
In order to be able to improve the marketability of our products, we have
determined it necessary to field test our products through cooperative sales
initiatives which are intended to accelerate our in-field assessment of our
explosive detection systems and software architecture for user operability and
stability, as well as provide us with critical feedback and suggested design
improvements based on each program participant's specific operational needs. The
programs are expected to stimulate sales by allowing us to bring our commercial
products to market more effectively and efficiently, enhance our products to
better satisfy the needs of the public transit industry, and test our
aftermarket service capabilities. During the remainder of 2007, we will continue
to offer similar programs to other early adopters in the first responder
community, including emergency response teams, bomb squads and explosive
ordnance disposal units from a wide array of federal, state, municipal and local
agencies around the U.S. In certain circumstances, as determined by the
purchasing policies of prospective customers, we may be required to enter into
pilot programs prior to receiving purchase commitments.
During the remainder of fiscal year 2007, we will continue to direct the greater
portion of our production budget to our SIEGMA(TM) system, which management has
prioritized in response to interest received from airport and transit system
operators. In January 2005, we received our first order for one SIEGMA(TM) 3E3,
followed by the order of two systems from SEPTA in June 2005. As for our
vehicle-borne CarBomb Finder(TM) 3C4, we have upgraded the delivery platform
design and are making enhancements to the vehicle assembly with the assistance
of integration partners. In October 2005, we announced the order of one CarBomb
Finder(TM) by the U.S. Army under a subcontract providing for the integration of
our system in the Army's SmarTruck Multi-Mission Vehicle platform, which is now
expected to be delivered by year end.
52
Initial assembly of orders is performed at our research and development facility
located in Irvine, CA. Assembly at this facility will be limited, and we may be
required to outsource certain functions and/or hire additional technicians as
needed. Based on preliminary marketing data suggesting a strong demand for
commercial versions of our explosion detection devices, we anticipate the need
to scale production to meet that demand. Previously, we have studied locations
to serve as our principal assembly facility in various states and continue to
meet with both local and state officials as part of this assessment. We have
estimated that the construction and/or build-out costs related to a dedicated
manufacturing facility fall between $1 million and $2.5 million, which costs are
expected to be supplemented by local municipalities and state agencies in the
form of monetary incentives offered to locate a facility to their respective
areas. As of the date of this report, we have not selected a site to locate a
facility and are unsure whether or not we will be able to meet the criteria
necessary to attract local municipalities and state suitors.
In June 2005, we hired a consultant for three months experienced in strategic
planning and financial and operational management to help us establish and
refine a production system which includes supplier relations, material handling,
manufacturing processes, labor force capabilities, and distribution systems.
Further, in September 2005, we engaged an engineering and production consultant
with substantial experience to build the internal mechanisms necessary to
engineer, package and deliver our core technologies in the most cost effective
manner, as well as develop a product test plan and quality control procedures.
During the remainder of fiscal year 2007 and forward, we will continue to
incorporate the business practices, management philosophies and technology tools
necessary to optimize product design and engineering to allow for the easiest
production, fastest assembly, best quality/reliability, and shortest time to
market of our systems.
During fiscal year 2007, we may be required to increase inventory of those core
components and parts that have greater delivery lead-times from vendors to
prevent potentially harmful delays in our product delivery cycle. Although we
remain adverse to building inventories, in light of the lead-times and
anticipated sales of our products, we have estimated that in order to meet, and
properly manage the sales cycle of, anticipated orders, we will require at any
one time sufficient components to deliver at least 5 to 10 units of our
explosive detection systems to buyers. In order to control inventory risk, we
will continue to identify and seek to engage additional sources of components in
order to reduce, limit or eliminate our exposure to single-source suppliers and
protracted delivery schedules. We have entered discussions with various vendors
and are in the process of securing commitments for volume discounting and to
shorten production times in anticipation of an increase in sales volume.
Materials and production costs for our explosive identification units will be
significant for the remainder of fiscal year 2007. Working capital requirements
and inventories are also expected to grow in remainder of fiscal year 2007, as
necessary components are purchased. Initial sales are projected to be at or near
cost with margins expected to improve significantly with the elimination of
non-recurring engineering costs, the realization of economies of scale attendant
to the opening of our production facility or the outlay of the assembly function
to a manufacturing partner, and the increased demand anticipated with the
introduction of our products into the marketplace. As we proceed with our
commercialization phase of our products and expand our operating structures,
enhancements to corporate management will also be necessary and we anticipate
increases in personnel requirements throughout our organization. An off-site
production facility, when operational, will require the hiring or contracting of
approximately 20 new personnel. We also anticipate the need to hire individuals
to manage the product engineering, manufacturing and distribution functions, and
to fill and upgrade key executive positions in fiscal year 2007, including,
among others, a new controller and possibly a chief financial officer. Other
areas that may require additional personnel include sales and marketing,
customer service and human resources. As funds are available, we also anticipate
hiring additional skilled personnel, such as advanced engineering professionals,
as part of a product development team that can operate and manage projects with
minimal supervision, additional scientists, and experienced technicians. Our
current facilities will be adequate to conduct our administrative, research and
development activities as well as initial assembly and distribution.
We plan to continue to focus on the research and development of additional
applications of our technologies and the further exploitation of our technology
assets both internally and through collaboration with third parties. We intend
to build upon our investments in the base units and core technologies upon which
our explosives identification and detection prototypes are based, as well as
introduce more sophisticated applications and configurations. We intend to
continue to work on expanding the number of explosive substances that can be
detected and identified by our systems, so as to provide the customer with the
most effective, reliable and adaptable tools possible. In order to capitalize on
additional commercial opportunities that have been identified for our
Atometer(TM) detectors, we will need to continue to pursue intensive research
and development initiatives and advance our Atometer(TM) detector system designs
to provide more rapid and precise detection and analytical capabilities. In
light of an increase in our grant application activity and current and
anticipated cooperative and research development agreements, we expect to use
the proceeds of government grants and/or research and development contracts,
together with other available funds, to accomplish these objectives.
53
While we are seeking to reduce our dependency on the sale of our securities by
funding working capital through proceeds from other sources, such as pre-sales,
sales, additional development grants, government contracts, as well as the
formation of joint ventures, we are still dependent on financing operations
through the sale of our securities. The uncertainties of securing financing has
limited our capacity to make greater investments in research and development,
inventory and component procurement, and human resources, as well as the
commercialization of our products. In light of the cost-cutting measures
accomplished, we have adjusted our budgeted general operating expense for fiscal
year 2007 to $3.2 million. Taking into consideration outstanding payables and
the estimated total costs to further advance our current product line we
estimate that our total financial requirements for calendar year 2007 (excluding
contributions received through research and development grants) will be between
$4 million and $6 million. We have recently raised $1.2 million through a
private placement and are currently seeking an additional capital infusion of
$3-4 million, which is our financial requirement for the remainder of fiscal
year 2007 for administrative and operational costs, including personnel and
consultant expenses, property and materials, and accounting/reporting and legal
expenses. While there can be no assurance, we are hopeful that the
cost-reduction plan affected during this period combined with anticipated
revenue growth will improve our condition as a going concern.
54
RISK FACTORS
We are a development stage company, and an investment, or maintaining an
ownership position, in our common stock is inherently risky. Some of these risks
pertain to our business in general, and others are risks which would only affect
our common stock. The price of our common stock could decline and/or remain
adversely affected due to any of these risks, and investors could lose all or
part of an investment in our company as a result of any of these risks coming to
pass. Readers of this Report should, in addition to considering these risks
carefully, refer to the other information contained in this Report, including
disclosures in our financial statements and all related notes, before making any
determination with respect to our stock. If any of the events described below
were to occur, our business, prospects, financial condition, or results of
operations or cash flow could be materially adversely affected. When we say that
something could or will have a material adverse effect on it, we mean that it
could or will have one or more of these effects. We also refer readers to the
information at the front of this Item 2, discussing the impact of
Forward-Looking Statements on the descriptions contained in this Report and
included in the Risk Factors discussed below.
Risks Related To Our Business
General Business Risks
We have a history of losses and an accumulated shareholders' deficit of
$42,239,799 as of July 31, 2006, and we may never achieve profitability.
We have not generated any revenue from operations, and we have incurred net
losses available to common shareholders every year since our inception,
including $1,807,211 for the three months ended July 31, 2006, as compared to
$2,053,305 for the prior year period, and $43,349,938 for the period from August
21, 1995 (inception) through July 31, 2006. Although we reduced operating
expenses during the last quarter of the fiscal year, our operating expenses
remain high due in part to investments we are making in connection with the
commercialization, manufacture and marketing of our initial Atometer(TM)
detectors. To achieve profitability, we will need to generate significant
revenue, while achieving reasonable costs and expense levels. We may not be able
to generate enough revenue to achieve profitability. If we cannot achieve or
sustain profitability, we may not be able to fund our expected cash needs or
continue our operations.
We will need additional capital to meet our operating needs, and additional
capital may not be available on favorable terms or at all.
During the period from May 1, 2005 through July 31, 2006, excluding sources or
uses from working capital, we have experienced average monthly negative cash
flows from operations of approximately $300,000 with no real revenue. As such,
we must continually raise capital from the sale of equity or the placement of
debt to private investors, or from government grants or development contracts,
in order to fund our operations at current levels or at all. Our ability to
raise additional funds in the public and private markets will be adversely
affected if the results of our business operation are not favorable, or if the
commercialization of our Atometer(TM) detectors are poorly received or fails
altogether.
Although we intend to seek additional funding through corporate collaborations
or from loans or investments from new or existing stockholders, additional
capital may not be available to us and, even if available, it may not be on
terms which our Board of Directors would be willing to accept. If we cannot
obtain the capital we need to fund our operations on terms which we can accept,
we may be required to curtail our operations significantly, or cease our
operations altogether, which would have a material adverse effect on our
business, our operations and our financial condition.
As a development stage company with an unproven business strategy, we may not be
able to achieve positive cash flows and our limited history of operations makes
evaluation of our business and prospects difficult.
While we have developed prototypes and are introducing our first commercial
products, except for the purchase by Southeastern Pennsylvania Transportation
Authority (SEPTA) and orders placed by our resellers in Spain, we have had no
significant sales. Because of the few orders and the fact that the markets for
our Atometer(TM) detectors remain largely untested and undefined in general, we
are still classified as a development stage company with a limited operating
history.
Since April 25, 2002, we have focused our resources on the development of
products using our proprietary stoichiometric technology. We believe that we are
the only company working on a commercial product using stoichiometric
technology, and so there is no proven market for our products once development
is complete. To date, we have no commercialization experience with our
technology, and it is difficult to evaluate our prospects for sustained growth
and profitability. Our future success is more uncertain than if we had a more
established and proven history of operations and greater experience in executing
similar business strategies. Furthermore, it is expected that our current
business and marketing approach will be modified from time to time, as we
continue to assess the markets and applications for our technology as well as
evaluate prospective customer interest. No assurance can be made that the
current strategies or any future changes in our business model, and the
marketing of products, will be met with success. For the last two fiscal years
we have not generated any significant revenues and, as a result, we have limited
resources and our potential ability to generate and maintain income also remains
unproven.
55
The commercial viability of our Atometer(TM) detectors is unproven, and may
never be realized.
As of the date of this Report, we have not had independent testing of the
Atometer(TM) detectors to rate or certify their functionality in explosive
detection, nor have we commissioned an independent market or research study to
determine their market potential. Consequently, the commercial viability of our
Atometer(TM) detectors is unproven at this time. We also have had limited field
testing experience and are unable at this time to qualify the amount and
frequency of maintenance to be required by our Atometer(TM) detectors, and we
have limited experience in causing, or simulating, extensive usage. We have
identified reliability issues which require us to create more "hardened" or
"ruggedized" equipment and will continue to seek improvements in design and
function. Our inability to resolve these issues or a significant increase in the
amount of maintenance required to keep the devices operating may result in
unforeseen problems or customer dissatisfaction. If this were to occur, current
or prospective customers could very well perceive that there are reliability
problems with our products, which could reduce the demand for our products. If
commercial opportunities are not realized from the use of our Atometer(TM)
detectors and we have difficulty attracting and maintaining customers, our
ability to generate revenues will be adversely affected. We also have not had
the ability to undertake extensive testing in real-world situations, and cannot
with certainty explain how the device would be impacted by severe weather,
burning or excessive heat, a wartime environment, various topographies or other
circumstances which maybe of particular importance to certain prospective
customers or in certain regions. Without internal data in respect of these kinds
of testing, prospective customers may be reluctant to spend the funds necessary
to purchase our Atometer(TM) detectors, or any of our other prototype
developments, and the sales cycle may be much longer than anticipated or may not
materialize at all, either of which events would have a materially adverse
effect on our business, operations and financial condition.
From time to time we may demonstrate our products to potential customers and/or
sources of funding, and any failures in these demonstrations could have a
materially adverse impact upon our ability to sell our products, and on our
business and financial condition generally.
As a defense products company, we are sometimes requested or required to
demonstrate, pilot or field test our technologies and our products at varying
product stages, which may be in front of potential purchasers of the products,
and/or sources of grant or private equity funding. To the extent that any
product or technology may not work in the manner in which it is intended, such
prospective purchasers and/or funding sources may lose confidence in our
products and technology, and may determine not to purchase any products or fund
any developments. If a demonstration should not work successfully at any time
when large numbers of people are present, the news could spread within the
homeland defense industry we are working in, especially among the relatively
small universe of large potential governmental agencies and other organizations
who are likely purchasers of our products. If that were to happen, it could have
a materially adverse effect upon our ability to make sales of our products, as
well as on our overall business operations and financial condition.
We have limited resources to devote to product development and
commercialization. If the commercialization of our Atometer(TM) detectors proves
unsuccessful, any reallocation of resources could substantially harm our
business.
Our business strategy is to develop, manufacture and market products
incorporating our stoichiometric technology to address initially the security
and counter-terrorism market and the chemical and petrochemical industry control
market. Our current and primary objective is to commercialize our proprietary
Atometer(TM) detectors. We believe that in the near term our revenue growth and
profitability, if any, will substantially depend upon several factors, including
the following:
o our ability to raise additional capital to manufacture and market
our current devices, the CarBomb Finder(TM), SIEGMA(TM) and
STARRAY(TM) systems;
o our ability to raise additional capital for general and
administrative costs relating to our operations;
56
o our ability to manufacture our Atometer(TM) detectors in commercial
quantities, at a reasonable profit margin;
o receipt of any requisite approvals from the Nuclear Regulatory
Commission (NRC), the Department of State, the Department of
Commerce, the Department of Defense, and similar state or foreign
authorities, as applicable;
o market acceptance of our Atometer(TM) detectors and after-market
satisfaction related to performance and maintenance issues;
o legislative or other government actions driven, in part, by the
public's perception of the threats facing the population and
unrelated political circumstances, which may leading to significant
fluctuations in demand for our products and services;
o the availability and cost of key components for our Atometer(TM)
detectors;
o the timing of completion of acceptance testing for our Atometer(TM)
detectors; and
o changes in pricing policies by us, our competitors or our suppliers,
including possible decreases in average selling prices of CarBomb
Finder(TM), SIEGMA(TM) and STARRAY(TM), caused by promotional
offerings, customer volume orders, or competitive pricing pressures.
We have introduced our CarBomb Finder(TM), SIEGMA(TM) and STARRAY(TM) systems
only recently, and all other applications of our technology are prototypes or at
earlier development stages. For the year the three months ended July 31, 2006,
we incurred expenses of $391,000 or 33% of total operating expenses on research
and development, and we incurred expenses of $784,000 or 67% of total operating
expenses on general and administrative expenses. We anticipate an increase in
general and administrative expenses due to additional operating expenses
demanded for commercialization and marketing of Atometer(TM) detectors. We
anticipate research and development costs to stay approximately at the same
level, to the extent that independent testing of our Atometer(TM) detectors will
be required in order to obtain approvals from regulatory authorities or gain
better market acceptance by industry partners or governmental officials.
If we fail to commercialize our CarBomb Finder(TM), SIEGMA(TM) and STARRAY(TM)
systems, we will have no other products to sell until we complete their
development and commercialization, which will require additional capital and
time. As a result, our ability to generate revenues will decrease, which could
substantially harm our business. Because we have limited resources to devote to
product development and commercialization, any reallocation of resources to the
commercialization and marketing of our devices that proves unsuccessful may
delay or jeopardize the development of other products. The development of new
products require time and financial resources much greater than what we
currently have or anticipate, and despite significant investments in research
and development, may not yield commercially successful products. The development
of our products for the detection of explosives, special nuclear materials,
illicit drugs, biological agents and other contraband is highly complex.
Due to our losses and accumulated deficit, we have concerns about our ability to
continue as a going concern.
Our independent and registered certified public accountants qualified their
opinion contained in our consolidated financial statements as of and for the
year ended April 30, 2006, and all subsequent periods, to include an explanatory
paragraph related to our ability to continue as a going concern, stating that
"the Company had negative cash flows from operations of $15,848,085 for the
period from August 21, 1995 (inception) to July 31, 2006. In addition, the
Company had an accumulated deficit of $42,239,799 and was in the development
stage as of July 31, 2006. These factors raise substantial doubt about the
Company's ability to continue as a going concern." The auditors recognize that
the cash flow uncertainty makes their basic assumptions about value uncertain.
When it seems uncertain whether an asset will be used in a "going concern" or
sold at auction, the auditors assume that the business is a "going concern" for
purposes of all their work, and then they disclose that there is material
uncertainty about that assumption. It is definitely a consequence of our
negative cash flows from operations that we continually need additional cash. At
any time, a serious deficiency in cash flows could occur and it is not always
possible or convenient to raise additional capital. A problem in raising capital
could result in temporary or permanent insolvency and consequently potential
lawsuits by unpaid creditors and perhaps closure of the business. All of these
things are possibilities. It is certain, in any case, that analysts and
investors view unfavorably any report of independent auditors expressing
substantial doubt about a company's ability to continue as a going concern.
Consequently, we urge potential investors to review the report of our
independent certified public accountants and our consolidated financial
statements before making a decision to invest in us, and not to invest in our
common stock unless they can afford the potential loss of their entire
investment.
Companies which possess much greater financial and other resources and have more
manufacturing, marketing, sales and distribution experience than we have, may
develop a technology which competes effectively with our stoichiometric
technology, and we may be unable to capture or maintain market share.
57
Based upon our review of the industry, we believe that no other company today
markets a technology which is similar to or competitive with our stoichiometric
technology used in our Atometer(TM) detectors, and the other prototype devices
referenced in this Report. The market for explosives and contraband detection
equipment generally is dominated by a few very large corporations (or their
subsidiaries), which have greater access to capital, manpower, technical
expertise, distribution channels and other elements which would give them a huge
competitive advantage over us were they to begin to compete in our market. Our
ability to market our technology as "unique" is dependent upon the fact that
these larger, better-established companies do not have the ability to determine
the exact identity, amount and weight of each element their equipment detects.
If one of these competitors was to throw sufficient capital and other resources
at developing a competitive technology, notwithstanding our efforts to secure
protection of our core intellectual property rights, they might be able to do
so, in which case it would be very difficult for us to compete and we might not
be able to maintain our existing market share as of that point, or capture any
additional market share, with our products. Furthermore, if one of these
competitors were to develop a technology which was viewed as an improvement over
our existing technology, our ability to maintain any segment of the
neutron-based detection market might disappear altogether, which would have a
materially adverse effect upon our business, operations and financial condition.
It is possible that competitors may introduce new technologies before we do,
allowing them to offer similar or more effective products at more competitive
prices. Any number of future technological developments could:
o adversely impact our competitive position;
o require write-downs of obsolete technology;
o require us to discontinue production of obsolete products before we
can recover any or all of our related research, development and
commercialization expenses; or
o require significant capital expenditures beyond those currently
contemplated.
We cannot assure investors that we will be able to achieve the technological
advances to remain competitive and profitable, that new products and services
will be developed and manufactured on schedule or on a cost-effective basis,
that anticipated markets will exist or develop for new products or services, or
that any marketed product will not become technologically obsolete.
We depend on key management and personnel and may not be able to hire or retain
additional key managers, employees and technical and scientific personnel when
needed.
Our future success will be due, in part, to the continued services of our senior
management team. The loss of services by one or more members of our management
and scientific teams could negatively affect our business and development
strategies. Members of our executive and scientific team, may be harmed. In
order to meet our objectives, we will need to recruit additional members for our
senior management team. We also anticipate hiring additional skilled personnel,
such as advanced engineering professionals, as part of a product development
team that could be self sufficient and operate with minimal supervision. As a
result, our future growth and success will depend in large part upon our need
and ability to attract and retain qualified personnel.
We are unable to predict the impact that the continuing threat of terrorism and
the responses to that threat by military, government, business and the public
may have on our financial condition and ability to continue to implement the
government sales portion of our business plan.
The terrorist attacks in the U.S. and other countries have brought devastation
to many people, shaken consumer confidence and disrupted commerce throughout the
world. The continuing threat of terrorism and heightened security measures, as
well as current and any future military and civil action in response to such
threat, may cause significant disruption to the global economy, including
widespread recession. We are unable to predict whether the continuing threat of
terrorism or the responses to such threat will interfere with our efforts to
raise additional capital to fund our operations through the development stage.
If we are unable to raise sufficient capital due to economic conditions, we may
be unable to finalize development of our detection systems under government
contracts and to bring them to military, civil or commercial markets as planned.
58
Our business may be subject to international risks that could materially harm
our business.
We are pursuing various international business opportunities, including
opportunities in Turkey, Spain and the Middle East. We anticipate a number of
additional risks associated with our international activities, which could
adversely affect our business including, among others, the following:
o changes in domestic and foreign regulatory requirements;
o political instability in the countries where we sell products;
o differences in technology standards;
o foreign currency controls;
o longer payment cycles and inadequate collection system;
o fluctuations in currency exchange rates;
o inconsistent intellectual property protections in foreign
jurisdictions;
o export restrictions, tariffs, embargoes or other barriers;
o prejudicial employment laws and business practices;
o difficulties in obtaining and managing distributors; and
o potentially negative tax consequences.
Manufacturing Risks
We have limited manufacturing experience and our ability to successfully execute
a manufacturing plan is untested.
In order to be successful, we must be able to manufacture, or contract for the
manufacture of, our Atometer(TM) detectors in a scalable and cost effective
manner, producing sufficient quantities on a timely basis, under strict quality
guidelines and in compliance with regulatory requirements. To date, we have
manufactured a limited number of systems for commercial sale, and have little
experience in contracting third parties to manufacture the product for us. In
order to move toward commercial production, in August 2004, we retained
engineering and construction consultants to develop a detailed conceptual plan
for a manufacturing facility, and in March 2005, we formed HiEnergy Mfg Company
in order to create a semi-autonomous division to develop and manage the
infrastructure, policies and controls for the manufacture and assembly of our
Atometer(TM) detectors. We anticipate that we will need to make a substantial
capital investment and recruit qualified personnel in order to build, equip
and/or operate any manufacturing facility. Although we have not yet determined
the timing as to the construction or build-out of a manufacturing facility, we
intend to begin the initial phases of production of the first 10 Atometer(TM)
detectors at our facilities in Irvine and to continue this effort during fiscal
year 2007, or until either a manufacturing facility is constructed and/or
equipped or an outsourced manufacturing contract is secured.
Our manufacturing strategy, as contemplated, depends on the following:
o the ability to raise additional capital to cover the costs of
constructing and equipping a facility and for the manufacturing of
our Atometer(TM) systems in quantities necessary to meet anticipated
demand should approval by regulatory authorities be obtained;
o the ability to manufacture products that have minimal and acceptable
defects;
o the ability to obtain product liability insurance;
o the ability to obtain approvals from any applicable state or federal
regulatory agencies;
o unexpected changes in regulatory requirements;
o inadequate protection of intellectual property; and
o risks of fire, earthquake, or other man-made or natural acts
affecting manufacturing facilities.
Any of these factors, or the failure to execute them, could delay the
manufacturing of our Atometer(TM) detectors, lead to higher costs, irreparably
damage our reputation with future customers due to factors such as quality
control or delays in order fulfillment, and result in our being unable to
effectively sell our Atometer(TM) detectors and substantially harm our business.
Before we can afford to have our own manufacturing facility, or engage a
third-party to manufacture units for us on an OEM basis, we must manufacture the
initial units we sell in our laboratory facility with limited staff on a one-off
basis, which renders us unable to create any manufacturing efficiencies or to
realize a profit from the resulting sales. If we are not able successfully to
transition our manufacturing to full-scale commercial production, it will have a
materially adverse effect on our business and financial condition.
We anticipate that at least the first 10 units of our Atometer(TM) detectors we
may be able to sell will have to be manufactured in-house, one at a time, with
limited staff and resources, and without the ability to take advantage of the
economic efficiencies which we would expect if our product is successfully
launched and can be manufactured at higher numbers in full production. We may
never reach that level of production and, if we don't, then our manufacturing
efforts will not produce any profit for us or our stockholders, and we may
potentially have to sell units at a loss (if our cost of goods, including
manufacturing of each unit, exceeds the purchase price we are able to charge our
customers for these initial units). If we cannot convert our commercial
manufacturing operation into a profit center for our company, it will have a
materially adverse impact on our business and operations, and our overall
financial condition.
59
We rely substantially on third-party suppliers and depend upon a limited number
of suppliers of one of our components for our Atometer(TM) detectors (the gamma
ray detector). The inability to obtain parts from these suppliers on a timely
basis and the loss of product or delays in product availability from one or more
third-party suppliers could substantially harm our business.
We currently rely on third-party suppliers for various parts of our Atometer(TM)
detectors, including neutron generators with custom modifications and certain
sub-assemblies. For example, we obtain the standard sealed tube neutron
generators we use from the supplier, on a purchase order basis.
We believe that alternative sources for these components in the event of a delay
or interruption in supply would be readily available on a timely basis, however,
any inability by us to find alternative sources of key components, alternative
third-party manufacturers or sub-assemblers, or sufficient quantities of these
key components, would impair our ability to manufacture and sell our
Atometer(TM) detectors and result in delays or interruptions in shipments, which
could cause current or potential customers to seek out competitors. In addition,
if we are unable to pay for these components on a timely basis, or cannot
arrange sufficient available credit, our third-party suppliers may delay or
cease shipments, which would also impair our ability to manufacture and sell our
Atometer(TM) detectors. We currently do not have long-term agreements with any
of these suppliers. Furthermore, in view of the high cost of many key
components, we would strive to avoid excess supplies. If our suppliers
experience financial, operational, production or quality assurance difficulties,
or our sole source suppliers are acquired or otherwise influenced by our
competitors, the supply of components to us would be reduced or interrupted. In
the event that a supplier ceases operations, discontinues a product or withholds
or interrupts supply for any reason, we may be unable to acquire the product
from alternative sources within a reasonable period of time, which would impair
our ability to manufacture and sell Atometer(TM) detectors and cause substantial
harm to our business.
Interruptions, delays or cost increases affecting our materials, parts,
equipment or suppliers may adversely affect our manufacturing operations.
Our manufacturing operations depend upon obtaining adequate supplies of
materials, parts and equipment on a timely basis from third parties. In
particular, there are few manufacturers worldwide of particle accelerators and
gamma ray detectors; sophisticated and expensive equipment which are the key
components of our products. Our reliance on third party suppliers limits our
control over product delivery schedules or product quality. Our results of
operations could be adversely affected if we are unable to obtain adequate
supplies of materials, parts and equipment of adequate quality in a timely
manner or if the costs of materials, parts or equipment increase significantly.
From time to time, suppliers may extend lead times, limit supplies or increase
prices due to capacity constraints or other factors. In the event that any of
our suppliers were to experience financial, operational, production or quality
assurance difficulties resulting in a reduction or interruption in supply to us,
our operating results could suffer until alternate suppliers, if any, were to
become available.
Our competitors could purchase the same components from our suppliers and
attempt to copy our products to the extent not covered by patents or other
intellectual property rights.
We, like most companies, purchase components for our products from third party
suppliers. We have patent applications pending that are directed to various
combinations of some of these components, but do not cover any of these
components separately. Competitors could purchase the same components from the
same suppliers and assemble similar products to the extent not protected by
patent protections or other intellectual property rights. We cannot assure you
that our competitors will not independently develop comparable or superior
technologies using similar or identical components or that our competitors will
not obtain unauthorized access to our proprietary technology and utilize it
where we have no patent protection or where patents do not cover the
competitor's technology. Areas of the world where we do not have patent
applications include, for instance, the Middle East, Russia, Africa, and South
America. We believe that we have applied for patents in countries, which
constitute the largest markets for our products, and we intend to expand our
patent portfolio. We have applied for patents in the United States, the European
Union, Canada, and Japan and as improvements are made we intend to file also
elsewhere for any potential patent protection. See the discussion under the
heading Intellectual Property Risks.
60
We may be unable to secure anticipated governmental funding for future products;
we are currently unable to obtain an SBA Certificate of Competency.
We plan to apply for several government contracts for the development of future
products; however, such contracts may not be obtained. We have successfully
obtained a total of seven government development contracts to date from the U.S.
Department of Defense, U.S. Department of Energy and U.S. Customs Service to
finance our research and development. Contracts may be denied for reasons that
include funding of the program, our financial position and abilities, or for
other reasons. We cannot assure investors that additional government research
and development contracts or funding will become available in the future or that
we will receive any additional funds due under previously secured contracts. If
the government discontinues its sponsorship for our technology, we would have to
raise or divert additional capital for product development, which could
adversely affect our business. Furthermore, we are aware that competitors and
potential competitors in the explosive detection market have also received
development grants. Any future grants to competitors or potential competitors
may improve their ability to develop and market advanced detection products that
could compete with our technologies.
In the past, we failed to receive a research grant from the U.S. Navy as a
result of our inability to obtain a Certificate of Competency from the U.S.
Small Business Administration certifying our financial condition as being
adequate to responsibly complete the grant work if it were awarded to us. Due to
our financial condition, we were not awarded the requisite Certificate of
Competency, nor was the Small Business Administration's determination reversed
in June, 2003 when we requested reconsideration of this decision. Management
believes that, in our present condition, the requirement to obtain Certificates
of Competency will continue to be a bar to our ability to win certain government
grants in the future, and is seeking the additional capital necessary to meet
the minimum competency requirements for the projects in which it desires to
participate. It is impossible to state how much money is necessary to obtain a
Certificate of Competency, because it varies from grant to grant and we have
never received a specific dollar amount that would need to be obtained in order
to qualify. There can be no assurance that we will ever obtain the additional
equity capitalization that we need to obtain Certificates of Competency in
respect of any given grant opportunity or, even if we do, that we will be
awarded any research and development grants.
Governmental agencies have special contracting requirements, which create
additional risks.
In contracting with governmental agencies, we are subject to public agency
contract requirements that vary from jurisdiction to jurisdiction. Any potential
sales to public agencies will depend, in part, on our ability to satisfy their
contract requirements, which may be difficult or impossible in certain cases.
Moreover, government contracts typically contain unilateral termination
provisions unfavorable to us and are subject to discretionary auditing and
modification by the government, which subject us to additional risks. The U.S.
government may terminate any of its contracts with us either for its convenience
or if we default by failing to perform in accordance with the contract schedule
and terms. Nonetheless, termination for convenience provisions generally enable
us to recover only our costs incurred or committed, and settlement expenses and
profit on the work completed prior to termination. Termination for default
provisions do not permit such recoveries and make us liable for excess costs
incurred by the U.S. government in procuring undelivered items from another
source. Any potential contracts with foreign governmental agencies or bodies may
contain similar provisions.
Consequently, our backlog on government contracts cannot be deemed a true
indicator of our future revenues. The government's termination of one or more of
the contracts for products under development would harm our business. In
addition, U.S. government contracts are conditioned upon the continuing
availability of Congressional appropriations, which are readdressed on an annual
basis. Consequently, our contracts with certain government agencies generally
are only funded in part at the outset and commit additional monies only as
Congress makes appropriations for future periods. The inability or failure by
the government in funding one or more of the contracts for our products under
development would harm our business.
In addition, contracts with governmental agencies are frequently awarded through
a formal bidding processes, which can be often protracted and contain
cancellation provisions in the event said public agency loses its funding. There
can be no assurance that we will be awarded any of the contracts for which our
products will be bid and even if we are awarded contracts, substantial delays or
cancellations of purchases could result from complaints filed by competing
bidders.
61
If our losses continue into the future, our business and our stockholders will
be adversely affected. We are therefore attempting to reduce our dependence on
governmental customers, which can require longer than average lead times before
sales are made.
We have incurred net losses since our inception. For the year ended July 31,
2006, we reported net losses available to common shareholders of $1,807,211 as
compared to a net loss available to common shareholders of approximately
$2,053,305 for the prior year period. Our accumulated deficit through July 31,
2006 is $42,239,799. We expect that our losses will continue into fiscal year
2007. We estimate that our aggregate financial requirements will be between
$4,000,000 and $6,000,000 for the fiscal year, until we can generate sufficient
revenues from sales to cover our operating costs. One of the factors for the
continuation of such anticipated losses is that we are highly dependent on
governmental customers, which typically require long lead times before sales are
made.
Marketing Risks
A failure to establish and maintain relationships with industry partners may
harm our business.
Our success will depend in part on establishing and maintaining relationships
with industry partners. Our ability to produce and market the CarBomb Finder(TM)
and SIEGMA(TM) devices is dependent upon our ability to establish and maintain
satisfactory relationships with other companies and individuals. We may not be
able to enter into relationships with these companies on commercially reasonable
terms or at all. Even if we establish such relationships, not all may result in
benefits for our company.
We may grant third parties substantial marketing rights to our Atometer(TM)
detectors in an important market or industry. If the third parties are
unsuccessful in marketing our detectors, our marketing plan for the relevant
territory or industry could be jeopardized or interrupted.
From time to time, we may enter into distribution agreements with third parties
which provide substantial rights or exclusivity with regard to the marketing and
sale of our products to a particular region or industry These agreements would
make us greatly dependent on the ability of these third-parties in penetrating
and making sales within certain markets or industries. We generally attempt to
control this dependency by providing minimum performance requirements as to
sales activity and tangible results and providing acceptable cancellation or
termination provisions. Although we may have the right to cancel or terminate
these agreements, there may still be significant costs associated with
extricating ourselves from certain agreement and market share could be
compromised if a smooth transition to another distributor is not made.
Intellectual Property Risks
We may not be able to protect our intellectual property and may infringe on the
intellectual property rights of others.
The protection of our intellectual property and the establishment of patents and
other proprietary rights are important to our success and our competitive
position. Accordingly, we devote substantial resources to the establishment and
protection of intellectual property through various methods such as patents and
patent applications, trademarks, copyrights, confidentiality and non-disclosure
agreements. We also rely on trade secrets, proprietary methodologies and
continuing technological innovation to remain competitive. We have taken
measures to protect our trade secrets and know-how, including the use of
confidentiality agreements with our employees. However, it is possible that
these agreements may be breached and that the available remedies for any breach
will not be sufficient to compensate us for damages incurred.
We currently have pending patent and provisional patent applications in the
United States and various foreign countries. There can be no assurance that our
patent applications will result in the issuance of any patents, or that the
claims allowed under any patents held by us will be sufficiently broad to
protect our technology against competition from third parties with similar
technologies or products. Moreover, we can give no assurance that others will
not assert rights in, or ownership of, patents and other proprietary rights we
may establish, or acquire or that we will be able to successfully resolve such
conflicts. In addition, we cannot assure investors that any patents issued to us
will not be challenged, invalidated or circumvented or that the rights granted
under these patents will provide a competitive advantage to us. Moreover, the
laws of some foreign countries do not protect intellectual property rights to
the same extent as the laws of the United States, and therefore we could
experience various obstacles and significant costs in protecting our
intellectual property rights in foreign countries. If we are unable to obtain or
maintain these protections, we may be unable to prevent third parties from using
our intellectual property.
In the operation of our business, it is inevitable that certain employees,
consultants, vendors, current or prospective customers, distributors, government
officials, investors and other persons having a business relationship with us
will come in contact from time to time with certain of our trade secrets and
other proprietary information. Although we use reasonable efforts to ensure that
such persons sign confidentiality agreements with us, or otherwise respect the
proprietary and confidential nature of this information, our ability to protect
our rights depends upon us being aware that proprietary information has been or
may be misused and, even if we are aware of such fact, our ability further
depends upon having the resources necessary to compel such person not to misuse
such information, which may require costly legal proceedings which we may not be
able to afford at the time. If that were to be the case, our inability to
protect our proprietary and confidential trade secrets and information could
impair or destroy our ability to continue to claim proprietary rights in such
information, and/or could allow our competitors to access such information to
their competitive advantage and at our expense, either of which results could
have a materially adverse effect upon our business, operations and financial
condition, as well as the value of some or all of our intellectual property
rights in general.
62
Information relating to any invention that is invented under a Small Business
Innovation Research contract may become public at some future time.
A portion of our research and development costs relating to the development of
our advanced SuperSenzor technology for anti-tank landmine identification
purposes is being funded under a Small Business Innovation Research ("SBIR")
contract. This development work essentially involves the incorporation of
sophisticated directional features into our core MiniSenzor technology. To date,
none of the funding we have received from SBIR grants has been utilized for the
development of technology which was incorporated in any patent we have filed
for, or otherwise comprises a portion of our proprietary rights in our
technology. However, in the future it is conceivable that we could undertake a
material technology development utilizing funding from an SBIR grant, in whole
or in part. If that were to occur, there is a risk that the concerns addressed
below could become applicable.
If an invention is developed under an SBIR contract, it must be reported to the
granting agency. The U.S. federal government has royalty-free rights when
purchasing the products from our federal government SBIR contracts. We
nevertheless own the data and title to the products resulting from those
contracts and are permitted to obtain patent protection. The U.S. federal
government does not contractually undertake to protect data or inventions from
public disclosure beyond four years after the term of an SBIR contract.
Therefore, our competitors possibly could gain access to certain information
relating to our SuperSenzor advancements or any other technologies we develop
under SBIR contracts. The U.S. government however, has no rights over our
patents because the inventions were developed prior to the SBIR contracts. Also,
the U.S. federal government might create competition by utilizing its own right
and license to any technology developed under the SBIR contract if it is not
being developed by the inventor. The U.S. government in exercising these rights
to produce or have produced for the U.S. government competing products using the
technology developed under the SBIR, could limit the marketability of our
products. Furthermore, if we were to participate in research and development
projects jointly with one of the U.S. or foreign military branches, where the
relevant government is deemed to be the owner of the resulting technology, we
may be foreclosed from using, or protecting as our own, technology which we
helped to develop and which could otherwise be eligible for patent protection if
we had developed it independently. Accordingly, technology which we develop
could end up becoming used by our competitors and against us. If either of these
events were to occur, it might lessen the value of that technology, or of our
company, to prospective future investors or candidates for our acquisition,
which could have a material effect upon the market for our shares.
Litigation as to enforcement or defense against claims of intellectual property
infringement could be expensive, and any judgment against us may prevent us from
selling our products.
We may be called upon to enforce our protections against intellectual property
and trade secrets, or to determine the validity and scope of the proprietary
rights of others. Any subsequent litigation, regardless of the outcome, could be
costly and divert the efforts of key management and technical and scientific
personnel. Both domestic and international competitors may have pre-existing
claims and patents against intellectual property that may prevent, limit or
interfere with our ability to manufacture and sell our products. As of this
date, we have not conducted an independent review of patents issued to third
parties. Because of the market opportunity we perceive, companies possessing
technology rights, which they believe we may be infringing upon, will be
motivated to assert claims of infringement against us. Any adverse outcome in
the defense of an infringement matter could subject us to significant
liabilities to third parties, require disputed rights to be licensed from third
parties, or prohibit us from selling our products.
63
Regulatory and Legal Risks
The CarBomb Finder(TM), SIEGMA(TM), STARRAY(TM) systems and any future products
in development utilizing our Atometry(TM) technology would be subject to
radiation safety regulations and licensing requirements. Complying with these
requirements may result in delays in the deployment and customer utilization of
these and future products.
Our CarBomb Finder(TM), SIEGMA(TM), STARRAY(TM) systems and any future products
in development utilize a process that results in neutron radiation. As a
potential manufacturer of a fast neutron emitting device, we and our customers
must comply with applicable state, local and federal governmental laws and
regulations and licensing requirements, which may include those promulgated by
the State of California, U.S. Nuclear Regulatory Commission ("NRC") and U.S.
Food and Drug Administration ("FDA"), governing the design and operation of our
products, including appropriate radiation shielding. Although fast neutron
radiation demonstrates some properties different than other forms of radiation,
we do not believe that fast neutron radiation presents any difficulties or
creates any risks beyond those ordinarily encountered in connection with the
fabrication and operation of other forms of radiation emitting devices commonly
used in the general population, such as x-ray equipment. Further, we believe
that the design and incorporation of appropriate shielding in our products and
the development of appropriate operating procedures in view of their intended
use are, as an engineering and public safety matter, relatively straight-forward
matters. Nevertheless, compliance with these rules and regulations and licensing
requirements entails additional expense, effort and time in bringing our
products to market.
The manufacture and sale of devices which emit radiation are subject to the
regulatory controls and standards of various domestic and foreign jurisdictions.
These regulations may become more restrictive as policies, guidelines and
standards change, and our activities as to current and future products may be
curtailed or interrupted.F
Currently, our Atometer(TM) detectors utilize a sealed tube neutron generator to
create the stream of fast neutrons which is emitted from the device. These
generators are off-the-shelf neutron generators which do not require licensing
by the NRC to manufacture, but may be subject to additional state and local
regulations. However, if we were to customize our own proprietary neutron
generator for use with our products, such new generator would be subject to
review and licensing by the NRC, and potentially by any other jurisdiction in
which we may manufacture or sell our products in the future. Currently, the end
users of our devices may be required to obtain NRC and other permits in order to
operate them. There can be no assurance that the need to obtain end-user
permits, and/or to comply with any future regulations which may be adopted by
the NRC or other U.S. or foreign regulatory bodies will not limit, or be a bar,
to our potential customers purchasing our products. Furthermore, the imposition
of stricter permitting regulations on the manufacturing of devices that utilize
the sealed tube neutron generator, or the increase in regulatory requirements if
we were to develop our own customized neutron source, could be prohibitively
expensive or adversely affect our ability to manufacture our devices as
currently contemplated, which could have a materially adverse effect upon our
future sales and financial condition.
If current Export Administration Act regulations were to change, or if our
devices are purchased in countries which are viewed as a threat to regional
stability, we could become subjected to the more stringent rules of the U.S.
Department of State, and certain currently permissible sales activities could be
limited or prohibited altogether.
Although we have not submitted a formal commodity classification request to the
BIS, we believe our Atometer(TM) detectors would most likely be classified under
ECCN 2A983, and subject to export control regulations administered by the U.S.
Department of Commerce, Bureau of Industry and Security ("BIS"). Accordingly,
sales of our currently anticipated products to countries which are not
restricted pursuant to the BIS' listings for "Region Stability (RS-2)",
"Anti-Terrorism (AT-1)", and/or "Non-Proliferation (NP-1)", require no special
licensing. Sales to other countries will require licenses to be obtained for
export, but we expect that we would fall into the category of items receiving
"favorable consideration" due to the non-aggressive nature of our planned
products. However, future sales to countries of concern, future products we may
develop, or future changes in the existing federal regulations governing the
administration of export controls by the U.S. Department of Commerce, may
require us to obtain federal licensing, or become subject to more stringent
rules of the U.S. Department of State. There can be no guarantee that we will be
able to obtain such licenses at that time, or if we can that costs of doing so
will not be prohibitive or significantly our poll of available customers.
If our products, such as the CarBomb Finder(TM), SIEGMA(TM) and STARRAY(TM) fail
to detect or confirm explosives, we could be exposed to product liability and
related claims and may fail to achieve market acceptance.
Inherent in the manufacturing, sale and maintenance of explosive detection
products are potential product liability risks. If our products malfunction, it
is possible that explosive material could pass undetected through our products,
which could lead to product liability claims. There are also many other factors
beyond our control that could lead to liability claims, such as the reliability
and competence of the customer's operators and the training of the operators.
The cost of defending product liability claims brought against us could be
significant and any adverse determination may result in liabilities in excess of
insurance coverage. We do not currently maintain product liability insurance,
but we anticipate obtaining product liability insurance as soon as it is
necessary. We also intend to address product liability issues by pursuing the
designation and certification of our products by the U.S. Department of Homeland
Security (" DHS") as Qualified Anti-Terrorism Technologies ("QATTs") and relying
upon certain protections provided for under The Support Anti-terrorism by
Fostering Effective Technologies Act of 2002, Public Law 107-296 (the "Safety
Act"). We cannot be certain that we will be able to attain on acceptable terms,
if at all, insurance coverage sufficient to contain liabilities in a meaningful
way, or qualify our products and services as QATTs under the Safety Act. In
addition, the failure of any product to detect explosives, even if due to
operator error and not to the mechanical failure of a product, could result in
public and customer perception that our products are ineffective. In the event
we are held liable for a claim against which we do not have insurance or for
damages exceeding our levels of insurance coverage, or which even if insured
results in significant adverse publicity against us or our products, we may be
required to make substantial payments and lose or fail to achieve market
acceptance.
64
If investors rely on projections or estimates we may make, they could assert in
a legal proceeding that we issued false or misleading statements about our
company. If they were able to prevail successfully in any such proceeding, it
could have a materially adverse impact on our business, operations, and
financial condition, as well as the market for our public securities
The Company may from time to time make projections as to the sale of its units
or the growth of its business. These are considered forward looking statements
and the Company advises investors to not rely on these projections in making any
determination whether or not to invest in, or maintain an investment in our
stock. However, to the extent that any investor has so relied, and if the
investor can prove that any misstatements we have made were intentional or
reckless, that such investor's reliance on these misstatements was reasonable,
and that the investor has suffered actual damages as a result of such reliance,
than such investor may have a cause of action against us. If any investor were
to prevail in making such assertions in any legal proceeding, it could have a
materially adverse impact on our business, operations, and financial condition,
as well as the market for our public securities.
We may owe indemnification obligations to our current and former directors and
officers.
Our certificate of incorporation and bylaws contain provisions that provide for
indemnification of officers and directors, in each instance to the maximum
extent permitted by law. To the extent indemnification for liabilities arising
under the Securities Act may be permitted to directors, officers and controlling
persons of HiEnergy Technologies under the above provisions, or otherwise, we
have been advised that in the opinion of the SEC such indemnification is against
public policy as expressed in the Securities Act, and is therefore
unenforceable. In May 2003, former director Barry Alter engaged his own separate
legal counsel with respect to the SEC investigation regarding SLW Enterprises,
and demanded that we advance him in excess of $24,000 in connection with the
investigation that the SEC has conducted. We did not advance him these expenses,
and he brought an action against us in Delaware seeking payment of his costs and
expenses, then subsequently informed us that the action had been voluntarily
dismissed without prejudice. Mr. Alter could make further demands for
advancement of expenses, and the voluntary dismissal of his action does not
prevent him from initiating a new action to recover past, present, and future
expenses from us. A stockholder's investment in our company may be adversely
affected to the extent that we pay costs of settlement and damage awards against
directors or officers under the indemnification provisions of the certificate of
incorporation and bylaws. The impact on a stockholder's investment in terms of
the costs of defending a lawsuit on behalf of a director or officer may also
deter us from bringing suit against former directors or officers. Claims for
indemnification under our certificate of incorporation or bylaws may also
dissuade us from bringing lawsuits against current or former directors or
officers.
Current and prior stockholders who purchased our shares could attempt to assert
claims against us if our disclosures they relied upon in making such purchases
are deemed inadequate.
Facts related to a former director, Mr. Gregory F. Gilbert, and a separate
investigation by the SEC involving persons suspected of stock manipulation were
not known to us and were not disclosed in sales materials or filings with the
SEC until February 2003. We do not believe that the information was material to
the value of our company, and we believe that we have valid defenses against
liability under the Securities Act of 1933, the Securities Exchange Act of 1934
and other state and federal securities laws. However, if a court decides to the
contrary, we could be subject to liability under the Securities Act and/or under
the Securities Exchange Act. Additionally, we may have liability under certain
U.S. state securities laws, which laws may apply similar or different standards
as the federal laws. In such case, we would pursue all of our rights and
remedies, if any, against our former officers and directors to the extent, if
any, they were culpable. We have disclosed these matters to our stockholders and
the public and, therefore, purchasers of shares of our common stock subsequent
to our making such disclosure in February 2003 would have no cause of action for
our previously having failed to ascertain and disclose such facts.
65
A former director's outside legal proceedings were not promptly disclosed to the
public.
Mr. Gregory F. Gilbert, a former director of the Company, was involved in
several legal proceedings that were not disclosed by us in various reports with
the SEC until we became aware of them in February 2003. Details of these legal
proceedings have been disclosed in prior filings made by us. Stockholders could
potentially assert that we acted negligently in failing to uncover a personal
involvement of a director in such legal proceedings. Any related litigation
could result in significant financial penalties and could have a negative effect
on our financial condition.
Corporate Risks
We have identified weaknesses in our internal controls which may affect our
ability to comply with our public company reporting obligations, and any lack of
compliance with these reporting obligations could give rise to potential
regulatory and/or shareholder actions that could have a material adverse effect
upon our business and financial condition, and the market value of our stock,
Although our management has concluded that while our system of disclosure
controls and procedures were effective in meeting our disclosure obligations
under the federal securities laws, two weaknesses exist: (i) a lack of
segregation of duties and (ii) a lack of a more systemic and formal approach to
the conduct of our corporate, financial and business affairs. These weaknesses
result primarily from a lack of capital and human resources. Although we plan to
hire additional personnel, we can offer no assurances that we will be
successful. If we are unsuccessful in strengthening our system of disclosure
controls and procedures, and if as a result we were to fail to disclose timely
material items as required under the Securities Exchange Act, it could give rise
to potential regulatory and/or shareholder actions, which could have a material
adverse effect on our business and financial condition, and on the market value
of our shares
We may have increasing difficulty to attract and retain outside members of our
board of directors.
The directors and management of publicly traded corporations are increasingly
concerned with the extent of their personal exposure and liability with regard
to lawsuits and stockholder claims, as well as governmental and creditor claims
which may be made against them in connection with their positions with
publicly-held companies. Outside directors are also becoming increasingly
concerned with the availability of directors and officers' liability insurance
and a carrier's ability to pay on a timely basis the costs incurred in defending
stockholder claims. Director's and officer's liability insurance has recently
become much more expensive and difficult to obtain than it had been. If we are
unable to continue obtaining directors and officer's liability insurance at
affordable rates, it may become increasingly more difficult to attract and
retain qualified outside directors to serve on our Board. It is anticipated that
the fees of directors will rise in response to increased exposure to such risks.
We may have insufficient amounts of, or may be otherwise unable to draw from,
directors' and officers' liability insurance.
Although we have obtained, and paid premiums for, levels of directors' and
officers' liability insurance to cover legal challenges where we may have
indemnification obligations to persons serving in such capacities on behalf of
our company, our insurance carrier may not pay all claims which we tender to it
under our policy. Even if they do honor claims which we may make at the maximum
levels required under our policy, the amounts of insurance which we can afford
to maintain at any given time may be insufficient to cover the amount of any
claims for indemnification made against us by our current or former officers or
directors. Furthermore, the policies of insurance which we currently or may in
future maintain normally do not fund amounts which we may pay out in defense
costs or indemnification directly, but rather will reimburse us for amounts
which we must pay up front, and normally only after significant deductible
amounts are paid for which we would not be reimbursed. Accordingly, if we were
to be required to fund expensive litigation involving our present or former
officers or directors, and/or to pay them amounts as indemnification which we
may owe to them, and to the extent that such amounts exceed the amount of
reimbursement we are able successfully to obtain from our relevant carriers, it
could have a materially adverse effect upon our business, operations and
financial condition.
66
Elimination of monetary liability of our current and former directors may
discourage lawsuits against directors.
Our certificate of incorporation and bylaws contain provisions that eliminate or
limit the liability of our corporate directors for monetary damages to the
maximum extent permitted by law. These provisions may discourage stockholders
from bringing a lawsuit against directors and officers for breaches of fiduciary
duty, and may also reduce the likelihood of derivative litigation against
directors and officers even though such action, if successful, might otherwise
have benefited the stockholders.
RISKS RELATED TO OUR STOCK
We will pay accruing penalties to certain holders of our securities based on our
failure to register their securities.
After August 2003, we entered into certain agreements for the purchase of
certain shares of stock, convertible notes and warrants in private transactions.
The terms of these securities purchase agreements require us to register the
shares of common stock, and the underlying shares of common stock issuable upon
exercise of the warrants and/or conversion of the convertible notes, with the
SEC for public trading as of certain dates which are specified in each purchase
agreement. If the subject securities are not registered within the dates
specified in the applicable agreement, we must pay (or accrue, as the case may
be) a penalty through the issuance of like securities. In accordance with the
relevant provisions in these securities purchase agreements, we have paid or
accrued penalties due purchasers in these offerings because we failed to meet
the specified deadlines for having a Registration Statement on Form SB-2
declared and maintained effective. Some of these penalties began to accrue as of
October 15, 2003, and we are obligated to continue to issue and pay these
securities as penalties until all of our obligations under the applicable
registration rights provisions in our agreements are satisfied in full, or the
penalties become impermissible or unenforceable as a matter of law or when the
securities can be sold pursuant to Rule 144.
The amount of the penalties paid or accrued as a result of the defaults
described above for the three months ended July 31, 2006 is 36,396 shares of
common stock and warrants to purchase an additional 558,120 shares of common
stock. Our existing stockholders have suffered, and will continue to suffer,
substantial dilution as a result of the issuance and payment of these securities
as penalties. Such dilution can have a material and adverse impact upon the
actual and perceived value of our shares, which can be a depressive force upon
the price of our stock at market and cause losses for our existing stockholders,
as well as render it much more difficult for us to raise additional equity
capital in the future.
Our common stock price is subject to significant volatility, which could result
in substantial losses for investors and litigation against us.
From February 27, 2002, when trading in our shares commenced, through the date
of this Report, the high and low closing bid prices of our common stock were
$3.10 and $0.11, respectively. The market price of our common stock may exhibit
significant fluctuations in the future in response to various factors, many of
which are beyond our control and include:
o variations in our quarterly financial results, which variations
could result from, among other things, the availability of funding;
o changes in market valuations of similar companies and stock market
price and volume fluctuations generally;
o economic conditions specific to the industries in which we operate;
o legislative and regulatory developments related to homeland security
and industry controls;
o announcements by us or our competitors of new or enhanced products,
technologies or services, and the formation or cancellation of
significant contracts, acquisition, strategic relationships, joint
ventures or capital commitments;
o changes in key customer and supplier relationships;
o recommendations of research analysts and guidance;
o additions or departures of key management or scientific personnel;
and
o future sales of our common stock or other debt or equity securities.
If our operating results in future quarters fall below the expectations of
market makers, securities analysts and investors, the price of our common stock
will likely decline, perhaps substantially. In the past, plaintiffs have often
initiated securities class action suits against a company following periods of
volatility in the market price of its securities. We may, in the future, be the
target of similar litigation. Securities litigation could result in substantial
costs and liabilities, and could divert management's attention and resources.
Additionally, the stock market has periodically experienced significant price
and volume fluctuations that have particularly affected the market prices of
common stock of technology companies. These changes have been generally
unrelated to the operating performance or fundamentals of particular companies.
These broad market fluctuations may also negatively affect the market price of
our common stock and the notes.
67
There is a risk of dilution resulting from continued issuances of securities to
management, employees, consultants, and related parties which may reduce the
market price of our common stock, and may also lead to difficulty in obtaining
additional equity capital.
We issued options to purchase 421,980 shares of our common stock to our former
Chairman in fiscal year 2005 and options to purchase 529,510 shares in fiscal
year 2006, pursuant to his employment contract. Also, pursuant to the terms of
various other agreements entered into by the Company, we also issued or
committed to issue options to purchase 2,535,000 shares and 1,464,510 shares in
fiscal years 2005 and 2006, respectively, to other employees and directors. As
to consultants, in fiscal year 2006 we issued or committed to issue options or
warrants to purchase 177,179 shares. Continued issuances of securities of this
magnitude may have a dilutive effect on the market price for our common stock
and of the percentages of ownership of stockholders, if the options and warrants
are exercised, or the notes are converted. The terms upon which we will be able
to obtain additional equity capital could also be adversely affected.
We plan to issue a significant number of additional equity securities in the
future and that will dilute the percentage ownership of the present holders or
purchasers of our common stock.
There were 67,767,431 shares of our common stock outstanding as of July 31,
2006. We also may be required to issue up to 704,190 shares of our common stock
to former holders of options and warrants of HiEnergy Microdevices who hold
rights to purchase our shares of common stock at $0.156 per share. These rights
survived the short-form merger completed in January 2005, and may be exercised
any time before April 25, 2007, subject to the payment of promissory notes
representing the purchase price. We also had outstanding as of July 31, 2006,
warrants to purchase 19,715,019 and options to purchase 9,534,844 shares of our
common stock. As of July 31, 2006, we also had convertible preferred stock
outstanding which may be converted at any time into 7,054,676 shares of our
common stock and convertible notes which may be converted at any time into
1,066,792 shares of our common stock. If we issue all of the shares underlying
for those warrants and options in-the money, based on the July 31, 2006 closing
price of our common shares of $0.31, and then outstanding convertible
securities, this would result in approximately 14% dilution, of the ownership
interest of holders of our common stock, and result in proceeds of approximately
$336,000 in cash and approximately $641,000 in forgiveness of indebtedness.
Under our current business plan, we must also raise funds in part by issuing new
equity securities, which would have a dilutive effect on the percentage
ownership of stockholders. The shares issued in such transactions could be very
large and may even exceed the number of shares issued and outstanding today,
which would significantly decrease the percentage ownership of current
stockholders. Our requirement for new equity capital for the financing of
operating deficits will continue until we successfully commercialize a product
and achieve a sufficient level of positive operating cash flow. Possible costs
that would require funding include investments in capital equipment, technology
and research and development, marketing initiatives, inventory, accounts
receivable and human resources, as well as financial contributions toward
potential joint ventures, acquisitions, collaborative projects and other general
corporate purposes.
We may be required to sell restricted equity securities at prices less than the
market price for unrestricted shares. We have thus far sold restricted equity
securities at prices less than prevailing market prices of our stock and have
issued convertible debt. When the shares that are issuable in connection with
those securities become available for public sale, the additional supply of
shares may adversely affect the market price of our common stock. Also, our
anticipated private financings and the exercise or conversion of securities
outstanding may dilute the voting or other rights of other holders at the time,
or be prior and senior or receive rights that the holders of common stock do not
have, which could reduce the economic value of our common stock. Further, we
have sold through private placements, warrants that have cashless exercise
provisions, in which the holder shall receive a net number of shares based upon
the share price on the trading day preceding the exercise date of the warrant if
the underlying shares of warrants with cashless exercise provisions are not
registered under an effective registration statement by a certain date. As of
July 31, 2006, we had outstanding warrants to purchase a total of 5,670,606
shares which may be exercised by means of a cashless exercise. Accordingly, in
the event there is a large spread between the exercise price and the share price
on the trading day of our common stock, a cashless exercise of warrants could
result in a significant amount of additional shares.
Because our stock is not listed on a national securities exchange, you may find
it difficult to dispose of or obtain quotations for our common stock.
Our common stock has been traded under the symbol "HIET" on the OTC Bulletin
Board since May 3, 2002 and previously under the symbol "SLWE" from February 22,
2002 through May 3, 2002. Because our stock trades on the OTC Bulletin Board
rather than on a national securities exchange or NASDAQ, you may find it
difficult to either dispose of, or to obtain quotations as to the price of, our
common stock. Once we meet applicable listing requirements and qualifications,
we intend to apply for listing of our stock on a national securities exchange.
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Because we are subject to the "penny stock" rules, the level of trading activity
in our stock may be reduced.
Broker-dealer practices in connection with transactions in "penny stocks" are
regulated by penny stock rules adopted by the Securities and Exchange
Commission. Penny stocks, like shares of our common stock, generally are equity
securities with a price of less than $5.00, other than securities registered on
some national securities exchanges or quoted on NASDAQ. The penny stock rules
require a broker-dealer, prior to a transaction in a penny stock not otherwise
exempt from the rules, to deliver a standardized risk disclosure document that
provides information about penny stocks and the nature and level of risks in the
penny stock market. The broker-dealer also must provide the customer with
current bid and offer quotations for the penny stock, the compensation of the
broker-dealer and its salesperson in the transaction, and, if the broker-dealer
is the sole market maker, the broker-dealer must disclose this fact and the
broker-dealer's presumed control over the market, and monthly account statements
showing the market value of each penny stock held in the customer's account. In
addition, broker-dealers who sell these securities to persons other than
established customers and "accredited investors" must make a special written
determination that the penny stock is a suitable investment for the purchaser
and receive the purchaser's written agreement to the transaction. Consequently,
these requirements may have the effect of reducing the level of trading
activity, if any, in the secondary market for a security subject to the penny
stock rules, and investors in our common stock may find it difficult to sell
their shares. We would like to raise financing in an amount that might qualify
us for a time for an AMEX listing and a NASDAQ small cap listing. However, doing
so would be very dilutive of existing stockholders.
Should persons engage in short sales of our common stock, including sales of
shares to be issued upon exercise of warrants and options, the price of our
common stock may decline.
Selling short is a technique used by a stockholder to take advantage of an
anticipated decline in the price of a security. A significant number of short
sales or a large volume of other sales within a relatively short period of time
can create downward pressure on the market price of a security. Further sales of
common stock issued upon exercise of our warrants and options could cause even
greater declines in the price of our common stock due to the number of
additional shares available in the market, which could encourage short sales
that could further undermine the value of our common stock. You could,
therefore, experience a decline in the value of your investment as a result of
short sales of our common stock. From January 2005, our shares have appeared
frequently on the "Threshold Security List" published in connection with
Regulation SHO, which may indicate questionable shorting activity involving our
securities. We have also learned that our listing on the Berlin-Bremen Stock
Exchange ("BBSE") by a third-party poses a risk to our stock and provides an
avenue for such short trading activity by providing a loophole in the short
sales regulations adopted by the National Association of Securities Dealers. The
loophole is applicable to those shares traded in the U.S. stock market and
listed for trading on a foreign stock market, such as the BBSE, and purportedly
held in foreign brokerage accounts. While we have taken steps to effectuate the
delisting of our stock from the BBSE, under the rules of that exchange an issuer
does not necessarily have the right to compel such delisting and, accordingly,
there can be no assurance if or when our stock might be delisted from the BBSE.
If our stock were not promptly delisted from the BBSE, it could have a
materially adverse effect upon the price of our shares in the market and
increase price volatility, which could in turn affect our ability to raise
needed capital, which could have a materially adverse effect upon our business,
operations and financial condition.
Delaware law and our charter documents contain provisions that could discourage
or prevent a potential takeover of our company that might otherwise result in
our stockholders receiving a premium over the market price for their shares.
Provisions of Delaware law and our certificate of incorporation and bylaws could
make an acquisition of us by means of a tender offer, a proxy contest, or
otherwise, and the removal of incumbent officers and directors, more difficult.
These provisions include:
o Section 203 of the Delaware General Corporation Law, which prohibits
a merger with a 15%-or-greater stockholder, including a party that
has completed a successful tender offer, until three years after
that party became a 15%-or-greater stockholder; and
o the authorization in our certificate of incorporation of
undesignated preferred stock, which could be issued without any
further vote or action by our stockholders, in a manner designed to
prevent or discourage a takeover or provide preferences for the
investor ahead of holders of common stock.
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Furthermore, preferred stock may have other rights, including economic rights
senior to the common stock, and, as a result, the issuance of preferred stock
could adversely affect the market value of our common stock.
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ITEM 3. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in our reports filed or submitted under the Securities
Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and
reported, within the time periods specified in the SEC'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 to allow timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, we carried out an evaluation
of the effectiveness of the design and operation of our disclosure controls and
procedures as of July 31, 2006. This evaluation was carried out by Roger W.A.
Spillmann in his capacity as our Chief Executive Officer and Treasurer. Based
upon that evaluation, Mr. Spillmann concluded that our disclosure controls and
procedures were not effective in meeting our requirements as to the disclosure
of material information in our reports filed under the Exchange Act. Two areas
of weakness were identified in the evaluation: (i) a lack of segregation of
duties due to understaffing and (ii) a lack of a more systematic and formal
approach to the conduct of our corporate, financial and business affairs. These
weaknesses, which we continue to experience, are primarily the result of a
general lack of capital and human resources dedicated to make the improvements
necessary for timelier reporting and disclosure with less reliance on internal
auditing. Currently, Mr. Spillmann serves simultaneously as our Chief Executive
Officer, President, Treasurer and Secretary. In order to further segregate the
duties of our officer positions, we are attempting to recruit additional
officers as well as other employees experienced with the implementation and
evaluation of disclosure controls and procedures for timely financial reporting,
including a full-time Controller. Currently, we employ the use of accounting
consultants to serve some of these roles. We can offer no assurance that we will
successfully recruit such employees, as our ability to do so is limited by our
available capital resources.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
In connection with his evaluation of our disclosure controls and procedures as
of July 31, 2006, as described above, Mr. Spillmann also determined that during
our most recent fiscal quarter, there was no change in our internal control over
financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the
Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
FILED COMPLAINTS
In January 2005, we were served with a Summons and Class Action Complaint for
Violations of Federal Securities Laws, which was filed on October 18, 2004, in
the Federal District Court for the Southern District of California under case
number SACV04-1226 GLT. The Complaint filed named HiEnergy and its former
Chairman, Dr. Bogdan C. Maglich, among other named defendants, on behalf of a
class of persons who acquired our stock during the period from February 22, 2002
through July 8, 2004. In February 2005, plaintiff's counsel filed a First
Amended Complaint entitled and styled, "In re: HiEnergy Technologies, Inc.
Securities Litigation," Master File No. 8:04-CV-01226-DOC (JTLx), alleging
various violations of the federal securities laws, generally asserting the same
claims involving Philip Gurian, Barry Alter, and our purported failure to
disclose their various securities violations including, without limitation,
allegations of fraud. The First Amended Complaint seeks, among other things,
monetary damages, attorney's fees, costs, and declaratory relief. We engaged two
legal firms to vigorously defend us in this matter and assess the impact of the
pending lawsuit. On Friday, March 25, 2005, we timely filed responsive pleadings
as well as Motions to Dismiss the Plaintiffs' First Amended Complaint arguing
that the Complaint failed to state a claim upon which relief can be granted. On
June 17, 2005, the Court issued an Order Granting the Motions to Dismiss (the
"Order"), finding that the Plaintiffs failed in the First Amended Complaint to
allege causation of loss resulting from any alleged omissions and/or
misrepresentations of HiEnergy or Dr. Maglich, to sustain a cause of action for
securities fraud under Section 10(b) of the Exchange Act and Rule 10b-5 of the
SEC, that the Plaintiffs had failed to plead actual reliance on any allegedly
false or misleading filings of HiEnergy to sustain a claim under Section 18 of
the Exchange Act, and that the Plaintiffs had failed to allege a primary
violation of any securities laws to sustain a claim for a violation of Section
20(a) of the Exchange Act. On July 5, 2005, the Plaintiffs filed a Second
Amended Complaint in compliance with the Court's Order. On October 24, 2005, the
Court issued a Minute Order granting in part and denying in part our Motions to
Dismiss, finding that the Plaintiffs failed in the Second Amended Complaint to
sustain a cause of action for securities fraud under Section 10(b) of the
Exchange Act and Rule 10b-5 of the SEC against Dr. Maglich and for claims that
we filed false and misleading financial statements and executed suspicious stock
sales. On November 14, 2005, the Court held a scheduling conference at which the
Plaintiff informed us that it would not file a Third Amended Complaint. In
accordance with the Scheduling Order from the Court, class representative
motions are to be filed within 90 to 120 days and pre-trial conference has been
scheduled for September 11, 2007. Our counsel will respond to any motions with
appropriate challenges to its legal sufficiency to state a claim upon which
relief may be granted. As of date, the costs to defend the class action have
been substantial and it is unable to predict an exact amount, or even a
meaningful estimate, of the aggregate costs that may be incurred, at this time.
In October 2005, a claim was filed against us with the Supreme Court of the
County of New York, New York by HWH Enterprises ("HWH") (Civil Action No. (Index
No. 603438/05). HWH is seeking collection of $101,621.18 allegedly owed to it
for public relations services purported to have been provided to us during the
prior fiscal year. We have engaged local counsel and intend to defend ourselves
and our counsel will respond with appropriate challenges. Depositions had been
scheduled in September 2006, but have been delayed. As of this date, the Company
and its legal counsel have made no other determination as to the merits of, or
possible defenses to, the claim, and are unable to predict a meaningful estimate
of the costs of defending against the claim at this time.
On July 27, 2006, we filed a complaint for breach of contract against our former
CEO, Dr. Bogdan C. Maglich with the Orange County Superior Court, Santa Ana,
California, Case No. 06CC08456. The complaint alleged, among other things, that
Dr. Maglich had violated his employee confidentiality agreement and sought
injunctive relief, unspecified damages according to proof, interest, and
attorneys' fees. On August 1, 2006, the Court granted an ex parte Temporary
Restraining Order and Order to Show Cause Why Preliminary Injunction Should Not
Be Issued ("TRO"). The TRO provided that, pending hearing on the Order to Show
Cause, which the court set for August 22, 2006, Dr. Maglich, his agents,
assigns, and all those acting in concert with him were restrained and enjoined
from: (i) "violating the Confidentiality and Assignment of Inventions Agreement
dated October 7, 2003;" and (ii) "violating the promise contained in your letter
agreement with plaintiff dated April 12, 2006 that you 'hereby agree to be bound
by the Cure Statements' of your then attorney, . . .attached thereto, that 'Dr.
Maglich agrees to refrain from disseminating any information that the Board [of
Directors of Plaintiff HiEnergy Technologies, Inc.] believes may be confidential
inside information without the Board's approval, and agrees to refrain from
disseminating any statements about the Company without the Board's approval."
The order continued: "Notwithstanding anything to the contrary herein, defendant
is not restrained from making private, bona fide complaints to regulators,
police, or prosecutors about the company." As of the date of this report, due to
limitations on the removal of directors by the Board under applicable corporate
law, Dr. Maglich currently continues to serve as a director.
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On August 22, 2006, after oral argument of counsel, the court invited our
counsel to submit a proposed preliminary injunction to enjoin disclosure of
specific categories of our trade secrets/confidential information. The court
declined to issue a preliminary injunction on terms as broad as set forth in the
TRO or based upon Dr. Maglich's letter dated April 12, 2006. On September 29,
2006, the Court granted a Preliminary Injunction which restrains and enjoins Dr.
Maglich, his agents, assigns, and all those acting in concert with him from
violating his confidentiality agreement pending trial.
On August 21, 2006, Dr. Maglich sent to one or more of our investors a copy of a
purported complaint by Dr. Maglich against the us and our CEO, Roger Spillmann.
The purported complaint claims, among other things, that the Orange County,
California Superior Court had been asked by us to override federal rules,
regulations, or statutes. The complaint appears to be largely a repetition of
prior allegations by Dr. Maglich, excluding the new allegation, as stated above,
that the state court had been asked to disregard federal law. We deny the
allegations and contend that (i) the state court has been acting lawfully in
restraining Dr. Maglich's improper conduct; (ii) Dr. Maglich's communications
with investors were in violation of the TRO; (iii) the allegations are frivolous
and are brought by a former disgruntled employee in bad faith; and (iv) Dr.
Maglich is involved in a vendetta against us for his own purposes. We are
committed to full compliance with all SEC and other state and federal rules,
regulations, and statutes.
On January 24, 2006, personal legal counsel for our former Chairman, Dr. Bogdan
Maglich, submitted a memorandum to our Board of Directors alleging that, despite
our payment to Dr. Maglich of salary, bonuses, expenses and other benefits, some
of the provisions of his employment agreement had not been implemented,
resulting in an adverse financial impact to Dr. Maglich personally. Dr.
Maglich's legal counsel proposed to settle this claim for (i) cash or a demand
note in the amount of $66,569, (ii) $188,271 worth of common stock registered
for sale, and (iii) $232,785 of restricted common stock. On January 25, 2006,
Dr. Maglich's personal legal counsel met with our Board during which meeting it
was agreed that Dr. Maglich and the Company would attempt to settle the claims.
However, in his cross-complaint, Dr. Maglich now claims that the memorandum
concluded that the Company owed him $487,000 in unpaid benefits and that the
Company "orally agreed" that it owed him this amount. On February 9, 2006, Dr.
Maglich's personal legal counsel sent a letter to the Board stating that the
failure to accede to these demands and provide Dr. Maglich with certain other
requested benefits, could be viewed as a constructive termination and entitle
Dr. Maglich to two years severance pay pursuant to his employment agreement and
"result in other significant effects on the Company." On February 17, 2006, the
Company's Board of Directors removed Dr. Bogdan Maglich from his position as our
Chief Executive Officer and suspended him from his duties as Chairman of the
Board, Treasurer and Chief Scientific Officer.
Effective April 18, 2006, we terminated Dr. Maglich as its Chairman and Chief
Scientist in accordance with Section 10(a) of his Employment Agreement, which
stated that the Company could terminate his employment at any time upon gross
negligence or willful malfeasance by Dr. Maglich in the material performance of
his duties and responsibilities to the Company under the agreement. Dr. Maglich
claims that his suspension and subsequent termination as an employee of the
Company was the result of age discrimination and national origin discrimination.
Dr. Maglich also claims that he is entitled to $416,000 plus interest in
severance payments under his Employment Agreement. However, the signed original
version of the Employment Agreement in our files state that Dr. Maglich is only
entitled to severance pay in the event of a termination "without cause."
On August 18, 2006, we were also served with a cross-complaint by Dr. Maglich
filed on July 27, 2006 Superior Court of California, County of Orange, under
case number 06CC084586. The cross-complaint alleges breach by the Company of
oral and written contracts, age discrimination and national origin
discrimination, retaliation for age and national origin discrimination,
violations the Ralph and Bane Civil Rights Act, withholding corporate records
from Dr. Maglich and withholding Dr. Maglich's personal property. Dr. Maglich
seeks damages in the amount of $903,000 plus interest for alleged breach of
contracts, a $25,000 civil penalty for alleged civil rights violations, punitive
damages, legal costs, and unspecified cash damages for lost wages and benefits
and for damages resulting form emotional distress, mental anguish and pain and
suffering. We believe Dr. Maglich's claims are without merit and intend to
assert a vigorous defense. The costs of defending against the charges could be
substantial; however we are unable to predict an exact amount, or even a
meaningful estimate, at this time.
In August 2006, we were served with a Summons and Complaint by Mary Ann Mashita,
filed on July 3, 2006 in the Superior Court of California, County of Orange,
under case number 06CC0770. The Complaint named HiEnergy Technologies, our
former Chairman, Dr. Bogdan C. Maglich, who is currently a member of our Board
of Directors, and Maglich Family Holdings, Inc., a company affiliated with Dr.
Maglich and a shareholder of the Company, In the Claim, Ms. Mashita alleges that
she worked for Maglich Family Holdings as Dr. Bogdan Maglich's assistant for
both personal and business matters and in December 2005, subject to written
employment agreements only between Maglich Family Holdings and Ms. Mashita. Ms.
Mashita alleges that she left her employment because of health and medical
problems, and that on July 25, 2005, the California Employment Development
Department ("EDD") mailed Maglich Family Holdings a request for information
concerning Ms. Mashita's condition in regard to her claim for benefits. Ms.
Mashita alleges a written response from Dr. Maglich was made to the EDD making
false and defamatory remarks about her. As a result of these statements, Ms.
Mashita claims that she became depressed and began suffering from obsessive
paranoia and is entitled to compensatory damages, emotional distress damages and
punitive damages. Ms. Mashita is seeking recovery against Dr. Bogdan Maglich,
Maglich Family Holdings, and HiEnergy Technologies, Inc. We have engaged counsel
and intend to vigorously defend these allegations in any further pleading with
appropriate challenges to their legal sufficiency to state a claim upon which
relief may be granted. We believe the Company's involvement in this legal
proceeding is primarily because Dr. Maglich incorrectly signed the written
response to the EDD as an officer of the Company, rather then in his capacity as
an officer of Maglich Family Holdings, Inc. The costs of defending against the
Complaint could be substantial; however we are unable to predict an exact
amount, or even a meaningful estimate, at this time.
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From time to time, we may be subject to other routine litigation incidental to
the ordinary course of business, for actual or perceived violations of our
agreements, or for other civil matters.
POTENTIAL LEGAL ACTIONS
In December 2005, we received a letter from EADS North America, Inc. ("EADS")
alleging that we breached a lease agreement between us and EADS, dated April 29,
2004 (the "Lease"). Pursuant to the terms of the Lease, EADS was to deliver ten
neutron generators on a fixed schedule agreed upon by both parties. We received
four of the ten neutron generators with significant delays due to production and
support issues and ceased payments pending resolution. Prior to the end of the
Lease, we returned the four generators that we had received due to
non-performance by EADS and sought termination of the contract. The letter from
EADS alleges that we failed to meet our payment obligations, and demands early
termination payments, cancellation of discounts and other charges unrecognized
by us, and threatens litigation in the event we fail to cure immediately. We
have recorded $239,017 for lease payments in accordance with terms of the lease
while we attempt to resolve the matter. In June 2006, we received a supplemental
letter from EADS detailing additional charges disputed by us for premature
cancellation and return of equipment in an amount equal to $280,415. As of this
date, no legal action has been filed by either party and we intend to defend
ourselves against any legal proceeding that may be brought by EADS on the basis
indicated in this letter. We are unable to predict a meaningful estimate of the
costs of defending ourselves against any possible legal action, should one be
filed in the future. We have other sources of neutron generators and our ability
to manufacture our products has not been materially impacted by this dispute.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
SET FORTH BELOW IS INFORMATION REGARDING THE ISSUANCE AND SALE OF UNREGISTERED
SECURITIES IN THE QUARTER ENDED JULY 31, 2006.
o In July 2006, we committed to issue 12,132 shares of our common
stock, par value $0.001, (the "Shares")and warrants to purchase
188,853 Shares at various exercise prices between $0.45 and $1.75,
to various holders of securities with registration rights as a
penalty, due to our inability to file and maintain effective a
registration statement within certain specified deadlines. These
holders were accredited investors when they acquired the right to
receive these shares and warrants and we believe the issuances of
these securities are exempt under Section 4(2) of the Securities Act
and Regulation D.
o In July 2006, we issued 125,516 Shares previously committed in the
prior year period, to various holders of securities with
registration rights as a penalty, due to our inability to file and
maintain effective a registration statement within certain specified
deadlines. These holders were accredited investors when they
acquired the right to receive these shares and warrants and we
believe the issuances of these securities are exempt under Section
4(2) of the Securities Act and Regulation D.
o In July 2006, we issued 1,886,600 Shares, previously committed in
the prior year period, to The Yocca Law Firm, LLP in settlement and
upon conversion of convertible promissory notes issued in connection
with legal services rendered in the aggregate amount of $448,722.06,
plus $117,257.94 of accrued interest. These holders were accredited
investors when they acquired the notes and we believe the issuances
of these securities are exempt under Section 4(2) of the Securities
Act and Regulation D.
o In July 2006, we issued 1,001,151 Shares, previously committed in
the prior year period, to Richard Melnick in settlement and upon
conversion of outstanding convertible promissory notes in the
aggregate amount of $300,345. Mr. Melnick is an accredited investor
and we believe the issuances of these securities are exempt under
Section 4(2) of the Securities Act and Regulation D.
o In June 2006, we committed to issue 180,000 Shares and a warrant to
purchase 50,000 shares of its common stock with an exercise price of
$0.60 per share to a to Vintage Filings LLC and assigns in exchange
for one year Edgar filing services. The holders are accredited
investors and we believe the issuances of these securities are
exempt under Section 4(2) of the Securities Act and Regulation D.
o In June 2006, we committed to issue 25,000 Shares to the members of
our Board of Directors, as compensation for meeting attendance, each
board member receiving 5,000 Shares. We believe the issuances of
these securities were exempt under Section 4(2) of the Securities
Act.
o In June 2006, we issued 12,132 Shares and committed to issue
warrants to purchase 186,038 Shares at various exercise prices
between $0.45 and $1.75, to various holders of securities with
registration rights as a penalty, due to our inability to file and
maintain effective a registration statement within certain specified
deadlines. These holders were accredited investors when they
acquired the right to receive these shares and warrants and we
believe the issuances of these securities are exempt under Section
4(2) of the Securities Act and Regulation D.
o In June 2006, we committed to issue 775,000 Shares to Yeffet
Security Consultants, Inc. as part of a settlement agreement of a
claim filed against us. The holder is an accredited investor and we
believe the issuance of these securities is exempt under Section
4(2) of the Securities Act and Regulation D.
o In June 2006, we committed to issue 125,000 Shares of common stock
to Vladimir Stanich, an engineering consultant in settlement for
$52,500 in consulting services earned from February 15, 2006 to May
30, 2006, pursuant to the terms of an engagement agreement. Mr.
Stanich is an accredited investor and we believe the issuances of
these securities are exempt under Section 4(2) of the Securities Act
and Regulation D.
75
o In June 2006, we issued to Dr. Robert J. Neborsky a convertible note
payable ("CNP") for $80,000, bearing interest at 10% per annum and
convertible into Shares at $0.30 per Share, with warrants to
purchase 100,000 Shares at a price of $0.45 per Share, in exchange
for a loan of $80,000. In July 2006, we repaid $80,000 of the CNP
together with $657 of accrued interest. The holder is an accredited
investor and we believe the issuance of these securities is exempt
under Section 4(2) of the Securities Act and Regulation D.
o In May 2006, we issued 12,132 Shares and committed warrants warrants
to purchase 183,225 Shares at various exercise prices between $0.45
and $1.75, to various holders of securities with registration rights
as a penalty, due to our inability to file and maintain effective a
registration statement within certain specified deadlines. These
holders were accredited investors when they acquired the right to
receive these shares and warrants and we believe the issuances of
these securities are exempt under Section 4(2) of the Securities Act
and Regulation D.
o In May 2006, we issued to Bruce Steinberg a convertible note payable
("CNP") for $100,000, bearing interest at 10% per annum and
convertible into Shares at $0.30 per Share, with warrants to
purchase 100,000 Shares at a price of $0.45 per Share, in exchange
for a loan of $100,000. In August 2006, we repaid $100,000 of the
CNP together with $2,383 of accrued interest. The holder is an
accredited investor and we believe the issuance of these securities
is exempt under Section 4(2) of the Securities Act and Regulation D.
o In May 2006, we issued to Dr. Robert J. Neborsky convertible note
payable ("CNP") for $85,000 in exchange for cash of $85,000, which
bear interest at 10% per annum. The CNP were issued with detachable
warrants to purchase 40,000 shares of common stock with a three year
term at an exercise price of $0.60 per share. In June 2006, the CNP
were automatically exchanged into our Series B Convertible Preferred
Offering at a 10% discount pursuant to the terms of the CNP. The
holder is an accredited investor and we believe the issuance of
these securities is exempt under Section 4(2) of the Securities Act
and Regulation D.
o In May 2006, we issued to Katherine Wiener convertible note payable
("CNP") for $50,000 in exchange for cash of $50,000, which bear
interest at 10% per annum. The CNP were issued with detachable
warrants to purchase 40,000 shares of common stock with a three year
term at an exercise price of $0.60 per share. In June 2006, the CNP
were automatically exchanged into our Series B Convertible Preferred
Offering at a 10% discount pursuant to the terms of the CNP. The
holder is an accredited investor and we believe the issuance of
these securities is exempt under Section 4(2) of the Securities Act
and Regulation D.
o In May 2006, we issued 611,892 Shares, previously committed in the
prior year period, to Jackson Asset Management and Richard Melnick
in exchange for $122,378 upon the exercise of warrants by accredited
investors. We believe the issuances of these securities are exempt
from registration pursuant to Sections 4(2) and 3(a)(9) of the
Securities Act of 1933 and Regulation D.
SERIES B PREFERRED
In June 2006, we issued 211.64 shares of our Series B Convertible Preferred
Stock to various accredited investors together with Series B-1 Warrants and
Series B-2 Warrants to purchase 2,186,403 at $0.45 per share and 1,464,269 at
$0.60 per share, respectively. An aggregate of convertible notes payable ("CNP")
of $552,653, previously issued, together with accrued interest were exchanged
into our Series B Convertible Preferred Offering at a 10% discount pursuant to
the terms of the CNP. In connection with the offering, we paid a commission in
the amount of $187,267, together with a warrant to purchase 335,711 shares of
our common stock at $0.30 per share to Burnham Hill Capital Partners, a division
of Pali Capital, a licensed broker-dealer.
The Series B Preferred Shares are convertible into shares of common stock of the
Company at $0.30 per share (the "Conversion Price"). The Conversion Price is
subject to downward adjustments in the event the Company issues or sells more
common stock, however are not required to make any adjustment to the Conversion
Price upon (i) issuances of any additional shares of common stock and warrants
therefore in connection with a merger, acquisition or consolidation, (ii)
issuances of additional shares of common stock pursuant to a bona fide firm
underwritten public offering of securities, (iii) any issuances of warrants to
purchase shares of common stock issued pursuant to the Agreement, (iv) issuances
of securities pursuant to the conversion or exercise of convertible or
exercisable securities issued or outstanding on or prior to the date hereof or
issued pursuant to the Agreement, (v) issuances of warrants to the placement
agent for the transactions contemplated by the Agreement or in connection with
other financial services rendered to the Company, (vi) the payments of any
dividends on the Series B Preferred Stock, (vii) issuances of additional shares
of common stock in connection with license agreements, joint ventures and other
strategic partnering arrangements so long as such issuances are not for the
primary purpose of raising capital, and (viii) issuances of common stock or the
issuance or grants of options to purchase common stock pursuant to the Company's
stock option plans and employee stock purchase plans outstanding on the date
hereof.
76
The Series B Preferred Shares have a liquidation preference of $10,000 per
share. The Series B Holders are entitled to receive, out of any assets at the
time legally available thereof and as declared by the Board of Directors,
dividends at the rate of 8% per share per annum until January 1, 2007, at which
time this rate will increase to 10%. If the Company has an effective
registration statement for the sale of the common shares to be received in
conversion of the Series B Preferred Shares and the closing bid price of the
Company's traded shares exceeds $1.00 for a period of 20 consecutive trading
days, the Series B Preferred Shares will automatically convert into shares of
common stock of the Company. On June 30, 2006, we committed to issue 241,874
shares of our common stock in lieu of cash at the rate of 8% percent per annum,
as a prepayment of dividends for the first six months following the closing
pursuant to the offering terms.
The Series B-1 Warrants and Series B-2 Warrants are exercisable until June 30,
2011 and have exercise prices of $0.45 and $0.60, respectively the "Warrant
Prices"). The Warrants provide the Investors with ratchet rights, whereby the
exercise price of the Warrants will be reduced to equal the price of any new
shares (or common share equivalents) sold below the Warrant Prices. Further,
commencing one (1) year following the date of issuance, if (i) the traded market
price of the shares of common stock of the Company is greater than the Warrant
Price and (ii) a registration statement under the Securities Act provided for
the resale of the shares underlying the Warrants is not then in effect, the
Investors may exercise the Warrants by cashless exercise.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITES HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
77
ITEM 6. EXHIBITS
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------------- -----------
2.1 (1) Voluntary Share Exchange Agreement by and between HiEnergy
Technologies, Inc. and HiEnergy Microdevices, Inc. dated March 22,
2002
2.2 (5) Agreement and Plan of Merger dated October 18, 2002 by and between
the Registrant and its wholly owned subsidiary, HiEnergy
Technologies, Inc., a Delaware corporation
3.1 (5) Certificate of Incorporation of HiEnergy Technologies, Inc., a
Delaware corporation, filed on October 17, 2002
3.2 (5) Bylaws of HiEnergy Technologies, Inc., a Delaware corporation,
adopted on October 18, 2002
3.3 (10) Certificate of Elimination of Series A Convertible Preferred Stock
3.4 Amendment to Bylaws of HiEnergy Technologies, Inc., adopted on
February 17, 2006
4.1.1 (5) Specimen Common Stock Certificate
4.1 (40) Certificate of Designation of the Relative Rights and Preferences
of the Series B Convertible Preferred Stock of HiEnergy
Technologies, Inc.
4.2 (1) Form of Registration Rights Agreement between the Registrant and
each April 2002 Private Placement Common Stock Investor. See also
Exhibit 10.55 Form of Subscription Agreement between the
Registrant and each April 2002 Private Placement Common Stock
investor.
4.2 (40) Form of Series B-1 Warrant
4.3 (1) Form of Amendment No. 1 to Registration Rights Agreement between
the Registrant and each April 2002 Private Placement Common Stock
Investor
4.3 (40) Form of Series B-2 Warrant
4.4 (3) Warrant Certificate issued to Rheal Cote by HiEnergy Technologies,
Inc. dated June 3, 2002
4.4.1 (5) Form of Registration Rights Agreement between the Registrant and
each June 2002 Private Placement Common Stock investor. See also
Exhibit 10.24 Form of Subscription Agreement between the
Registrant and each June 2002 Private Placement Common Stock
investor.
4.5 (5) Registration Rights Agreement dated July 12, 2002 between the
Registrant and Isaac Yeffet
4.6 (5) Registration Rights Agreement dated August 19, 2002 between the
Registrant and Primoris Group Inc.
4.7 (5) Registration Rights Agreement dated October 7, 2002 between the
Registrant and Series A Convertible Preferred Stock Investors.
4.8 (5) Form of Warrant Certificate dated October 7, 2002 issued by the
Registrant to each Series A Convertible Preferred Stock investor
4.9 (5) Form of Registration Rights Agreement between the Registrant and
each October 2002 Private Placement Common Stock Investor
4.10 (5) Form of Warrant Certificate issued by the Registrant to each
October 2002 Private Placement Common Stock investor
4.11 (35) HiEnergy Technologies, Inc. Special Warrant Offer dated December
13, 2005
10.1 (5) Lease Agreement dated August 15, 2002 between the Registrant and
Del Mar Avionics
10.1 (40) Form of the Series B Convertible Preferred Stock Purchase
Agreement
10.1.1 (10) Addendum to Original Lease Agreement dated August 15, 2002,
between the Registrant and Del Mar Avionics dated July 1, 2003
10.1.2 (16) Addendum No. 2 to Original Lease Agreement dated August 15, 2002,
between the Registrant and Del Mar Avionics dated January 1, 2004.
10.1.3 (16) Addendum No. 3 to Original Lease Agreement dated August 15, 2002,
between the Registrant and Del Mar Avionics dated January 20,
2004.
78
10.2 (40) Form of the Registration Rights Agreement
10.3 (4) Stock Option Agreement between Isaac Yeffet and HiEnergy
Technologies, Inc. dated July 12, 2002
10.4 (4) Letter Agreement between H.C. Wainwright & Co., Inc. and HiEnergy
Technologies, Inc. dated August 8, 2002
10.4.1 (3) Award Contract between HiEnergy Microdevices, Inc. and the U.S.
Department of Defense dated February 12, 2002
10.6 (3) Assignment and Assumption of Employment Agreement between HiEnergy
Technologies, Inc., HiEnergy Microdevices, Inc. and Dr. Bogdan C.
Maglich dated July 16, 2002*
10.7 (3) Stock Option Agreement between Dr. Bogdan C. Maglich and HiEnergy
Technologies, Inc. effective April 24, 2002*
10.8 (3) Consulting Agreement between Yeffet Security Consultant, Inc. and
HiEnergy Technologies, Inc. dated July 12, 2002
10.9 (5) Amended and Restated Nonqualified Stock Option dated July 12, 2002
issued by the Registrant to Isaac Yeffet
10.11 (5) Consulting Agreement dated August 1, 2002 between the Registrant
and Primoris Group Inc.
10.12 (5) Amendment No. 1 to the Consulting Agreement dated August 19, 2002
between the Registrant and Primoris Group Inc.
10.13 (5) Nonqualified Stock Option (Warrant) dated August 1, 2002 issued by
the Registrant to Primoris Group Inc.
10.15 (5) Letter Employment Agreement dated February 26, 2002 between
HiEnergy Microdevices, Inc. and Michal Levy*
10.16 (5) Assignment, Assumption and Amendment of Employment Agreement dated
September 17, 2002 by and among the Registrant, HiEnergy
Microdevices, Inc. and Michal Levy*
10.17 (5) Nonqualified Stock Option dated September 17, 2002 issued by the
Registrant to Michael Levy*
10.17.1 (6) Form of Warrant Certificate dated August 11, 2002 issued by the
Registrant to H.C. Wainwright & Co., Inc. and Assigns
10.18 (5) Nonqualified Stock Option dated September 25, 2002 issued by the
Registrant to Chapin E. Wilson
10.18 (6) Form of Warrant Certificate dated October 7, 2002 issued by the
Registrant to H.C. Wainwright &Co., Inc.
10.19 (6) Form of Warrant Certificate dated October 31, 2002 issued by the
Registrant to H.C. Wainwright &Co., Inc.
10.19 (5) Nonqualified Stock Option dated September 25, 2002 issued by the
Registrant to Derek W. Woolston
10.20 (5) Employment Agreement dated September 25, 2002 between the
Registrant and Tom Pascoe*
10.21 (5) Nonqualified Stock Option effective September 25, 2002 issued by
the Registrant to Tom Pascoe*
10.22 (16) Series A Convertible Preferred Stock Purchase Agreement dated
October 7, 2002 between the Registrant and the Series A
Convertible Preferred Stock investors.
10.23 (16) Consulting Agreement dated September 25, 2002 between the
Registrant and Barry Alter*
10.24 (5) Form of Subscription Agreement between the Registrant and each
June 2002 Private Placement Common Stock investor. See also
Exhibit 4.4.1 Form of Registration Rights Agreement between the
Registrant and each June 2002 Private Placement Common Stock
investor.
10.25 (5) Form of Subscription Agreement between the Registrant and each
October 2002 Private Placement Common Stock investor.
10.26 (7) Warrant Certificate dated December 9, 2002 issued by the
Registrant to Wolfe Axelrod Weinberger Associates LLC.
10.29 (16) Termination Agreement dated November 27, 2002 between HiEnergy
Technologies, Inc. and H.C. Wainwright & Co., Inc.
10.30 (7) Termination Agreement dated December 2, 2002 between HiEnergy
Technologies, Inc. and Wolfe Axelrod Weinberger Associates LLC.
79
10.31 (7) Form of Warrant Certificate dated December 9, 2002 issued by the
Registrant to H.C. Wainwright & Co., Inc. and Assigns.
10.32 (16) Placement Agent Agreement dated December 16, 2002 between HiEnergy
Technologies, Inc. and Seabury Transportation Advisors LLC.
10.32.1 (10) Letter dated July 2003 terminating agreement with Seabury
Transportation Advisors, LLC.
10.33 (7) Nonqualified Stock Option dated December 19, 2002 issued by
HiEnergy Technologies, Inc. to Chapin E. Wilson.
10.34 (7) Nonqualified Stock Option dated December 19, 2002 issued by
HiEnergy Technologies, Inc. to Derek W. Woolston.
10.35 (7) Settlement Agreement dated January 15, 2003 between HiEnergy
Technologies, Inc. and Keith Cowan.
10.36 (7) Settlement Agreement dated February 14, 2003 among HiEnergy
Technologies, Inc., Columbus Group/cFour Partners, Robert W.
Bellano and Shaun Corrales. See also Exhibit 10.37 Form of Warrant
Certificate dated February 17, 2003 between HiEnergy Technologies,
Inc. and the principals of Columbus Group/cFour Partners.
10.37 (7) Form of Warrant Certificate dated February 17, 2003 between
HiEnergy Technologies, Inc. and the principals of Columbus
Group/cFour Partners. See also Exhibit 10.36 Settlement Agreement
dated February 14, 2003 among HiEnergy Technologies, Inc.,
Columbus Group/cFour Partners, Robert W. Bellano and Shaun
Corrales.
10.38 (16) Award Contract dated January 15, 2003 by the U.S. Department of
Defense to HiEnergy Technologies, Inc.
10.39 (8) Letter Agreement dated November 18, 2002 between HiEnergy
Technologies, Inc. and HWH Enterprises, Inc.
10.40.1 (9) Client Fee Agreement between HiEnergy Technologies and Yocca,
Patch & Yocca, LLP
10.40.2 (9) Form of Promissory Note between HiEnergy Technologies, Inc. and
Yocca, Patch & Yocca, LLP
10.40.3 (12) Amendment of the Promissory Note issued to Yocca, Patch & Yocca,
LLP
10.41 (9) Jenkins Capital Management LLC Private Placement Agreement dated
April 22, 2003
10.42 (9) Vertical Ventures Investments LLC Stock Purchase Agreement dated
April 23, 2003. See also Exhibit 10.72 Form of Escrow Agreement.
10.43 (9) Greenwich Growth Fund Limited Stock Purchase Agreement dated April
28, 2003. See also Exhibit 10.72 Form of Escrow Agreement.
10.44 (9) Consulting Agreement dated April 15, 2003, between HiEnergy
Technologies, Inc. and Charles Van Musscher
10.45 (9) Letter Agreement between HiEnergy Technologies, Inc. and Roth
Investor Relations
10.46 (9) Stock Option Agreement between Bogdan C. Maglich and HiEnergy
Technologies, Inc. dated February 11, 2003*
10.47 (10) HiEnergy Technologies, Inc. 2003 Stock Option Plan*
10.48 (10) HiEnergy Technologies, Inc. Form of Stock Option Agreement*
10.49 (10) Yocca, Patch & Yocca, LLP Stock Purchase Agreement dated June 16,
2003
10.50 (10) Richard Melnick Stock Purchase Agreement dated June 18, 2003. See
also Exhibit 10.72 Form of Escrow Agreement.
10.51 (10) Jeffrey Herman Stock Purchase Agreement dated June 23, 2003. See
also Exhibit 10.72 Form of Escrow Agreement.
10.52 (10) Form of Stock Purchase Agreement dated August 5-29, 2003 between
HiEnergy Technologies, Inc. and the purchasers of common stock and
warrants. See also Exhibit 10.72 Form of Escrow Agreement.
10.53 (10) Form of Warrant Certificate dated August 8-29, 2003 between
HiEnergy Technologies, Inc. and the purchasers of common stock and
warrants
80
10.53.1 (13) Form of Amendment of Warrant dated December 15, 2003 between
HiEnergy Technologies, Inc. and the purchasers of common stock and
warrants
10.54 (10) International Distribution Agreement between the Registrant and
Electronic Equipment Marketing Company (EEMCO) dated July 25, 2003
10.55 (10) Form of Subscription Agreement between the Registrant and each
April 2002 Private Placement Common Stock investor. See also
Exhibit 4.2 Form of Registration Rights Agreement between the
Registrant and each April 2002 Private Placement Common Stock
investor.
10.56 (16) Form of Amendment No. 1 to Subscription Agreement between the
Registrant and each April 2002 Private Placement Common Stock
investor
10.57 (11) Memorandum of Understanding between HiEnergy Technologies, Inc.
and Aeropuertos Espanoles y Navegacion Aerea, Edificio La Piovera
- Peonias dated October 6, 2003
10.58 (12) Form of Stock Purchase Agreement dated October 15 - December 2,
2003 between HiEnergy Technologies, Inc. and the purchasers of
common stock and warrants. See also Exhibit 10.72 Form of Escrow
Agreement.
10.59 (12) Form of Warrant Agreement dated October 28 - December 2, 2003
between HiEnergy Technologies, Inc. and the purchasers of common
stock and warrants.
10.60 (16) Letter Agreement between SBI - USA LLC and HiEnergy Technologies,
Inc. dated August 1, 2003
10.61 (14) Promissory Note issued to Bogdan Maglich by HiEnergy Technologies,
Inc.
10.62 (14) Note Purchase Agreement dated January 16, 2004 between HiEnergy
Technologies, Inc. and Platinum Partners Value Fund LP, with
attached Form of Convertible Note and Warrant
10.63 (14) Note Purchase Agreement dated January 31, 2004 between HiEnergy
Technologies, Inc. and Richard Melnick with attached Form of
Convertible Note and Warrant
10.64 (14) Stock Purchase Agreement dated February 9, 2004 between HiEnergy
Technologies, Inc. and Bullbear Capital Partners, LLC with
attached Form of Warrant
10.65 (14) Letter Agreement between KCSA Public Relations Worldwide and
HiEnergy Technologies, Inc. dated January 6, 2003
10.66 (14) Assignment of Patent Rights by Dr. Bogdan C. Maglich to HiEnergy
Microdevices, Inc. dated March 26, 2002.
10.66.1 (14) Assignment of Patent Rights from HiEnergy Microdevices, Inc. to
HiEnergy Technologies, Inc. dated November 17, 2003.
10.67 (14) Assignment of Patent Rights by Dr. Bogdan C. Maglich to HiEnergy
Technologies, Inc. dated November 17, 2003
10.68 (14) Employment Agreement between HiEnergy Technologies, Inc. and Ioana
C. Nicodin dated February 3, 2004
10.69 (14) Note Purchase Agreement dated January 28, 2004 between HiEnergy
Technologies, Inc. and Nicholas J. Yocca with attached Form of
Convertible Note and Warrant
10.70 (15) Form of Consent and Waiver from April 2003 purchasers of common
stock.
10.71 (15) Form of Release from June 2003 purchasers of common stock.
10.72 (16) Form of Escrow Agreement utilized in connection with the Stock
Purchase Agreements filed as Exhibits 10.50, 10.51, 10.52 and
10.58.
10.73 (19) Employment Letter dated April 12, 2004 between Sean Moore and
HiEnergy Technologies, Inc.
10.74 (19) Proposal for Detailed Concept Design Services dated June 7, 2004
between Lockwood Greene Engineering & Construction and HiEnergy
Technologies, Inc.
10.75 (19) Employment letter dated July 26, 2004 between Jim Hertzog and
HiEnergy Technologies, Inc.
10.76 (19) Engagement Agreement dated July 27, 2004 between Pacific Summit
Securities and HiEnergy Technologies, Inc.
10.77 (19) Teaming Agreement dated August 4, 2004 between HiEnergy
Technologies, Inc. and Siemens Maintenance Services, LLC
10.78 (20) Consulting Agreement dated July 22, 2004 between Greg Henkel and
HiEnergy Technologies, Inc.
81
10.79 (21) Form of Stock Purchase Agreement and Warrant dated October 18,
2004 - December 15, 2004 issued in connection with the sale of
restricted shares to various accredited investors and HiEnergy
Technologies, Inc.
10.80 (21) Form of Debt Conversion Agreement and Warrant between Maglich
Family Holdings and HiEnergy Technologies, dated November 19, 2004
10.81 (24) Amendment to Share Purchase Agreement dated January 24, 2005
between HiEnergy Technologies, Inc. and Bull Bear Capital
Partners, LLC
10.82 (23) Employment letter dated November 22, 2004 between Roger Spillmann
and HiEnergy Technologies, Inc.
10.83 (22) Consulting Agreement dated November 22, 2004 between Don Abbe and
HiEnergy Technologies, Inc.
10.84 (25) Proposal for Preliminary Manufacturing Facility Assessment
Consulting Services dated April 13, 2004 between HiEnergy
Technologies, Inc. and Lockwood Greene Engineering & Construction
(filed in its entirety)
10.85 (25) Promissory Note dated January 15, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.86 (25) Promissory Note dated January 15, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.87 (25) Promissory Note dated January 15, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.88 (25) Promissory Note dated March 15, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.89 (25) Promissory Note dated April 5, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.90 (25) Promissory Note dated April 15, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.91 (25) Promissory Note dated April 29, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.92 (25) Promissory Note dated August 3, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.93 (25) Promissory Note dated August 4, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.94 (25) Promissory Note dated August 10, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.95 (25) Promissory Note dated August 18, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.96 (25) Promissory Note dated August 25, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.97 (25) Promissory Note dated August 30, 2004 issued to Bogdan Maglich by
HiEnergy Technologies, Inc.
10.98 (25) Proposal for Detailed Concept Design Services between HiEnergy
Technologies, Inc. and Lockwood Greene Engineering & Construction
dated June 7, 2004
10.99 (25) Consulting Agreement between HiEnergy Technologies, Inc. and Greg
Henkel dated July 22, 2004
10.100 (25) Consulting Agreement between HiEnergy Technologies, Inc. and Jim
Hertzog dated July 26, 2004
10.101 (25) Engagement letter between HiEnergy Technologies, Inc. and Pacific
Summit Securities dated July 27, 2004
10.102 (25) Employment letter dated April 12, 2004 between Sean Moore and
HiEnergy Technologies, Inc.
10.103 (25) Teaming Agreement between HiEnergy Technologies, Inc. and Siemens
Maintenance Services, LLC dated August 4, 2004
10.104 (25) Retention Agreement between HiEnergy Technologies, Inc. and
Pellettieri, Rabstein and Altman dated November 11, 2004
10.105 (25) Retention Agreement between HiEnergy Technologies, Inc. and
Feldhake Roquemore LLP dated January 12, 2005
10.106 (26) Form of Stock Purchase Agreement dated March 22, 2005 and issued
in connection with the sale of restricted shares to various
accredited investors and HiEnergy Technologies, Inc.
10.107 (26) Form of Warrant to Purchase Shares of Common Stock of HiEnergy
Technologies, Inc. dated March 22, 2005 and issued in connection
with the sale of restricted shares to various accredited investors
10.108 (26) Form of Stock Purchase Agreement dated April 2005 and issued in
connection with the sale of restricted shares to various
accredited investors and HiEnergy Technologies, Inc.
10.109 (26) Form of Warrant to Purchase Shares of Common Stock of HiEnergy
Technologies, Inc. dated April 2005 and issued in connection with
the sale of restricted shares to various accredited investors.
10.110 (26) Form of Stock Purchase Agreement for the period from May 16, 2005
through July 12, 2005 and issued in connection with the sale of
restricted shares to various accredited investors.
82
10.111 (26) Form of Warrant to Purchase Shares of Common Stock of HiEnergy
Technologies, Inc. for the period from May 16, 2005 through July
12, 2005 and issued in connection with the sale of restricted
shares to various accredited investors.
10.112 (26) Form of Debt Conversion Agreement between Nicholas J. Yocca and
HiEnergy Technologies, Inc., dated May 13, 2005.
10.113 (26) Debt Conversion Agreement between David R. Baker and HiEnergy
Technologies, Inc., dated July 15, 2005, and form of detachable
warrant.
10.114 (26) Debt Conversion Agreement between Baker, Johnston & Wilson LLP and
HiEnergy Technologies, Inc., dated July 15, 2005, and form of
detachable warrant.
10.115 (26) Agreement between Mason, Griffin & Pierson and HiEnergy
Technologies, Inc., dated April 29, 2005.
10.116 (26) Subcontract Agreement between Siemens Maintenance Services LLC and
HiEnergy Technologies, Inc., dated April 15, 2005
10.117 (26) Agreement between Vintage Filings, LLC and HiEnergy Technologies,
Inc., dated May 1, 2005.
10.118 (26) Engagement Letter between Henry S. Sprintz and HiEnergy
Technologies, dated June 20, 2005.
10.119 (26) Employment Agreement between Gregory C. Henkel, Controller, and
HiEnergy Technologies, Inc., dated March 1, 2005.
10.120 (26) Equipment Sales Agreement between Southeastern Pennsylvania
Transportation Authority and HiEnergy Technologies, Inc., dated
June 6, 2005.
10.121 (26) Time and Material Subcontract between Integrated Concepts &
Research Corporation and HiEnergy Technologies, dated July 18,
2005.
10.122 (26) International Distribution Agreement between Electronic Equipment
Marketing Company (EEMCO) and HiEnergy Technologies, dated July
25, 2003
10.123 (27) Form of Stock Purchase Agreement dated July 26, 2005 and issued in
connection with the sale of restricted shares to various
accredited investors.
10.124 (27) Form of Warrant to Purchase Shares of Common Stock of HiEnergy
Technologies, Inc. dated July 26, 2005 and issued in connection
with the sale of restricted shares to various accredited
investors.
10.125 (29) Engagement Letter between Vladimir Stanich and HiEnergy
Technologies, dated September 9, 2005.
10.126 (29) Independent Contractor Agreement between Metaskill, Inc. and
HiEnergy Technologies, dated September 15, 2005.
10.127 (32) Form of Senior Convertible Bridge Note and Warrant issued in
connection with the sale of restricted shares to various
accredited investors.
10.128 (34) Secured Convertible Promissory Note issued to First Regional Bank,
CFBO Bruce Steinberg Roth IRA dated November 18, 2005.
10.129 (34) Warrant to Purchase Shares of Common Stock of HiEnergy
Technologies, Inc. dated November 18, 2005 issued to Bruce
Steinberg Roth IRA.
10.130 (34) Assignment of Accounts Receivable issued by HiEnergy Technologies,
Inc. to First Regional Bank, CFBO Bruce Steinberg Roth IRA dated
November 18, 2005.
10.131 (34) Memorandum of Understanding between Williams-Sterling, Inc. and
HiEnergy Technologies dated November 16, 2005.
10.132 (34) Reseller Agreement between GTSI Corp. and HiEnergy Technologies,
Inc. dated November 18, 2005.
10.133 + (34) Cooperative Agreement between Transportation Security
Administration and HiEnergy Technologies, Inc. dated September 27,
2004
10.134 (34) Addendum No. 4 to Original Lease Agreement dated August 15, 2002,
between the Registrant and Del Mar Avionics dated October 14, 2005
10.135 (34) Placement Agent Agreement between Burnham Hill Partners and
HiEnergy Technologies, Inc. dated September 26, 2005.
10.136 (36) International Distribution Agreement between HiEnergy
Technologies, Inc. and Electronic Equipment Marketing Company
(EEMCO) dated July 25, 2003, as amended on August 27, 2003.
83
10.137 (36) Award Contract between HiEnergy Microdevices, Inc. and the U.S.
Department of Defense dated February 12, 2002 (filed in its
entirety)
10.138 (36) Assignment of Patent Rights by Dr. Bogdan C. Maglich to HiEnergy
Microdevices, Inc. dated March 26, 2002 (filed in its entirety).
10.139 (36) Assignment of Patent Rights by Dr. Bogdan C. Maglich to HiEnergy
Technologies, Inc. dated November 17, 2003 (filed in its entirety)
10.140 (36) Form of Convertible Promissory Note issued to Yocca, Patch &
Yocca, LLP and/or Nicholas J. Yocca
10.141 (36) Form of Promissory Note issued to Maglich Family Holdings, Inc.
10.142 (36) Debt Conversion Agreement with form of Warrant to purchase shares
of common stock of HiEnergy Technologies, Inc. dated October 27,
2004 between HiEnergy Technologies, Inc. and Maglich Family
Holdings, Inc.
10.143 (36) Assignment of Patent Rights by Dr. Bogdan C. Maglich to HiEnergy
Technologies, Inc. dated November 17, 2003 (filed in its entirety)
10.144 (36) Assignment of Patent Rights by Dr. Kevin Mckinny to HiEnergy
Technologies, Inc. dated November 17, 2003 (filed in its entirety)
10.145 (36) Teaming Agreement between HiEnergy Technologies, Inc. and
Williams-Sterling, Inc. dated effective January 30, 2006
10.146 (36) Reseller Agreement between HiEnergy Technologies, Inc. and
Williams-Sterling, Inc. dated effective January 30, 2006
10.147 (36) Joint Marketing Agreement between HiEnergy Technologies, Inc. and
Laseroptronix, AB dated January 15, 2006
10.148 (36) Engagement Letter between HiEnergy Technologies, Inc. and Dr.
Vladivoj Valkovic dated February 16, 2006
10.149 (36) Independent Contractor Agreement between HiEnergy Technologies,
Inc. and Radiation Safety Academy dated February 8, 2006
10.150 (37) Employment Agreement between HiEnergy Microdevices, Inc and Dr.
Bogdan C. Maglich dated March 6, 2002 (Corrected version of the
agreement previously filed as Exhibit 10.5 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended April 20, 2002
filed with the SEC on July 29, 2002.
10.151 (38) Equipment Sales Agreement (Contract No. 19107), as amended,
between Southeastern Pennsylvania Transportation Authority and
HiEnergy Technologies, Inc., dated May 18, 2006.
10.152 (38) Purchase Order in the amount of $200,000 from the Commonwealth of
Pennsylvania, Pennsylvania Emergency Management Agency (PEMA) on
behalf of Southeastern Pennsylvania Transportation Authority.
10.153 (39) Confidential Settlement Agreement and Mutual Release between
HiEnergy Technologies, Inc. and Yeffet Security Consultants, Inc.,
dated June 9, 2006.
10.154 (41) Confidential Settlement Agreement between CH2M Hill Lockwood
Greene and the HiEnergy Technologies, Inc., dated July 20, 2006.
10.155(42) Copy of U.S. Nuclear Regulatory Commission Materials License dated
June 30, 2006 and expiring June 30, 2016.
10.156(42) Copy of State of California Certificate of Radiation Machine
Registration expiring March 31, 2008.
10.157 * HiEnergy Technologies, Inc. 2006 Consultant Stock Plan
14.1 (9) Code of Ethics for Senior Financial Officers of HiEnergy
Technologies, Inc.
16.1 (1) Letter of Manning Elliott
21.1 (9) List of Subsidiaries
21.2 (26) List of Subsidiaries
31.1* Certification of Chief Executive Officer and Treasurer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of Chief Executive Officer and Treasurer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
84
+ Portions of this exhibit have been omitted pursuant to an Application for
Confidential Treatment filed by the Company with the Securities and
Exchange Commission pursuant to the Rules of the Exchange Act.
* Filed herewith
(1) Filed on May 10, 2002 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated April 25, 2002 and incorporated herein by reference.
(2) Filed on June 2, 2000 as an exhibit to HiEnergy Technologies' registration
statement on Form SB-2 (File No. 333-38536) and incorporated herein by
reference.
(3) Filed on July 29, 2002 as an exhibit to HiEnergy Technologies' annual
report on Form 10-KSB for the fiscal year ended April 30, 2002, and
incorporated herein by reference.
(4) Filed on September 20, 2002 as an exhibit to HiEnergy Technologies'
quarterly report on Form 10-QSB for the fiscal quarter ended October 31,
2002, and incorporated herein by reference.
(5) Filed on November 6, 2002 as an exhibit to HiEnergy Technologies'
registration statement on Form SB-2 and incorporated herein by reference.
(6) Filed on December 16, 2002 as an exhibit to HiEnergy Technologies'
quarterly report on Form 10-QSB for the fiscal quarter ended October 31,
2002, and incorporated herein by reference.
(7) Filed on February 25, 2003 as an exhibit to HiEnergy Technologies'
registration statement on Form SB-2/A (File No. 333-101055) and
incorporated herein by reference.
(8) Filed on March 24, 2003 as an exhibit to HiEnergy Technologies' quarterly
report on Form 10-QSB for the fiscal quarter ended January 31, 2003, and
incorporated herein by reference.
(9) Filed on August 8, 2003 as an exhibit to HiEnergy Technologies' annual
report on Form 10-KSB for the fiscal year ended April 30, 2003, and
incorporated herein by reference.
(10) Filed on September 19, 2003 as an exhibit to HiEnergy Technologies'
registration statement on Form SB-2 (File No. 333-108934) and incorporated
herein by reference.
(11) Filed on October 8, 2003 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated October 7, 2003 and incorporated herein by reference.
(12) Filed on December 16, 2003 as an exhibit to HiEnergy Technologies'
quarterly report on Form 10-QSB for the fiscal quarter ended January 31,
2004, and incorporated herein by reference.
(13) Filed on December 24, 2003 as an exhibit to Pre-Effective Amendment No. 1
to HiEnergy Technologies' registration statement on Form SB-2 (File No.
333-108934) and incorporated herein by reference.
(14) Filed on February 25, 2004 as a like numbered exhibit to HiEnergy
Technologies' current report on Form 8-K dated February 24, 2004 and
incorporated herein by reference.
(15) Filed on March 25, 2004 as an exhibit to HiEnergy Technologies'
Pre-Effective Amendment No 2 registration statement on Form SB-2 (File No.
333-108934) and incorporated herein by reference.
(16) Filed on April 12, 2004 as a like numbered exhibit to HiEnergy
Technologies' current report on Form 8-K/A dated April 9, 2004 and
incorporated herein by reference.
(17) Filed on May 17, 2004 as a like numbered exhibit to HiEnergy Technologies'
current report on Form 8-K dated May 17, 2004 and incorporated herein by
reference.
85
(19) Filed on May 21, 2004 as a like numbered exhibit to HiEnergy Technologies'
current report on Form 8-K dated May 21, 2004 and incorporated herein by
reference.
(20) Filed on September 14, 2004 as a like numbered exhibit to HiEnergy
Technologies' annual report on Form 10-KSB for the fiscal year ended April
30, 2004 and incorporated herein by reference.
(21) Filed on October 20, 2004 as an exhibit to HiEnergy Technologies' quarterly
report on Form 10-QSB for the quarter ended October 31, 2004, and
incorporated herein by reference.
(22) Filed on November 30, 2004 as exhibit 99.1 to HiEnergy Technologies'
current report on Form 8-K dated November 30, 2004 and incorporated herein
by reference.
(23) Filed on December 17, 2004 as Exhibit 10.80 to HiEnergy Technologies'
quarterly report on Form 10-QSB for the quarter ended October 31, 2004 and
incorporated herein by reference.
(24) Filed on January 11, 2005 as Exhibit 99.3 to HiEnergy Technologies' current
report on Form 8-K dated January 7, 2005 and incorporated herein by
reference.
(25) Filed on February 2, 2005 as Exhibit 10.81 to HiEnergy Technologies'
current report on Form 8-K dated January 27, 2005 and incorporated herein
by reference.
(25) Filed on March 17, 2005 as a like numbered exhibit to HiEnergy
Technologies' quarterly report on Form 10-QSB for the quarter ended January
31, 2005 and incorporated herein by reference.
(26) Filed on July 27, 2005 as a like numbered exhibit to HiEnergy Technologies'
amendment to its annual report on Form 10-KSB for the fiscal year ended
April 30, 2004 and incorporated herein by reference.
(27) Filed on August 15, 2005 as a like numbered exhibit to HiEnergy
Technologies' annual report on Form 10-KSB for the fiscal year ended April
30, 2005 and incorporated herein by reference.
(28) Filed on September 6, 2005 as an exhibit to HiEnergy Technologies' report
on Form 8-K dated September 2, 2005 and incorporated herein by reference.
(29) Filed on September 19, 2005 as an exhibit to HiEnergy Technologies'
quarterly report on Form 10-QSB for the quarter ended July 31, 2005 and
incorporated herein by reference.
(30) Filed on October 11, 2005 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated October 11, 2005 and incorporated herein by reference.
(31) Filed on October 24, 2005 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated October 20, 2005 and incorporated herein by reference.
(32) Filed on November 17, 2005 as an exhibit to HiEnergy Technologies' report
on Form 8-K dated November 17, 2005 and incorporated herein by reference.
(33) Filed on November 30, 2005 as an exhibit to HiEnergy Technologies' report
on Form 8-K dated November 30, 2005 and incorporated herein by reference.
(34) Filed on December 16, 2005 as an exhibit to HiEnergy Technologies'
quarterly report on Form 10-QSB for the quarter ended October 31, 2005 and
incorporated herein by reference.
(35) Filed on January 3, 2006 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated December 23, 2005 and incorporated herein by reference.
(36) Filed on March 22, 2006 as an exhibit to HiEnergy Technologies' quarterly
report on Form 10-QSB for the quarter ended January 31, 2006 and
incorporated herein by reference.
86
(37) Filed on April 24, 2006 as Exhibit 150 to HiEnergy Technologies' report on
Form 8-K dated April 24, 2006 and incorporated herein by reference.
(38) Filed on June 1, 2006 as Exhibit 150 to HiEnergy Technologies' report on
Form 8-K dated June 1, 2006 and incorporated herein by reference.
(39) Filed on June 15, 2006 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated June 15, 2006 and incorporated herein by reference.
(40) Filed on July 10, 2006 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated July 7, 2006 and incorporated herein by reference.
(41) Filed on July 27, 2006 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated July 27, 2006 and incorporated herein by reference.
(42) Filed on August 4, 2006 as an exhibit to HiEnergy Technologies' report on
Form 8-K dated August 4, 2006 and incorporated herein by reference.
87
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
HIENERGY TECHNOLOGIES, INC.
Date: October 12, 2006 /s/ Roger W.A. Spillmann
----------------------------------------
Roger W.A. Spillmann,
Chief Executive Officer, President,
and Treasurer
(Principal Executive Officer and
88