ITEM 1 DESCRIPTION OF BUSINESS ........................................... 1
ITEM 2 DESCRIPTION OF PROPERTY ........................................... 6
ITEM 3 LEGAL PROCEEDINGS ................................................. 6
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............... 6
ITEM 5 MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS .......... 7
ITEM 6 SELECTED FINANCIAL DATA............................................ 8
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ........................................ 9
ITEM 8 FINANCIAL STATEMENTS .............................................. 16
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ......................................... 16
ITEM 9A CONTROLS AND PROCEDURES ........................................... 17
ITEM 9B OTHER INFORMATION ................................................. 17
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT ................ 17
ITEM 11 EXECUTIVE COMPENSATION ............................................ 19
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS .................................. 24
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS .................... 25
ITEM 14 EXHIBITS .......................................................... 26
ITEM 15 PRINCIPAL ACCOUNTANT FEES AND SERVICES ............................ 27
SIGNATURES ................................................................. 28
PART I
ITEM 1. BUSINESS
DEVELOPMENT OF BUSINESS
American Soil Technologies, Inc., formerly Soil Wash Technologies, Inc., was incorporated in California on September 22, 1993 in the soil remediation business. In May 2002, we discontinued the soil remediation business.
BUSINESS OF ISSUER
We develop, manufacture and market cutting-edge technology that decreases the need for water and improves the soil in the "Green Industry" consisting of agriculture, turf and horticulture. Our products enhance growing environments and reduce the environmental damage caused by common growing practices.
We manufacture three primary products: Agriblend(R), a patented soil amendment developed for agriculture; Soil Medic, a patented slow release liquid fertilizer; and NutrimoistL(R), developed for homes, parks, golf courses and other turf related applications.
We market our products primarily in the United States. We are continually adding sales representatives and distributors in both the agriculture and turf industries. The following table shows the current distributors and sales representatives of our products and products we license from others:
Distributor/Sales Representative Product Territory -------------- ------- --------- Gigot Aqua Services Agriblend(R) Kansas, Oklahoma, Nebraska, Nutrimoist(R) Colorado, northern Texas, Extend(TM) northern New Mexico Stockosorb(R) Sircle Saver Sacks(R)
The Pacific Tree Company Agriblend(R) Exclusive distributor of our Soil Medic products for the Paulownia Nutrimoist(R) Megafolia Tree in the United States
Environmental Development Nutrimoist Kuwait and the UAE Company Agriblend
Donald Weishuhn Agriblend(R) The state of Texas from south Nutrimoist(R) of Lubbock to Dallas Extend(TM) Stockosorb(R) Stockopam(R) Dust Contain
Turf Masters Soil Medic(TM) San Diego and Orange Counties Soil Therapy(TM) California and Northern Mexico
Ag Pro Tech, Inc. Agriblend(R) Eastern North Dakota and Nutrimoist(R) Western Minnesota Extend(TM) Stockosorb(R) Stockopam(R) Dust Contain
Reinke Pasco, Inc. Agriblend(R) Washington Nutrimoist(R) Extend(TM) Stockosorb(R) Stockopam(R) Dust Contain Sircle Saver Sack(R)
The Kern Company Agriblend(R) Washington Nutrimoist(R) Extend(TM) Stockosorb(R) Stockopam(R) Canal Seal Dust Contain Anchor MP Sircle Saver Sack(R) Hydromulch
Pure Chemicals Nutrimoist and future products Israel
Echo Trading Company Agriblend Country of Morocco Nutrimoist
We also act as a distributor for products manufactured by others as follows:
On July 7, 2006, we acquired Smart World Organics, Inc. ("Smart World") as a wholly-owned subsidiary. Smart World is a "C" corporation located in Hudson, Florida. Smart World has developed organic and sustainable products through a unique research approach. The products are sold directly to the end user and through distributors on a worldwide basis.
Smart World provides next-generation organic and sustainable fertilizers to commercial and residential customers worldwide. Smart World also provides advanced, custom-formulated products built to suit unusual growing conditions and environments. The product line includes homogenized fertilizers, non-toxic insect controls, plant protectants, seed, soil and silage inoculants.
Smart World distributes products to many countries including China, Japan, Taiwan, the United Arab Emirates, Turkey, Greece, Spain and Costa Rica. They have also made major ties with cotton growers throughout the United States and Argentina.
We issued 2,300,000 shares of common stock to the shareholders of Smart World in exchange for 100% of the shares of common stock of Smart World and assumed approximately $400,000 in notes and trade payables.
On December 20, 2006, we entered into an Intellectual Property Purchase Agreement with Ray Nielsen whereby we purchased from Mr. Nielsen any and all intellectual property of Mr. Nielsen, including all formulas developed by Mr. Nielsen over the past 30 years, including but not limited to all formulas and intellectual property used in the business of Smart World, including all graphics and logos; all domain names and URL's; any proprietary software and its source code; all existing content and HTML files; all branding and trademarks; all trade names; all services marks; all copywritten material; all patents; and all products and proceeds of the foregoing, in any form whatsoever and wheresoever located (collectively the "Intellectual Property"), in exchange for a convertible debenture in the amount of $1,500,000 and bearing an interest rate of 8% per annum (the "Convertible Debenture").
The Convertible Debenture is secured by the Intellectual Property. The principal of the Convertible Debenture and any unpaid accrued interest thereon is due and payable on January 19, 2008. We were to make quarterly interest payments until the maturity date. The Convertible Debenture is convertible at the option of Mr. Nielsen at any time prior to the maturity sate into shares of our common stock at a conversion price equal to the closing price of our common stock for the day immediately proceeding the date of conversion. A dispute has arisen between Mr. Nielsen and us regarding the Convertible Debenture and the uniqueness and value of the Intellectual Property. See "Legal Proceedings."
COMPETITION
To the best knowledge of our management, there is no direct competition for our Agriblend(R) product, however, earlier polymer based technology was very expensive and the remembrance of its cost has a negative effect on marketing Agriblend(R). Accordingly, educating the end user regarding the benefits of using Agriblend(R) and gaining general acceptance of the new "micro grain" technology are obstacles to marketing the product.
There is some competition to our straight polymer products by companies that have been in business for a number of years.
There is some competition for Extend(TM) however we have not as yet found a higher quality liquid linear polymer product.
We are not aware of any competition to Nutrimoist(R) L other than from our manufacturer(s) who would have to use our polymer to manufacture the product pursuant to our agreement.
The newly acquired slow release fertilizer Soil Medic does not seem to have competition at this time.
There is competition for the organic products that we distribute and manufacture through Smart World.
SOURCES AND AVAILABILITY OF RAW MATERIAL AND PRINCIPAL SUPPLIERS
Our products are proprietary blends that include cross-linked micro grain polymer in the blend. Cross-linked polymer is manufactured by several chemical companies that include Stockhausen, BASF; Ciba Specialties; and Floerger. All other components of our products are readily available commercially throughout the world. Agriblend(R) products are custom blended in accordance with our specifications at a blending facility located near Truth or Consequences, New Mexico. Our warehouse facilities are located in Phoenix, Arizona and Pacoima, California. Nutrimoist(R) is blended by us through contract blenders and is a combination of different formulations, which include our polymer products. Two licensees under our patent manufacture our liquid slow release fertilizer. Custom blending of Soil Medic, as needed, is performed by us through independent blenders. Our organic products are manufactured at our Smart World plant in Hudson, Florida. The Agro Tower is manufactured for us by Make-It Manufacturing in Paso Robles, California.
DEPENDENCE ON MAJOR CUSTOMERS
We are not dependent on any one customer for a substantial portion of our sales of any product.
INTELLECTUAL PROPERTY
We have six patents on the M-216 Polymer Injector machine designed to install our Nutrimoist(R) product into mature turf.
On March 21, 2006, we acquired the U.S. patent on a slow release liquid fertilizer through our acquisition of Advanced Fertilizer Technologies, Inc.
We have exclusive worldwide manufacturing/marketing rights to patented super absorbent cross-linked polymer application technology. The underlying patents include United States Patent number 5,649,495 and 5,868,087, commonly known and described as "Agricultural Retention Mixture and Application Technique."
We have exclusive worldwide marketing rights to the patent pending linear polymer product known as the Sircle Saver Sack(TM).
We own registered trademarks on the names, Agriblend(R), Nutrimoist(R) and Prosper(R).
We have world wide marketing rights to a patented product known as the Agro Tower.
We own the right to numerous formulas used to manufacture organic and sustainable soil amendments, fertilizers and insecticides.
GOVERNMENT APPROVAL
Agriblend(R) and our other polymers are subject to regulatory standards developed by the Environmental Protection Agency ("EPA") that are applicable to maximum monomer concentrations in polymers. Polymer products cannot exceed monomer concentrations of 200 mg/kg. All of the polymers we use are well below the maximum monomer standard.
Many of our products are organically approved through the National Organic Program ("NOP") and registered under EPA section 25B.
RESEARCH AND DEVELOPMENT COSTS
We spent $4,299 on research and development during the year ended September 30, 2008 as compared to $9,801 spent on research and development during the nine months ended September 30, 2007.
COST AND EFFECTS OF COMPLIANCE WITH ENVIRONMENTAL LAWS AND REGULATIONS
We provide Material Safety Data Sheets on all components of our product line and comply with labeling requirement for our products. In addition, we comply with EPA regulations applicable to monomer content in its polymer additives (no greater than five-hundredths percent (0.05%)). We believe that our operations currently comply in all material respects with applicable federal, state and local laws, rules, regulations and ordinances regarding the discharge of materials into the environment. We do not believe that such compliance will have a material impact on our capital expenditures, future earnings and competitive position. No material capital expenditures for environmental control equipment presently are planned.
EMPLOYEES
As of the date hereof, we have eight full-time employees. We hire independent contractors on an "as needed" basis only. We have no collective bargaining agreements with our employees. We believe that our employee relationships are satisfactory.
ITEM 1A
ITEM 1A NON APPLICABLE
ITEM 1B
ITEM 1B NON APPLICABLE
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
On April 1, 2004, we entered into a Sublease Agreement to sublet 923.50 square feet located at a facility in Pacoima, California. The majority shareholder of the sublessor is a related party to us. All of our operations are conducted from this facility, which requires monthly rental payments of approximately $554. The Sublease Agreement terminates on December 31, 2008. We also rent storage space in Tucson and Phoenix, Arizona for approximately $200 per month. On June 1, 2007 we entered into a one year Lease Agreement to lease 6,800 square feet located in Hudson Florida for $2,914 per month. This facility is used for office and manufacturing of our Smart World products.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On or about September 21, 2007, Stockhausen, Inc. ("Stockhausen") filed a Complaint in the United States District Court, for the Middle District of North Carolina, against us seeking damages. Stockhausen alleges that we breached an agreement with them by failing to pay for goods purchased and failing to purchase a minimum quantity of goods. We believe that Stockhausen provided Defective products and waived any minimum purchase requirements. Stockhausen is seeking a judgment in the amount of $188,180 plus interest and lost profits in an unspecified amount, along with costs and attorneys fees. We filed an Answer to the Complaint and a Cross-Complaint against Stockhausen on November 14, 2007. Discovery has not been completed and settlement discussions are ongoing
On or about October 4, 2007, Raymond J. Nielsen and Cheryl K. Nielsen (collectively, "Plaintiffs"), filed a Complaint in the Circuit Court in the Sixth Judicial District of Pasco County, Florida, against us and Smart World (collectively "Defendants") seeking damages, declaratory, and injunctive relief. Plaintiffs allege that Defendants failed to pay interest when due on the Convertible Debenture from Defendants to Plaintiffs and, thus, the entire amount of the Convertible Debenture is accelerated and Plaintiffs are seeking a judgment in the amount of $1,500,000 plus interest. We allege that jurisdiction of this matter belongs in the California court system per the terms of the documents. We have filed a Motion to Dismiss the lawsuit which has been denied. We have filed an answer and affirmative defenses. It is our position that the intellectual property we purchased from the Plaintiffs is not what it was represented to be.
To the best knowledge of our management, there are no other legal proceedings pending against us.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITES
MARKET FOR COMMON EQUITY
Our common stock is currently quoted on the Over-The-Counter Bulletin Board under the Symbol "SOYL." Set forth below is the trading history of our common stock without retail mark-up, mark-down or commissions:
High Low ---- --- First Quarter ...................... 0.34 0.18 Second Quarter ..................... 0.95 0.22 Third Quarter ...................... 0.44 0.22 Fourth Quarter ..................... 0.40 0.17
First Quarter ...................... 0.35 0.19 Second Quarter ..................... 0.30 0.16 Third Quarter ...................... 0.25 0.09 Fourth Quarter ..................... 0.10 0.07
First Quarter ...................... 0.15 0.07 Second Quarter ..................... 0.12 0.05 Third Quarter ...................... 0.09 0.01 Fourth Quarter ..................... 0.09 0.01
On January 8, 2009, the closing stock price was $0.01.
The above quotations are inter-dealer quotations from market makers of our common stock. At certain times the actual closing or opening quotations may not represent actual trades that took place.
HOLDERS
As of January 9, 2009, there were 289 shareholders holding certificated securities and approximately 539 shareholders currently listed in the Depository Trust Company as holding shares in brokerage accounts. Our transfer agent is Standard Registrar & Transfer Company 1528 South 1840 East, Draper, Utah 84020.
DIVIDENDS
We have paid no dividends on our common stock since inception and do not anticipate or contemplate paying cash dividends in the foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES
On August 18, 2008, Ms. Visco converted $41,383 of notes into 1,379,4280 shares of common stock at the current market price of $0.03 per share. We believe that Ms Visco is an "accredited investor" under Rule 501 under Regulation D of the Act and had adequate access to information about us.
On August 18,2008, Dr. Patrick Haydel converted a $30,000 of convertible debenture into 300,000 shares of common stock at the stated conversion price of $0.10 per share. Dr. Haydel also covertedaccrued interest in the amount of $1,921 into 64,045 share. We believe that Dr. Haydel is an "accredited investor" under Rule 501 Regulation D of the Act and had adequate access to information about us.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
The following table sets forth, for the periods indicated, our selected financial information:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our financial statements, including the notes thereto, appearing elsewhere in this Report.
ThE following information contains certain forward-looking statements of OUR management. Forward-looking statements are statements that estimate the happening of future events and are not based on historical fact. Forward-looking statements may be identified by the use of forward-looking terminology, such as "may," "could," "expect," "estimate," "anticipate," "PLAN," "predict," "probable," "possible," "should," "continue," or similar terms, variations of those terms or the negative of those terms. The forward-looking statements specified in the following information have been compiled by our management on the basis of assumptions made by management and considered by management to be reasonable. Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements.
OVERVIEW
We develop, manufacture and market cutting-edge technology that decreases the need for water and improves the soil in the "Green Industry" consisting of agriculture, turf and horticulture.
RESULTS OF OPERATIONS
We changed our fiscal year end from December 31 to September 30, effective for the period ended September 30, 2007. As a result, the following discussion of our financial results include the operating results for the nine month period ended September 30, 2008, as compared to the twelve month period for the period ended September 30, 2008.
YEAR ENDED SEPTEMBER 30, 2008 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2007
REVENUES
Revenues for the fiscal year-ended September 30, 2008 were $561,704 compared to $764,591 for the nine months ended September 30, 2007, a decrease of 26.5%. This decrease in revenue is directly related to the reduced revenues of Smart World in the amount of $216,985 caused by severe weather conditions that impacted our largest region for agriculture sales and competition from a former employee.
COST OF SALES
Cost of goods sold decreased to $344,884 for the fiscal year ended September 30, 2008 from $473,147 for the fiscal year ended September 30, 2007. The decrease in the cost of sales is the result of the decrease in revenues during this period. Our gross margins were 38.6% and 38% for the years ended September 30, 2008 and September 30, 2007, respectively. The slight increase in our gross margins was caused by a decrease in the cost of raw materials
OPERATING EXPENSES
Operating expenses increased approximately 22% for the fiscal year ended September 30, 2008. This increase in operating expenses is a result of many factors.
General and administrative expenses decreased approximately 2% for the fiscal year ended September 30, 2008 due to a decreased in payroll expenses which was slightly offset by an increase in accounting and legal fees.
Sales and marketing expenses decreased approximately 38% in that we reduced the amount of trade shows we attended and reduced the amount of print advertising.
Research and development costs decreased approximately 57% because we have basically completed our research and development on our existing products.
The amortization expense was $507,157 and $693,672 for the year ended September 30, 2008 and for the period ended September 30, 2007, respectively.
Impairment of intangible assets increased from $400,000 for the period ending September 30, 2007 to $843,390 for theyear ended September 30, 2008.
INTEREST EXPENSE
Interest expense decreased 74% for the fiscal year ended September 30, 2008 from the period ended September 30, 2007. The decrease resulted from the elimination of higher average debt balances and non-cash interest expense relating to the amortization of a debt discount as reported in the prior audited period.
CHANGE IN THE FAIR VALUE OF DERIVATIVE LIABILITY
The change resulting from a decrease in our stock price from September 30, 2007 to September 30, 2008.
NET LOSS
For the reasons detailed above, we experienced losses in the year ended September 30, 2008 and the period ended September 30, 2007. We expect that as a result of our efforts during the last three years to develop strategic alliances, marketing agreements, and distribution networks, sales volume in subsequent periods should increase. Revenues for the fiscal year-ended September 30, 2008 were $561,704 compared to $764,591 for the nine months ended September 30, 2007. However, since these arrangements are new and untested, it is uncertain whether these actions will be sufficient to produce net operating income for the fiscal year ending September 30, 2009. However, given the gross margins of our new products in turf and our acquisition of Smart World, as well as our joint venture in the retail market with Green Hippo future operating results should improve.
SEASONALITY
Our efforts in the United States have focused on the southern states and therefore generally experience year round growing cycles, with the sale of the agricultural products preceding the growing cycle of various crops. International sales have not been sufficient enough or the geographic distribution of sales concentrated enough to determine if a seasonal trend exists although the initial indication is that our markets will become diverse and therefore not indicate significant seasonal variations. As we expand into the residential and commercial segments nationally, we will experience some seasonal declines in sales during the fall and winter quarters in less temperate climates.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents totaled $6,286 and $34,855 at September 30, 2008 and September 30, 2007, respectively. Net cash used by operations was $667,937 for the year ended ended September 30, 2008 as compared to $1,369,526 for the period ended September 30, 2007. We have historically relied upon one of our officers and significant shareholders to provide cash to meet short term operating cash requirements.
In March 2000, we authorized the issuance of an aggregate of $1,325,000 of convertible debentures with interest payable quarterly at 10% per annum. The convertible debentures are convertible to our common stock at a rate of one share for each three dollars converted. The debentures matured in the first calendar quarter of 2002. All of the debentures were subscribed and at September 30, 2008, the outstanding balance of all notes payable totaled $2,874,013. At September 30, 2008, convertible debentures consisted of one $1,500,000 of 8% debenture convertible at the closing price on the day immediately preceding the day of conversion, which is currently in default and in dispute among the parties, $50,000 of 8% per annum debentures at a rate of $0.50 per share, $60,000 of 8% debenture convertible at $0.10 per share, $30,000 of 8% per annum debentures at a rate of $0.25 per share, $75,000 of 8% per annum debentures at a rate of $0.19 per share, and $177,024 of 10% per annum convertible at a rate of $3.00 per share. If the remaining debt is converted today, we would issue an additional 1,273,745 shares.
Interest expense for the year ended ended September 30, 2008 was $71,842 and interest expense for the period ended September 30, 2007 was $164,683.
As of September 30, 2008 we had a working capital deficit (current assets less current liabilities) of $4,183,192 compared to a deficit of $2,765,049 as of September 30, 2007. The increase in the working capital deficit has been caused by an increase in our current liabilities caused by a lack of funding in debts which have been reclassified as current.
As shown in the accompanying financial statements, we have incurred an accumulated deficit of $22,984,490 and a working capital deficit of $4,183,192 as of September 30, 2008. This working capital deficit is directly related to the increase in the current portion of our liabilities. Our ability to continue as a going concern is dependent on obtaining additional capital and financing and operating at a profitable level. We intend to seek additional capital either through debt or equity offerings and to increase sales volume and operating margins to achieve profitability. Our working capital and other capital requirements during the next fiscal year and thereafter will vary based on the sales revenue generated by the recent accumulation of additional products and the distribution and sales network we have created and will continue to grow.
We will consider both the public and private sale of securities and debt instruments for expansion of our operations if such expansion would benefit our overall growth and income objectives. Should sales growth not materialize, we may look to these public and private sources of financing. There can be no assurance, however, that we can obtain sufficient capital on acceptable terms, if at all. Under such conditions, failure to obtain such capital likely would, at a minimum, negatively impact our ability to timely meet our business objectives. Our Auditors issued a statement in their report that there is sunstantial doubt about the Company's ability to continue as a going concern.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which requires us to make estimates and assumptions in certain circumstances that affect amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. We believe that of our significant accounting policies (more fully described in notes to the consolidated financial statements), the following are particularly important to the portrayal of our results of operations and financial position and may require the application of a higher level of judgment by our management, and as a result are subject to an inherent degree of uncertainty.
ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. We review our estimates on an on-going basis, including those related to the allowance for doubtful accounts, inventories and related reserves, long-lived assets, income taxes, litigation and stock-based compensation. We base our estimates on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates, and material effects on our operating results and financial position may result. We believe the following critical accounting policies involve our more significant judgments and estimates used in the preparation of our consolidated financial statements.
REVENUE RECOGNITION
We generate our revenues from the sale of products and services and recognize revenue when the following fundamental criteria are met:
* persuasive evidence that an arrangement exists; * the products and services have been delivered; * selling prices are fixed and determinable and not subject to refund or adjustment; and * collection of amounts due is reasonably assured.
Delivery occurs when goods are shipped and title and risk of loss transfer to the customer, in accordance with the terms specified in the arrangement with the customer. Revenue recognition is deferred in all instances where the earnings process is incomplete. We provide for sales returns and allowances in the same period as the related revenues are recognized. We base these estimates on our historical experience or the specific identification of an event necessitating a reserve. To the extent actual sales returns differ from our estimates; our future results of operations may be affected. Should changes in conditions cause management to determine that these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.
ACCOUNTS RECEIVABLE
We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer's current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. While our credit losses have historically been within our expectations and the allowance established, we may not continue to experience the same credit loss rates as we have in the past. Our accounts receivable are concentrated in a relatively few number of customers. Therefore, a significant change in the liquidity or financial position of any one customer could make it more difficult for us to collect our accounts receivable and require us to increase our allowance for doubtful accounts, which could have a material adverse impact on our consolidated financial position, results of operations and cash flows.
INVENTORIES
We seek to purchase and maintain raw materials at sufficient levels to meet lead times based on forecasted demand. If forecasted demand exceeds actual demand, we may need to provide an allowance for excess or obsolete quantities on hand. We also review our inventories for changes in the market prices of our products and provide reserves as deemed necessary. If actual market conditions are less favorable than those projected by management, additional inventory reserves may be required. We state our inventories at the lower of cost, using the first-in, first-out method on an average costs basis, or market.
We adopted SFAS No. 151, "Inventory Costs, an amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4" beginning January 1, 2006, with no material effect on our financial condition or results of operations. Abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) are recognized as current-period charges. Fixed production overhead is allocated to the costs of conversion into inventories based on the normal capacity of the production facilities. We utilize an expected normal level of production units, based on our plant capacity. To the extent we do not achieve a normal expected production levels, we charge such under-absorption of fixed overhead to operations.
We account for goodwill and acquired intangible assets in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets", whereby goodwill is not amortized, and is tested for impairment at the reporting unit level annually or when there are any indications of impairment. A reporting unit is an operating segment for which discrete financial information is available and is regularly reviewed by management. We have one reporting unit,.
SFAS No. 142 requires a two-step approach to test goodwill for impairment for each reporting unit. The first step tests for impairment by applying fair value-based tests to a reporting unit. The second step, if deemed necessary, measures the impairment by applying fair value-based tests to specific assets and liabilities within the reporting unit. Application of the goodwill impairment tests require judgment, including identification of reporting units, assignment of assets and liabilities to each reporting unit, assignment of goodwill to each reporting unit, and determination of the fair value of each reporting unit. The determination of fair value for a reporting unit could be materially affected by changes in these estimates and assumptions.
LONG-LIVED ASSETS
We continually monitor and review long-lived assets, including fixed assets, goodwill and intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. The determination of recoverability is based on an estimate of the cash flows expected to result from the use of an asset and its eventual disposition. The estimate of cash flows is based upon, among other things, certain assumptions about expected future operating performance, growth rates and other factors. If the sums of the cash flows are less than the carrying value, we recognize an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset.
We evaluated the Soil Medic intangible asset totaling $1,325,966 net, consisting of the slow release patent, undiscounted cash flows, and recently identified customers that we believe will sublicense our patent and pay us royalties of $1.50 per gallon on certain products. We estimate that sublicense fees will be generated in the middle of fiscal 2009 and continue through 2014, at which time the patent expires. The marketing plan will be further developed to include overseas opportunities as it is being expanded throughout the country.
We also evaluated the Smart World intangible assets, consisting of the formulas, trade secrets and goodwill, aggregating $696,319 net. We evaluated undiscounted cash flows for definite lived intangible assets and fair value related to goodwill. We believe that with the entrance into the retail market with a major retailer beginning in 2009, that no impairment of the Smart World intangible assets is required, as future expected cash flows should recover such assets. The retail market is designed to meet the needs of the consumer to be used in home gardens and lawns.
ACCOUNTING FOR INCOME TAXES
We account for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes". Under this method, we determine deferred tax assets and liabilities based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of most events recognized in the current year's financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenues, expenses, gains and losses, differences arise between the amount of taxable income and pre-tax financial income for a year and between the tax bases of assets or liabilities and their reported amounts in the financial statements. Because it is assumed that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or a liability and its reported amount on the consolidated balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or the reported amounts of the assets are recovered. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and unless we believe that recovery is more likely than not, we must establish a valuation allowance.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an interpretation of FASB Statement No. 109" ("FIN48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes". FIN 48 describes a recognition threshold and measurement attribute for the recognition and measurement of tax positions taken or expected to be taken in a tax return and 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. Therefore, FIN 48 was effective for us beginning July 1, 2007. The adoption of FIN 48 on July 1, 2007 did not have a material impact to our consolidated financial statements.
We have provided a full valuation allowance against our U.S federal and state deferred tax assets. If sufficient evidence of our ability to generate future U.S federal and/or state taxable income becomes apparent, we may be required to reduce our valuation allowance, resulting in income tax benefits in our statement of operations. We evaluate the realizability of our deferred tax assets and assess the need for a valuation allowance quarterly.
STOCK-BASED COMPENSATION
We account for stock-based compensation in accordance with SFAS No. 123R, "Share-Based Payment." SFAS 123R requires that we account for all stock-based compensation transactions using a fair-value method and recognize the fair value of each award as an expense, generally over the service period. The fair value of stock options is based upon the market price of our common stock at the grant date. We estimate the fair value of stock option awards, as of the grant date, using the Black-Scholes option-pricing model. The use of the Black-Scholes model requires that we make a number of estimates, including the expected option term, the expected volatility in the price of our common stock, the risk-free rate of interest and the dividend yield on our common stock. If our expected option term and stock-price volatility assumptions were different, the resulting determination of the fair value of stock option awards could be materially different and our results of operations could be materially impacted.
ACCOUNTING FOR NON-EMPLOYEE STOCK-BASED COMPENSATION
We measure compensation expense for its non-employee stock-based compensation under the Financial Accounting Standards Board (FASB) Emerging Issues Task Force (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 ". The fair value of the option issued or expected to be issued is used to measure the transaction, as this is more reliable than the fair value of the services received. The fair value is measured at the value of our common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty's performance is complete. In the case of the issuance of stock options, we determine the fair value using the Black-Scholes option pricing model. The fair value of the equity instrument is charged directly to stock-based compensation expense and credited to additional paid-in capital.
ACCOUNTING FOR CONVERSION FEATURES AND WARRANTS ISSUED WITH CONVERTIBLE DEBT
Our derivative financial instruments consisted of embedded derivatives related to the issuance of our $1.5 million convertible note payable to Ray Nielsen. These embedded derivatives included the conversion feature that was not considered conventional as defined in EITF 05-2, "The Meaning of Conventional Convertible Debt Instruments" in issue No. 00-19). The accounting treatment of derivative financial instruments require that we record the derivative at its fair value and record it at fair value as of each subsequent balance sheet date. Changes in fair value is recorded as non-operating, non-cash income or expense at each reporting date. The derivatives were valued using the Black-Scholes Option Pricing Model
On December 31, 1999, we purchased exclusive license rights to patented polymer application techniques. The licenses are being amortized using the straight line method over the life of the licenses, which is 14 1/2 years. The carrying value of these assets is periodically evaluated for impairment. The amortization expense was $103,833 and $35,133 and for the years ended September 30, 2008 and September 30, 2007, respectively.
On March 15, 2006, the Company acquired a patent and $300,000 of cash from Advanced Fertilizer Technologies, Inc. ("AFT") in exchange for 4,500,000 shares of Series B preferred stock with a stated value of $0.50 per share, or $2,250,000. The Company recorded an intangible asset of $1,950,000. AFT had no operations and owned the intellectual property, including patents on a slow release fertilizer used primarily in the turf segment of its business. The Company will collect royalty revenues from two existing licenses and will sell products derived from the patents directly to its customers including qualified distributors. The patent has approximately eight years left to expiration. Amortization expense of the patent rights was $252,565 and $182,813 and for the year ended September 30, 2008 and September 30, 2007, respectively. Our intangible asset were impaired because we experienced a problem in manufacturing our product and we did not have sufficient funds to properly market this asset subsequent to correcting the manufacturing problem.
We have capitalized approximately $380,199 less accumulated depreciation of $356,217 associated with the construction of a demonstration injection machine. We placed the machine in service in the fiscal year ended December 31, 2004. Management believes that although the capitalized costs exceed a value at which the unit could be sold, we will derive several years of benefits from the unit by using it in sales demonstrations and as a loaner unit.
We had constructed equipment with a carrying value of approximately $134,000. In February 2006, we entered into the sale-leaseback transaction. We recorded an impairment loss for the equipment in fiscal 2005 on the basis that it was evident that the carrying value at September 30, 2006 was impaired due to the valuation received as part of the sale-leaseback transaction. We received proceeds of $75,000 in February 2006. Since the equipment was written down to the present value of lease arrangement in 2005, there was no gain or loss recorded or deferred in connection with this transaction in 2006.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued Statement of SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 provides a common definition of fair value and establishes a framework to make the measurement of fair value in generally accepted accounting principles more consistent and comparable. SFAS 157 also requires expanded disclosures to provide information about the extent to which fair value is used to measure assets and liabilities, the methods and assumptions used to measure fair value, and the effect of fair value measures on earnings. SFAS 157 is effective for fiscal years beginning after November 15, 2007, although early adoption is permitted. We are currently assessing the potential effect; however, believe the adoption will not have a material impact to our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities -- Including an amendment of FASB Statement No. 115" ("SFAS 159"). SFAS 159 permits an entity to elect fair value as the initial and subsequent measurement attribute for many financial assets and liabilities. Entities electing the fair value option would be required to recognize changes in fair value in earnings. Entities electing the fair value option are required to distinguish, on the face of the statement of financial position, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The adjustment to reflect the difference between the fair value and the carrying amount would be accounted for as a cumulative-effect adjustment to retained earnings as of the date of initial adoption. We are currently evaluating the impact, if any, of SFAS 159 on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R) Business Combinations (SFAS 141(R)), which replaces FAS No. 141. SFAS No. 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is to be applied prospectively to business combinations.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160"). This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and for the deconsolidation of a subsidiary. Upon its adoption, effective for us in the fiscal year beginning July 1, 2009, noncontrolling interests will be classified as equity in the Company's balance sheet and income and comprehensive income attributed to the noncontrolling interest will be included in the Company's income and comprehensive income, respectively. The provisions of this standard must be applied prospectively upon adoption except for the presentation and disclosure requirements. We do not expect the adoption of SFAS 160 to have an impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133". SFAS 161 amends and expands the disclosure requirements of SFAS 133 for derivative instruments and hedging activities. SFAS 161 requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. We do not expect the adoption of SFAS 161 to have a significant impact on our consolidated financial statements.
In April 2008, The FASB issued FASB Staff Position FSP No. 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP 142-3"). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. FSP 142-3 is effective for us in the fiscal year beginning July 1, 2009. We are currently evaluating the impact of the adoption of FSP 142-3 on our consolidated financial statements.
In May 2008, the FASB issued SFAS 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the GAAP hierarchy). SFAS will become effective 60 days following the Security and Exchange Commission's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles". We do not expect the adoption of SFAS 162 to have a significant impact on our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT FINANCIAL RISKS
Not Applicable
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required to be filed pursuant to this Item 8 begin on page of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
ITEM 9A
ITEM 9A CONTROLS AND PROCEDURES
Our President and Chief Financial Officer (the "Certifying Officers") is responsible for establishing and maintaining our disclosure controls and procedures. The Certifying Officer have designed such disclosure controls and procedures to ensure that material information is made known tohim, particularly during the period in which this report was prepared. The Certifying Officer has evaluated the effectiveness of our disclosure controls and procedures and has determined that our projections and impairment analysis need to be improved. We have hired a financial expert to assist us in improving our disclosure controls and procedures. We believe that the changes to be implemented will enable the Company to improve its timely reporting of the rquired impairment analysis.
ITEM 9A(T). CONTROLS AND PROCEDURES
Not Applicable
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS
Our directors and executive officers are as follows:
Name Age Position - ---- --- -------- Carl P. Ranno 68 Director, Chief Executive Officer, President, Chief Financial Officer
Neil C. Kitchen 60 Director, Vice President
Diana Visco 49 Secretary
Scott Baker 50 Director
Johnny Dickinson 67 Vice President - Marketing
Donette Lamson 43 Vice President - Turf and Horticulture
MR. CARL P. RANNO, DIRECTOR, CHIEF EXECUTIVE OFFICER, PRESIDENT, CHIEF FINANCIAL OFFICER, received a degree in Economics from Xavier University in Cincinnati, Ohio and his Juris Doctor from the University of Detroit School of Law. Mr. Ranno became a Director in September 2001 and Chief Executive Officer and President in May 2002. For the five years prior to becoming the President/CEO of the Company, he has acted as an advisor in strategic planning, mergers and acquisitions and as a securities attorney to numerous public companies. He has served as president and CEO of public and private companies. He is also a member of the board of directors of Central Utilities Production Company.
MR. NEIL C. KITCHEN, DIRECTOR, VICE PRESIDENT, has over 20 years experience in business management in the environmental sector including management of companies involved in general engineering, toxicology, and environmental cleanup. Prior to joining us in 1994, he was Vice President of a publicly-held environmental cleanup company. He holds a B.S. in Business Management from San Diego State University and a class "A" General Engineering license with Hazardous Material Certification from the State of California.
MS. DIANA VISCO, SECRETARY, Diana Visco, Secretary, has worked with us since January 1999. Prior to that, she worked for 21 years with the Americana Leadership College, Inc., traveling to all of its offices and conferences across the USA and Caribbean in addition to Australia, New Zealand, Canada and Europe. Ms Visco spent several years as a traveling administrator and as International Administrator handling all aspects of finance, administration as well as marketing and promotion in addition to being assistant to the President of that company. She is the daughter of Mr. Louie Visco, a former director who passed away on January 3, 2008
MR. SCOTT BAKER, DIRECTOR, has practiced law in Arizona for the past 19 years. He graduated from the University of Arizona with a B.S. in business in 1978 and obtained his J.D. from the University of Arizona in 1981. As a general practitioner, he has appeared before the U.S. District Tax Court and the U.S. District Court.
MR. JOHNNY DICKINSON, VICE PRESIDENT MARKETING, prior to joining us, Mr. Dickinson served for more than 30 years at John Deere, most recently as Division Manager of Worldwide Marketing for the past ten years. He received his B.A. degree in Finance and Marketing from Eastern New Mexico University.
Ms. DONETTE LAMSON, VICE PRESIDENT TURF and HORTICULTURE obtained her Bachelor of Science Degree in Horticulture with a Business Management Concentration from Colorado State University (C.S.U.). She has been a Horticulture Extension Agent and served as a manger of one of the nations largest Certified Master Gardener Programs. Additionally, Ms. Lamson has over 20 years of regional, national and international turf, horticulture and landscape products manufacturing, distribution and sales experience with Lesco, Helena, SAJ Turf Products (currently United Horticultural Supply) and Golf Enviro Systems.
Directors serve until the next annual meeting or until their successors are qualified and elected. Officers serve at the discretion of the Board of Directors.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and certain officers, as well as persons who own more than 10% of a registered class of our equity securities, ("Reporting Persons") to file reports of ownership and changes in ownership on Forms 3, 4 and 5 with the Securities and Exchange Commission.
Based solely upon a review of the copies of such forms, we believe that all Reporting Persons have complied on a timely basis with all filing requirements applicable to them, except that Louie Visco filed one late report on Form 4 disclosing his conversion of debt to equity.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
Set forth below is a summary of compensation for our principal executive officer and our two most highly compensated officers other than our principal executive officer (collectively, the "named executive officers") for our last two fiscal years. There have been no annuity, pension or retirement benefits ever paid to our officers, directors or employees.
With the exception of reimbursement of expenses incurred by our named executive officers during the scope of their employment and unless expressly stated otherwise in a footnote below, none of the named executive officers received other compensation, perquisites and/or personal benefits in excess of $10,000.
- ---------- 1. Joined us in January 2006.
GRANTS OF PLAN-BASED AWARDS
We did not grant any plan-based awards during this fiscal year ended September 30, 2008:
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table sets forth information for the named executive officers regarding the number of shares and underlying shares both exercisable and unexercisable stock options, as well as the exercise prices and expiration dates thereof, as of September 30, 2008.
EMPLOYMENT AGREEMENTS
We have an employment agreement Carl P. Ranno as our Chief Executive Officer and President. The Agreement is for a term of five years, commencing on May 23, 2008 and expiring on May 22, 2013 with automatic one-year extensions unless either the Company or Mr. Ranno provides written notice of their intention not to renew the Agreement at least 30 days prior to the expiration of the then current term. The Agreement provides that, in addition to receiving paid vacation in accordance with the Company's policies as well as other customary benefits and provisions, Mr. Ranno shall receive an annual base salary of $200,000. If, at
any time during the term of the Agreement, Mr. Ranno is terminated "without cause," he will be entitled to receive a cash payment equal to the aggregate compensation payable to Mr. Ranno during the remaining term of the Agreement. This Agreement has not been implemented.
On May 23, 2008 the Company entered into an Employment Agreement with Neil C. Kitchen to act as the Company's Vice President and Chief Technical Officer (the "Agreement").
The Agreement is for a term of five years, commencing on May 23, 2008 and expiring on May 22, 2013 with automatic one-year extensions unless either the Company or Mr. Kitchen provides written notice of their intention not to renew the Agreement at least 30 days prior to the expiration of the then current term. The Agreement provides that, in addition to receiving paid vacation in accordance with the Company's policies as well as other customary benefits and provisions, Mr. Kitchen shall receive an annual base salary of $130,000. If, at any time during the term of the Agreement, Mr. Kitchen is terminated "without cause," he will be entitled to receive a cash payment equal to the aggregate compensation payable to Mr. Kitchen during the remaining term of the Agreement. This Agreement has not been implemented.
On May 23, 2008, and effective the same date, the Company entered into an Employment Agreement with Diana Visco to act as the Company's Secretary and Administrative Assistant to the President (the "Agreement").
The Agreement is for a term of five years, commencing on May 23, 2008 and expiring on May 22, 2013 with automatic one-year extensions unless either the Company or Ms. Visco provides written notice of their intention not to renew the Agreement at least 30 days prior to the expiration of the then current term. The Agreement provides that, in addition to receiving paid vacation in accordance with the Company's policies as well as other customary benefits and provisions, Ms. Visco shall receive an annual base salary of $85,000. If, at any time during the term of the Agreement, Ms. Visco is terminated "without cause," she will be entitled to receive a cash payment equal to the aggregate compensation payable to Ms. Visco during the remaining term of the Agreement. This Agreement has not been implemented.
We have an employment agreement Donette Lamson as our Vice President in charge of the Turf, Horticulture and Landscape Division. The agreement has a term of three years from January 2006. Per the terms of the agreement, Ms. Lamson is to receive a salary of $75,000 per year, bonus compensation based upon sales in her division, and standard employee benefits. If we terminate Ms. Lamson without cause, we shall continue to pay her salary and all other benefits for the remainder of the term of the agreement.
2002 STOCK OPTION PLAN
Our shareholders adopted a Stock Option Plan on November 8, 2002 (the "2002 Plan"). Under the 2002 Plan, 2,000,000 shares of common stock have been authorized for issuance as Incentive Stock Options or Nonstatutory Stock Options. Under the 2002 Plan, options may be granted to our key employees, officers, directors or consultants. The purchase price of the common stock subject to each Incentive Stock Option shall not be less than the fair market value (as determined in the 2002 Plan), or in the case of the grant of an
Incentive Stock Option to a principal stockholder, not less that 110% of fair market value of such common stock at the time such option is granted. The purchase price of the common stock subject to each Nonstatutory Stock Option shall be determined at the time such option is granted, but in no case less than 100% of the fair market value of such shares of common stock at the time such option is granted.
The 2002 Plan shall terminate ten years from the date of its adoption by our shareholders, and no option shall be granted after termination of the 2002 Plan. Subject to certain restrictions, the 2002 Plan may at any time be terminated and from time to time be modified or amended by the affirmative vote of the holders of a majority of the outstanding shares of our capital stock present, or represented, and entitled to vote at a meeting duly held in accordance with the applicable laws of the State of Nevada.
As of the date hereof, 1,310,000 options have been issued pursuant to the 2002 Plan.
2005 STOCK OPTION/STOCK ISSUANCE PLAN
GENERAL
On January 31, 2005, our Board of Directors adopted our 2005 Stock Option/Stock Issuance Plan (the "2005 Plan") and directed that it be presented to the stockholders for their approval and adoption.
The 2005 Plan provides for the issuance of up to 10,000,000 shares of common stock to our directors, officers, employees and consultants in the form of stock options and shares of common stock.
Our Board of Directors will initially administer the 2005 Plan, except that the Board may, at its discretion, establish a committee comprised of two or more members of the Board or two or more other persons to administer the 2005 Plan (the "Plan Administrator").
The 2005 Plan has two separate components: the option grant program and the stock issuance program. To date, 498,240 shares of common stock have been issued pursuant to the 2005 Plan.
OPTION GRANT PROGRAM
Incentive stock options (those stock options that qualify under Section 422 of the Internal Revenue Code of 1986 ("the "Code")) may be granted to any individual who is, at the time of the grant, our employee. Non-qualified stock options (those options that do not qualify under Section 422 of the Code) may be granted to employees and other people, including our directors and officers.
Grants under the option grant program may be structured as installment options which become exercisable for vested shares over the optionee's period of service or as immediately exercisable options for unvested shares which will be subject to repurchase by us, at the option exercise price paid per share, upon the optionee's termination of service prior to vesting in those shares. All option grants must have an exercise price not less than 100% of the fair market value of the option shares on the grant date.
Each option is to have a maximum term of ten years, subject to earlier termination in the event the optionee leaves our service. The optionee will have up to a three month period following termination of service (for reasons other than death or disability) in which to exercise the option. This period will be extended to 12 months if the optionee's service terminates by reason of disability, and in the event of the optionee's death, the personal representative of the optionee's estate (or the person inheriting the option) will have up to a 12 month period following the optionee's death in which to exercise the option.
To exercise the option, the optionee must execute a stock purchase agreement and pay the exercise price for the purchased shares. Payment is to be made in cash; however, the Plan Administrator may also permit the optionee to deliver a full-recourse interest-bearing promissory note for the purchased shares payable in one or more installments. Provided that our shares remain publicly traded, the exercise price may be paid in shares of common stock or, alternatively, through the optionee's participation in a same-day sale program. Under such program, the option shares are sold immediately following the exercise of the option, and a portion of the sale proceeds is applied to the payment of the exercise price and all applicable withholding taxes.
In the event we are acquired by merger or asset sale, the option shares will immediately vest, and the option may be exercised for any or all of those vested shares prior to the effective date of such acquisition. However, such accelerated vesting will not occur if our repurchase rights with respect to the unvested option shares are assigned to the acquiring entity. The Plan Administrator will have the discretion to structure one or more option grants under the Plan so that the shares subject to those options will immediately vest in the event the optionee's service is involuntarily terminated within 18 months following an acquisition in which our repurchase rights are so assigned, and the optionee would then have a one-year period to exercise the accelerated options for fully-vested shares. It is anticipated that this special vesting acceleration provision would be made available only on a limited case-by-case basis.
The stock purchase agreement will provide us with the right to repurchase, at the original exercise price paid per share, any unvested shares held by the optionee at the time of his or her termination of service. The applicable vesting schedule will be set forth in the Notice of Grant. Full and immediate vesting of all the option shares will occur upon an acquisition by merger or asset sale, unless the repurchase right applicable to those shares is assigned to the successor company. One or more repurchase rights outstanding under the Plan may be structured so that those rights will subsequently lapse (and the option shares will immediately vest) upon an involuntary termination of the optionee's service within 18 months following the effective date of an acquisition in which the repurchase rights are assigned to the successor company.
STOCK ISSUANCE PROGRAM
Shares of common stock may be issued to employees and other people, including our directors and officers.
The stock issuance program allows eligible persons to purchase shares of common stock at fair market value or at a discount of up to 15% of fair market value. The shares may be fully vested when issued or may vest over time as the recipient provides services or as specified performance objectives are attained. In addition, shares of common stock may be issued as bonus awards in recognition of services rendered, without any cash outlay required of the recipient.
The stock issuance component is structured as a stock purchase transaction, with the purchase price for the shares to be paid in cash or by promissory note at the time of issuance of the shares. The same repurchase rights summarized above for the "Stock Purchase Agreement" under the option grant program will apply to the purchased shares, namely, our right to repurchase, at the original purchase price, any unvested shares held by the participant at the time of his or her termination of service.
It is anticipated that any issued shares will vest either immediately or in a series of installments over the participant's period of service. Full and immediate vesting of all the shares will occur upon an acquisition by merger or asset sale, unless the repurchase right applicable to those shares is assigned to the successor company. The assigned repurchase rights may be structured so that they will subsequently lapse (and the shares will immediately vest) upon an involuntary termination of the participant's service within 18 months following the effective date of the acquisition.
COMPENSATION OF DIRECTORS
Our Directors do not receive any cash compensation, but are entitled to reimbursement of their reasonable expenses incurred in attending directors' meetings.
We do not have any audit, nominating, compensation or other committee of our Board of Directors.
Scott Baker is our only independent director.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth certain information regarding our shares of outstanding common stock beneficially owned as of the date hereof by (i) each of our directors and executive officers, (ii) all directors and executive officers as a group, and (iii) each other person who is known by us to own beneficially more than 5% of our common stock based upon 60,965,590issued shares of common stock.
- ---------- * Less than 1%. 1. C/o our address, 12224 Montague Street Pacoima, CA 91331, unless otherwise noted. 2. Except as otherwise indicated, we believe that the beneficial owners of common stock listed above, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable, or exercisable within 60 days, are deemed outstanding for purposes of computing the percentage of the person holding such options or warrants, but are not deemed outstanding for purposes of computing the percentage of any other person. 3. Includes options to purchase 150,000 shares of common stock at an exercise price of $0.50 expiring June 30, 2012. 4. Includes options to purchase 150,000 shares of common stock at an exercise price of $0.50 expiring June 30, 2012. 5. Includes options to purchase 150,000 shares of common stock at an exercise price of $0.50 expiring June 30, 2012. 6. Includes options to purchase 252,000 shares of common stock at an exercise price of $0.50 expiring June 30, 2012. 7. The Visco family which includes the Secretary of the Company Diana Visco owns the controlling shares of FLD. 8. The Visco family which includes the Secretary of the Company Diana Visco owns the controlling shares of Benz Group.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Visco Family is an owner and director of FLD Corporation, which holds a warrant exercisable for 334,000 shares of common stock expiring on October 15, 2009 and 17,907,003 shares of common stock.
The Visco Family is an owner and director of Benz Group, the holder of 2,819,061 shares of common stock.
On April 1, 2004, we entered into a Sublease Agreement to sublet 923.50 square feet located at a facility in Pacoima, California. The majority shareholder of the sublessor is a related party to us. All of our operations are conducted from this facility, which requires monthly rental payments of approximately $554. The Sublease Agreement has been continued beyond December 31, 2008.
ITEM 14.
ITEM 14. EXHIBITS
3.1 Articles of Incorporation of New Directions Manufacturing, Inc., a Nevada corporation, dated January 9, 1997 (1) 3.2 Amendment to Articles of Incorporation of New Directions Manufacturing, Inc., a Nevada corporation, dated May 29, 1997 (1) 3.3 Amendment to Articles of Incorporation of New Directions Manufacturing, Inc., dated January 4, 2000 (2) 3.4 Amendment to Articles of Incorporation of American Soil Technologies, Inc., dated August 4, 2003 (3) 3.4 Bylaws of New Directions Manufacturing, Inc., dated May 29, 1997 (1) 3.5 Amended and Restated Bylaws of New Directions Manufacturing, Inc., dated July 20, 1998 (4) 3.6 Amendment to Articles of Incorporation, dated November 30, 2006 4.1 Convertible Debenture - Lump Sum Contribution (Form) (5) 4.2 Convertible Debenture - Incremental (Form) (5) 10.1 License Agreement between Ron Salestrom, American Soil Technologies, Inc., and Polymers Plus, L.L.C., dated January 4, 2000 (2) 10.2 Sublease Agreement with The Customized Box Company, dated April 1, 20046 10.8 Employment Contract with Donette Lamson, dated January 18, 2006 (7) 10.12 Acquisition Agreement for Smart World Organics, dated July 7, 2006 (8) 10.14 Intellectual Property Purchase Agreement with Ray Nielsen, dated December 20, 2006 (9)
- ---------- 1. Incorporated by reference from our Registration Statement on Form SB-2, filed on July 2, 1997, as amended (Registration No. 333-30583). 2. Incorporated by reference from our Form 10-KSB for the fiscal year ended June 30, 2000, filed on September 27, 2000 (File No. 000-22855). 3. Incorporated by reference from our Form 10-KSB for the fiscal year ended December 31, 2005, filed on April 3, 2006. 4. Incorporated by reference from our Form 10-KSB for the fiscal year ended June 30, 1998, filed on September 16, 1998. 5. Incorporated by reference from our Form 10-QSB for the quarterly period ended March 31, 2000, filed on May 15, 2000. 6. Incorporated by reference from our Form 10-QSB for the quarterly period ended March 31, 2004, filed on May 5, 2004. 7. Incorporated by reference from our Form 10-QSB for the quarterly period ended March 31, 2006, filed on May 17, 2006. 8. Incorporated by reference from our Form 10-QSB for the quarterly period ended June 30, 2006, filed on August 14, 2006. 9. Incorporated by reference from our Form 10-KSB for the fiscal year ended December 31, 2006, filed on April 18, 2007. 10. Incorporated by reference from our Form 10-KSB for the fiscal year ended December 31, 2006, filed on April 18, 2007. 11. Incorporated by reference from our Form 10-KSB for the fiscal year ended December 31, 2006, filed on April 18, 2007. 12. Incorporated by reference from our Form 10-KSB for the transition period ended September 30, 2007, filed on February 15, 2008.
10.15 Security Agreement with Ray Nielsen, dated December 22, 2006 (9) 10.16 Purchase and Sale Agreement and Joint Escrow Instructions for Silver Terrace Nurseries, dated November 27, 2007 (12) 10.17 Employment Contract with Carl Ranno, dated May 23, 2008 10.18 Employment Contract with Neil Kitchen, dated May 23, 2008 10.19 Employment Contract with Diana Visco, dated May 23, 2008 21 Subsidiaries: Smart World Organics Inc. a Florida corporation 31.1 Certification of Chief Executive Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002
ITEM 15.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES
MCKENNON, WILSON & MORGAN, LLP ("MCKENNON")
McKennon was our independent auditor and examined our financial statements for the fiscal years ending September 30, 2008 and September 30, 2007. McKennon performed the services listed below and was paid the fees listed below for the fiscal years ended September 30, 2008.
AUDIT FEES
McKennon was paid aggregate fees of approximately $182,532 during the fiscal year ended September 30, 2008 for professional services rendered for the audits of our annual financial statements for the periods ended September 30, 2008 and 2007 and for the reviews of the financial statements included in our quarterly reports on Form 10-QSB included these two periods.
AUDIT RELATED FEES
McKennon was not paid additional fees for either of the fiscal years ended September 30, 2008 or September 30, 2007 for assurance and related services reasonably related to the performance of the audit or review of our financial statements.
TAX FEES
McKennon was paid aggregate fees of approximately $7,232 for the fiscal year ended September 30, 2008 and or professional services rendered for tax compliance, tax advice and tax planning during this fiscal year.
ALL OTHER FEES
McKennon was not paid any other fees for professional services during the fiscal years ended September 30, 2008 and September 30, 2007.
AUDIT COMMITTEE
We do not have an audit committee.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, duly authorized.
AMERICAN SOIL TECHNOLOGIES, INC.
DATED: January 12, 2009 By: /s/ Carl P. Ranno ------------------------------------------------- Carl P. Ranno Director, Chief Executive Officer, President, and Chief Financial Officer (Principal Executive Officer, Principal Financial Officer and Principal Accounting Officer)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Shareholders and Board of Directors American Soil Technologies, Inc.
We have audited the accompanying consolidated balance sheets of American Soil Technologies, Inc. and subsidiary (the "Company") as of September 30, 2008 and 2007, and the related consolidated statements of operations, stockholders' deficit and cash flows for the year ended September 30, 2008, and the nine-month period ended September 30, 2007. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Soil Technologies, Inc. and subsidiary as of September 30, 2008 and 2007, and the results of their operations and their cash flows for the year ended September 30, 2008, and the nine-month period ended September 30, 2007, in conformity with accounting principles generally accepted in the United States.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 2 of the consolidated financial statements, the Company has incurred losses in recent history, and has significant working capital and accumulated deficits. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans with respect to these matters are also discussed in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ McKennon, Wilson & Morgan LLP - ---------------------------------------- Irvine, California January 13, 2009
American Soil Technologies, Inc. Consolidated Balance Sheets
See Notes to Consolidated Financial Statements.
American Soil Technologies, Inc. Consolidated Statements of Operations
See Notes to Consolidated Financial Statements.
American Soil Technologies, Inc. Consolidated Statements of Stockholders' Deficit
See Notes to Consolidated Financial Statements.
American Soil Technologies, Inc. Consolidated Statements of Cash Flows
See Notes to Consolidated Financial Statements.
American Soil Technologies, Inc. Notes to Consolidated Financial Statements
1. ORGANIZATION AND BASIS OF PRESENTATION
ORGANIZATION American Soil Technologies, Inc. (the "Company"), formerly Soil Wash Technologies, Inc., was incorporated in the state of California on September 22, 1993. On November 24, 1999, the Company entered into an exchange agreement for the reverse acquisition of New Directions Manufacturing, Inc., a publicly traded Nevada corporation incorporated on January 9, 1997 ("New Directions"), wherein New Directions would acquire the assets of the Company and change its name to American Soil Technologies, Inc. This exchange agreement was effective as of the close of business on December 31, 1999.
The Company is primarily engaged in the marketing of polymer and other soil amendments to the agricultural turf and horticulture industries. The Company's products are used to decrease water usage, increase nutrient retention in soil, enhance seed germination and sprout emergence, clarify ponds and increase the effectiveness of chemical fertilizers and biological additives. In 2006, the Company acquired the patent to a slow release fertilizer. The Company also has exclusive license rights to the use of patented polymer application techniques, as well as numerous patents on a unique machine designed to inject polymer and other liquid products into existing turf and some crops.
The Company also expanded to provide next-generation and sustainable fertilizers thru the acquisition of Smart World Organics, Inc. ("Smart World") on December 20, 2006. Simultaneously, the Company entered into an Intellectual Property Purchase Agreement with the founder of Smart World, Ray Nielsen ("Nielsen") that included certain formulas originally believed to be proprietary and intellectual properties used in the business of Smart World. The formulas acquired from Nielsen were deemed not to be proprietary and subsequently deemed to have little or no value (see Note 3). Smart World sells homogenized fertilizers, non-toxic insect controls, plant protectants, seed, and soil and silage inoculants. Smart World also provides advanced, custom-formulated products built to suit unusual growing conditions and environments. Due to losses incurred in 2008, management terminated Smart World employees and seeks to operate through commission-based sales representatives. Additionally, the Company has several debt obligations that are past the contractual maturity date or are due and payable due to non payment of interest
GOING CONCERN AND MANAGEMENT'S PLANS The Company has sustained significant losses and has an accumulated deficit of $(22,984,490) and negative working capital of $(4,183,192) as of September 30, 2008. The ability of the Company to continue as a going concern is dependent upon obtaining additional capital and financing, and generating positive cash flows from operations. The Company intends to seek additional capital either through debt or equity offerings and is attempting to increase sales volume and operating margins to achieve profitability. Due to the current economic environment and the Company's current financial condition, management cannot be assured there will be adequate capital available when needed and on acceptable terms. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CHANGE OF FISCAL YEAR END The Company has changed its fiscal year end from December 31 to September 30 effective for the period ended September 30, 2007. As a result, the accompanying consolidated statements of operations, shareholders' deficit and of cash flows for this period includes operating results for the nine month period ended September 30, 2007 as compared to a twelve-month period ended September 30, 2008.
USE OF ESTIMATES The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The Company's significant estimates made in connection with the preparation of the accompanying financial statements include the valuation of inventories, impairment of goodwill, carrying value of the intangible assets, valuation of stock options and warrants to purchase common stock and the valuation of the derivative liability.
Estimates are periodically reviewed in light of changes in circumstances, facts and experience. The effects of material revisions in estimates are reflected in the consolidated financial statements prospectively from the date of the change in estimate in accordance with Statement of Financial Accounting Standards ("SFAS") No. 154, "Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3".
During the fourth quarter of fiscal 2007, the Company changed the amortization period for the American Fertilizer Technology, Inc. ("AFT") and Smart World intangible assets for patents and formulas from 15 years to a range of three to seven years depending on the underlying intangible asset. Management's change in these estimates resulted from refining the underlying formulas and reassesment of the remaining period of future economic benefit.
CASH AND CASH EQUIVALENTS Cash and cash equivalents includes all short-term highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less.
ACCOUNTS AND NOTES RECEIVABLE The Company utilizes the allowance method to provide a reserve for uncollectible accounts. The Company determines any required allowance by considering a number of factors including length of time trade accounts receivable are past due and the Company's previous loss history. The Company records a reserve account for accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.
The Company performs ongoing credit evaluations and continually monitors its collection of amounts due from its customers. The Company adjusts credit limits and payment terms granted to its customers based upon payment history and the customer's current creditworthiness. The Company does not require collateral from its customers to secure amounts due from them. Reserves for uncollectible amounts are provided based on past experience and a specific analysis of the accounts which management believes is sufficient.
INVENTORIES Inventories consist primarily of purchased polymer soil amendments. Inventories are stated at the lower of cost (on a first-in, first-out basis) or market.
PROPERTY AND EQUIPMENT Property and equipment is stated at cost less accumulated depreciation. Depreciation is recorded on a straight-line basis over the estimated useful lives of the assets ranging from three to 15 years. Betterments, renewals and extraordinary repairs that extend the lives of the assets are capitalized. Repairs and maintenance costs are expensed as incurred. The cost and related accumulated depreciation applicable to assets disposed or retired are removed from the accounts, and the gain or loss on disposition is recognized in the respective period.
LONG-LIVED ASSETS The Company reviews its fixed assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted operating cash flow expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
GOODWILL AND INTANGIBLE ASSETS WITH INDEFINITE LIVES SFAS No. 141 "Business Combinations", requires that all business combinations be accounted for under the purchase method. The statement further requires separate recognition of intangible assets that meet certain criteria. SFAS No. 142, requires that an acquired intangible asset meeting certain criteria shall be initially recognized, and measured based on its fair value. The statement also provides that goodwill and other indefinite-lived assets should not be amortized, but shall be tested for impairment annually or more frequently, if circumstances indicate potential impairment, through a comparison of fair value to their carrying amount.
In accordance with SFAS No. 142 "Goodwill and Intangible Assets", the goodwill impairment test has two steps. The first step of the impairment test identifies potential impairment by comparing the fair value with the carrying amount of the reporting unit, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the second step of the impairment test shall be performed to measure the amount of the impairment loss, if any. Intangibles with indefinite useful lives are measured for impairment by the amount that the carrying value exceeds the estimated fair value of the intangible. The fair value is calculated using the income approach. Intangible assets with definite useful lives will continue to be amortized over their estimated useful lives. Any impairment is recorded at the date of determination.
ACCOUNTING FOR CONVERTIBLE DEBT Convertible debt is accounted for under the guidelines established by Accounting Principles Board ("APB") Opinion No. 14 "Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants" under the direction of Emerging Issues Task Force 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios", ("EITF 98-5") EITF 00-27 "Application of Issue No 98-5 to Certain Convertible Instruments" ("EITF 00-27"), and EITF 05-8 "Income Tax Consequences of Issuing Convertible Debt with Beneficial Conversion Features". The Company records a beneficial conversion feature ("BCF") related to the issuance of convertible debt that have conversion features at fixed or adjustable rates that are in-the-money when issued and records the fair value of warrants issued with those instruments. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds to warrants and as a reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the conversion features, both of which are credited to paid-in-capital. The Company calculates the fair value of warrants issued with the convertible instruments using the Black-Scholes valuation method, using the same assumptions used for valuing employee options for purposes of SFAS No. 123R "Share Based Payments", except that the contractual life of the warrant is used. Under these guidelines, the Company allocates the value of the proceeds received from a convertible debt transaction between the conversion feature and any other detachable instruments (such as warrants) on a relative fair value basis. The allocated fair value is recorded as a debt discount or premium and is amortized over the expected term of the convertible debt to interest expense.
DERIVATIVE FINANCIAL INSTRUMENTS Derivative financial instruments, as defined in SFAS No. 133, "Accounting for Derivative Instruments", consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.
The Company does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, the Company has issued financial instruments including convertible dent that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. As required by SFAS No. 133, in certain instances, these instruments are required to be carried as derivative liabilities, at fair value, in the Company's consolidated financial statements.
The Company estimates the fair values of its derivative financial instrument using the Black-Scholes option valuation technique because it embodies all of the requisite assumptions (including trading volatility, estimated terms and risk free rates) necessary to fair value these instruments. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the trading market price of our common stock, which has a high-historical volatility. Since derivative financial instruments are initially and subsequently carried at fair values, the Company's operating results reflect the volatility in these estimate and assumption changes in each reporting period.
INTELLECTUAL PROPERTY Intellectual property includes the exclusive licenses to the patented polymer application techniques and certain acquired intellectual property which are being amortized using the straight-line method over the respective estimated useful lives.
ADVERTISING The Company expenses advertising costs as incurred. Advertising expense was $17,952 and $78,475, for year ended September 30, 2008 and the nine-month period ended September 30, 2007, respectively.
REVENUE RECOGNITION Revenue is recognized in accordance with Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements", as revised by SAB No. 104. The Company recognizes revenue when products are shipped to a customer and the risks and rewards of ownership have passed based on the terms of the sale.
SHIPPING AND HANDLING COST Shipping and handling fees charged to customers are included in net sales in accordance with EITF 00-10, "Accounting for Shipping and Handling Fees and Costs." The shipping and handling costs incurred by the Company are included in cost of sales.
INCOME TAXES Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded when recovery is doubtful.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-- an interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes". FIN 48 describes a recognition threshold and measurement attribute for the recognition and measurement of tax positions taken or expected to be taken in a tax return and 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 cumulative effect of adopting FIN 48 is required to be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity) for that fiscal year, presented separately. The adoption of FIN 48 on July 1, 2007 did not have a material impact to the Company's consolidated financial statements.
FAIR VALUE OF FINANCIAL INSTRUMENTS Financial instruments are recorded on the consolidated balance sheets. The carrying amount for cash and cash equivalents, accounts receivable, accounts payable, accrued expenses approximates fair value due to the immediate or short-term maturity of these financial instruments. The fair value of long-term debt approximates the carrying amounts based upon our expected borrowing rate for debt with similar remaining maturities and comparable risk. The fair value of notes payable to related parties cannot readily be determined.
RESEARCH AND DEVELOPMENT EXPENSES The Company expenses research and development costs as incurred.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
CONCENTRATION OF CREDIT RISK Accounts receivable from individual customers representing 10% or more of the net accounts receivable balance consists of the following as of September 30:
2008 2007 ---- ---- Percent of accounts receivable 69% 81% Number of customers 4 6
Sales from individual customers representing 10% or more of sales consist of the following customers for the years ended September 30:
2008 2007 ---- ---- Percent of sales 10% 15% Number of customers 1 2
As a result of the Company's concentration of its customer base, the loss or cancellation of business from, or significant changes in scheduled deliveries of product sold to the above customers or a change in their financial position could materially and adversely affect the Company's consolidated financial position, results of operations and cash flows.
LONG-LIVED ASSETS The Company reviews its fixed assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted operating cash flow expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
STOCK-BASED COMPENSATION Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R requires that the Company account for all stock-based compensation using a fair-value method and recognize the fair value of each award as an expense over the service period.
ACCOUNTING FOR STOCK OPTIONS ISSUED TO CONSULTANTS The Company measures compensation expense for its non-employee stock-based compensation under EITF No. 96-18 "Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services". The fair value of the option issued or committed to be issued is used to measure the transaction, as this is more reliable than the fair value of the services received. The fair value is measured at the value of the Company's common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty's performance is complete. The fair value of the equity instrument is charged directly to stock-based compensation expense and credited to additional paid-in capital.
NET LOSS PER SHARE Basic loss per share is calculated by dividing net loss by the weighted average common shares outstanding during the period. Diluted net loss per share reflects the potential dilution to basic EPS that could occur upon conversion or exercise of securities, options or other such items to common shares using the treasury stock method, based upon the weighted average fair value of our common shares during the period. For each period presented, basic and diluted loss per share amounts are identical as the effect of potential common shares is antidilutive.
The following is a summary of outstanding securities which have been excluded from the calculation of diluted net loss per share because the effect would have been antidilutive for the following periods:
2008 2007 ---------- ---------- Convertible debt 50,000,000 9,466,668 Series A convertible preferred stock 2,763,699 2,763,699 ---------- ---------- 52,763,699 12,230,367 ========== ==========
RECENT ACCOUNTING PRONOUNCEMENTS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 provides a common definition of fair value and establishes a framework to make the measurement of fair value in generally accepted accounting principles more consistent and comparable. SFAS No. 157 also requires expanded disclosures to provide information about the extent to which fair value is used to measure assets and liabilities, the methods and assumptions used to measure fair value, and the effect of fair value measures on earnings. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, although early adoption is permitted. The Company is currently assessing the potential effect, if any, of SFAS No. 157 on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities -- Including an amendment of FASB Statement No. 115 ("SFAS No. 159")". SFAS No. 159 permits an entity to elect fair value as the initial and subsequent measurement attribute for many financial assets and liabilities. Entities electing the fair value option would be required to recognize changes in fair value in earnings. Entities electing the fair value option are required to distinguish, on the face of the statement of financial position, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The adjustment to reflect the difference between the fair value and the carrying amount would be accounted for as a
cumulative-effect adjustment to retained earnings as of the date of initial adoption. The Company is currently evaluating the impact, if any, of SFAS No. 159 on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations", which replaces SFAS No. 141. SFAS No. 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is to be applied prospectively to business combinations.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51". This statement amends Accounting Research Bulletin No. 51 to establish accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and for the deconsolidation of a subsidiary. Upon its adoption, effective for us in the fiscal year beginning July 1, 2009, noncontrolling interests will be classified as equity in the Company's balance sheet and income and comprehensive income attributed to the noncontrolling interest will be included in the Company's income and comprehensive income, respectively. The provisions of this standard must be applied prospectively upon adoption except for the presentation and disclosure requirements. We do not expect the adoption of SFAS No. 160 to have an impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133". SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 for derivative instruments and hedging activities. SFAS No. 161 requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. We do not expect the adoption of SFAS No. 161 to have a significant impact on our consolidated financial statements.
In April 2008, the FASB issued FASB Staff Position FSP No. 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP 142-3"). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142. FSP 142-3 is effective for us in the fiscal year beginning September 30, 2009. We are currently evaluating the impact of the adoption of FSP 142-3 on our consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles". SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the GAAP hierarchy). SFAS will become effective 60 days following the Security and Exchange Commission's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles". We do not expect the adoption of SFAS No. 162 to have a significant impact on our consolidated financial statements.
3. ACQUISITIONS
In March 2006, the Company acquired the issued and outstanding common stock of AFTI in a tax-free stock-for-stock exchange for a purchase price of $1,950,000. AFTI has patent rights to products under the name of Soil Medic. The Company also acquired the exclusive license rights to the use of patented polymer application techniques, as well as numerous patents on a unique machine designed to inject polymer and other liquid products into existing turf and some crops. Because the exchange was specifically agreed to be a tax-free exchange, the Company recorded a deferred income tax liability in an amount equal to the effective tax totaling approximately $780,000. The acquisition was not deemed a business, and no goodwill resulted. Accordingly, the Company recorded a charge to the statement of operations for the excess of purchase price over the fair value of the assets of $1,950,000. This resulted in an income tax benefit and a deferred tax asset totaling $780,000.
Effective December 31, 2006, the Company acquired 100% of the outstanding stock of Smart World for an aggregate purchase price of $564,000. The Company also purchased intellectual property from Raymond J. Nielsen ("Nielsen IP") for $1,500,000, a stockholder of Smart World. The acquisition of the Nielsen intellectual property did not constitute a business.
The purpose of this acquisition was to enhance the Company's product lines and intellectual portfolios.
The purchase price of Smart World consisted of $150,000 in cash and the issuance of 2,300,000 shares of common stock. The value assigned to the common stock was based on the closing stock price on the date of the acquisition. The intellectual property acquired from Raymond Nielsen was paid through the issuance of a $1,500,000 convertible promissory note. The purchase price of Smart World and the Nielsen IP has been allocated to assets acquired and liabilities assumed based on their estimated fair values determined by management as follows:
The purchase price of the Nielsen IP represented a premium over its estimated fair value resulting in the recognition of an impairment on the date of acquisition of $1,100,000. The purchase price represented a premium over the fair value of the net assets of Smart World's and the Nielsen IP resulting in the recognition of $364,600 and $0 of goodwill, respectively.
4. INVENTORIES
Inventories consist of the following at September 30:
2008 2007 -------- -------- Raw materials $ 89,822 $ 95,970 -------- -------- Finished goods 49,502 154,095 -------- -------- $139,324 $250,065 ======== ========
5. PROPERTY AND EQUIPMENT, NET
Property and equipment consisted of the following at September 30:
Depreciation expense for the year ended September 30, 2008 and for the period ended September 30, 2007 was $121,444 and $93,509, respectively.
6. INTANGIBLE ASSETS AND GOODWILL
The following table summarizes the components of intangible assets as of September 30:
The above intangible assets, excluding goodwill, have definite lives. Accordingly, they are amortized over the remaining periods to be benefited. In 2007, management revised the amortization period of the patents and formulas for Soil Medic and AFT because management was in the process of refining certain formulas for much higher sales and royalties from its products which are expected to be realized in future periods. During 2007, the amortization period was changed to three to seven years. During 2007, management determined the Nielsen IP acquired that such formulas would not generate sufficient cash flows to recover these intangible assets because the formulas were misrepresented to the Company's management to be proprietary and effective, and would have wide uses. Accordingly, management recorded an impairment of $400,000 during the year ended September 30, 2007.
As of September 30, 2008, the Company evaluated its intangible assets for potential impairment. In connection with the Soil Medic patent rights acquired in the Company's acquisition of AFTI, during fiscal 2007 and early into fiscal 2008 and the management experienced a problem with the manufacturing of the formulas. During 2008, the Company resolved the manufacturing problems and began to remarket these products. During the fourth quarter of fiscal 2008, management evaluated the carrying value of these formulas. As a result of the above problems, management reduced its projected future sales and resulting cash flows resulted in an impairment charge of $845,390 during the year ended September 30, 2008.
The amortization expense was $507,157 and $693,672 for the year ended September 30, 2008 and for the period ended September 30, 2007, respectively.
Estimated intangible asset amortization expense for the remaining carrying amount of intangible assets is as follows for the years ending September 30:
2009 $ 346,131 2010 346,131 2011 230,802 2012 230,802 2013 230,802 Thereafter 22,885 ---------- $1,407,553 ==========
7. ACCRUED EXPENSES
Accrued expenses consisted of the following at September 30:
2008 2007 -------- -------- Interest $291,669 $178,162 Compensation and related 236,287 13,985 Other 28,760 3,010 -------- -------- $556,716 $195,147 ======== ========
8. NOTES PAYABLE
Notes payable consists of the following at September 30:
Maturities of notes payable consist of the following at September 30:
2009 $2,865,747 2010 8,540 Thereafter -- ---------- Total $2,874,014 ==========
CONVERTIBLE NOTES PAYABLE On October 25, 2007, the Company and holders of an aggregate of $120,000 outstanding convertible notes agreed to extend the maturity of the outstanding principal balance from $0.30 to $0.10 while the market price was $0.09 per share. The Company also granted to one holder, a warrant to purchase 100,000 shares of the Company's common stock. The warrants vested immediately have an exercise price of $0.10 per share and expire two years from the date of issuance. The fair value of the warrants was approximately $6,267 as determined by the Black-Scholes option pricing model using the following assumptions:
Estimated fair value of underlying common stock $0.09 Exercise price $0.10 Expected life (in years) 2 Risk-free interest rate 3.69% Expected volatility 146.9% Dividend yield 0%
Since the notes had matured, the Company determined the extensions represent the issuance of new notes. No modification or extinguishment accounting was required. The proceeds were allocated between the convertible notes and the warrant based on their relative fair values and resulted in $24,816 being allocated to the convertible notes payable and $5,184 to the warrants. The resulting discount related to the warrants is being amortized over the life of the convertible notes.
NOTES PAYABLE On December 7, 2007, the Company issued a $150,000 face value non-convertible note due January 15, 2008 together with 500,000 shares of common stock. The proceeds from the issuance of the note and underlying common stock were allocated based on their relative fair value on the date of issuance. The note was assumed and repaid by Ms. Visco in January 2008.
8% CONVERTIBLE DEBENTURE On December 20, 2006, the Company purchased exclusive soil additive formulas, proprietary software, trademarks and patents. The Company funded the acquisition through the issuance of $1,500,000 of 8% Convertible Debenture ("Convertible Note") to Raymond Nielsen ("Holder"). The Debenture is convertible into common
stock at the option of the Holder. The conversion price is equal to the closing price of the Company's common stock for the day immediately preceding the date of the conversion.
The Convertible Note contains an embedded conversion feature ("ECF") as prescribed in paragraph 12 of SFAS No. 133. The Company also assessed whether bifurcation of the ECF from the debt host met certain criteria. The ECF met all three criteria of paragraph 12: (1) the conversion feature is not clearly and closely related to the host component, (2) the convertible instrument is not accounted for at fair value, and (3) the ECF meets the definition of a derivative in paragraph 6 of SFAS No. 133.
To assess whether or not the ECF would be classified as stockholders' equity if it were freestanding, management considered the guidance in EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock." In assessing whether or not the conversion option would be classified as equity or a liability if it were freestanding, management determined whether or not the Convertible Note was considered "conventional." EITF 00-19 and EITF 05-2, "The Meaning of Conventional Convertible Debt Instruments in issue No. 00-19," defines conventional convertible debt as debt whereby the holder will, at the issuer's option, receive a fixed amount of shares or the equivalent amount of cash as proceeds when he exercises the conversion option. As a result of the ECF not being convertible into a fixed number of shares of stock and that the Company not ultimately knowing the number of common shares that could be issued upon exercise (no floor on the ECF) management determined the Convertible Note was not "conventional". As of September 30, 2008, based on the current number of outstanding common shares, together with the number of shares of common stock the Convertible Note may be converted into, the Company does not have enough authorized shares available for issuance to permit for this potential conversion.
This caused the ECF to be classified as derivative financial instruments under SFAS No. 133. The accounting treatment requires the Company to record the ECF as a derivative liability on the balance sheet at its fair values as of each reporting date. Any change in the Company's stock price results in a change in the fair value of the derivative liability is recorded as non-operating, non-cash income or expense at each reporting date in the accompanying consolidated statement of operations. The derivative was valued using the Black-Scholes option pricing model and has been classified in the consolidated balance sheet as a short-term liability as the underlying note is past due and in default for non-payment.
The fair value of the ECF was determined using the Black-Scholes option pricing model with the following assumptions at September 30:
2008 2007 ------- ------- Fair value of underlying common stock $ 0.03 $ 0.23 Expected life (in years) 0 1.08 Risk-free interest rate 1.02% 4.96% Expected volatility 193.50% 156.70% Dividend yield 0% 0%
9. INCOME TAXES
The provision for income taxes is comprised of the following for the years ended September 30:
2008 2007 ------- ------- Federal $ -- $ -- State (800) (800) ------ ------ Provision for income taxes $ (800) $ (800) ====== ======
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The differences between the federal statutory tax rate of 34% and the effective tax rates are primarily due to state income tax provisions, net operating loss ("NOL") carry forwards, deferred tax valuation allowance and permanent differences as follows for the years ended September 30:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities consist of the following at September 30:
2008 2007 ----------- ----------- Deferred tax assets (liabilities): Current: Reserves and accruals $ 229,282 $ 173,587 Non-current: Intangible assets 237,935 (382,921) Net operating losses 5,868,713 6,029,141 Other 49,764 28,663 Valuation allowance (6,385,694) (5,918,519) ----------- ----------- $ -- $ -- =========== ===========
At September 30, 2008 and 2007, the valuation allowance was increased by a total of $467,175 and $889,000 respectively. At September 30, 2008, the Company had federal net operating loss carryforwards of approximately $17,811,203 that expire from 2009 through 2026 and state net operating carryforwards of $5 million expiring from 2009 through 2012. These net operating losses may be suspended or limited due to changes in State and Federal legislation, as well as a possible change in ownership as defined under Section 382 of the IRC.
10. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES The Company leases real property located in Pacoima, California from an entity owned by Ms. Visco. The lease expired in December 2008. The Company currently occupies this facility on a month-to-month basis. Rent expense under this lease for the year ended September 30, 2008 and the period ended September 30, 2007 was $7,061 and $5,124, respectively.
In connection with the acquisition Smart World, the Company assumed leases for a warehouse and office space which expired on April 30, 2008 and November 30, 2007, respectively. The Company is currently renting this facility on a month-to-month basis for $2,914 per month.
CAPITAL LEASES The Company leases certain equipment under capital leases. Minimum annual required lease payments under the lease agreements are as follows as of September 30:
2009 $ 21,600 2010 21,600 2011 3,600 2012 -- 2012 -- Thereafter -- -------- Total minimum lease payments 46,800
Less amount representing interest (7,654) -------- Present value of future minimum lease payments $ 39,146 ========
Equipment under capital leases included in machinery and equipment at September 30, 2008 are as follows:
Machinery and equipment $ 75,000 Less - accumulated depreciation (41,250) -------- $ 33,750 ========
PENDING PROPERTY ACQUISITION On November 27, 2007, the Company entered into a Purchase and Sale Agreement and Joint Escrow Instructions to acquire real property in Pescadero, California for a purchase price of $5,400,000. The property has been improved with approximately 700,000 square feet of greenhouses and the Company plans to continue to operate the property as a nursery. In connection with the agreement, the Company deposited $50,000 with the escrow agent of which a $10,000 non-refundable deposit was released to the sellers. In December 2007, per the terms of the agreement, the Company was to have deposited an additional $100,000 into the escrow account on or before December 14, 2007 if the Company's due diligence had been completed. Said due diligence has not been completed, therefore the deposit has not been made. The remaining $5,350,000 was due by December 28, 2007, the original closing date, and then extended to May 27, 2008 for additional consideration of $50,000. As of the current date, the remaining amounts have not been paid and the parties have verbally agreed to set the closing date as soon as possible after the completion of the due diligence
LITIGATION On or about September 21, 2007, Stockhausen, Inc. ("Stockhausen") filed a Complaint in the United States District Court, for the Middle District of North Carolina, against us seeking damages. Stockhausen alleges that the Company breached an agreement with them by failing to pay for goods purchased and failing to purchase a minimum quantity of goods. We believe that Stockhausen provided defective products and waived any minimum purchase requirements. Stockhausen is seeking a judgment in the amount of $188,180 plus interest and lost profits in an unspecified amount, along with costs and attorneys fees. We filed an Answer to the Complaint and a Cross-Complaint against Stockhausen on November 14, 2007. Discovery has not been completed and settlement discussions are ongoing
On or about October 4, 2007, Raymond J. Nielsen and Cheryl K. Nielsen (collectively, "Plaintiffs"), filed a Complaint in the Circuit Court in the Sixth Judicial District of Pasco County, Florida, against us and Smart World (collectively "Defendants") seeking damages, declaratory, and injunctive relief. Plaintiffs allege that Defendants failed to pay interest when due on the Convertible Debenture from Defendants to Plaintiffs and, thus, the entire amount of the Convertible Debenture is accelerated and Plaintiffs are seeking a judgment in the amount of $1,500,000 plus interest. We allege that jurisdiction of this matter belongs in the California court system per the terms of the documents. We have filed a Motion to Dismiss the lawsuit which has been denied. We have filed an answer and affirmative defenses. It is our position that the intellectual property we purchased from the Plaintiffs is not what it was represented to be.
11. PREFERRED STOCK
The Company has 10,000,000 preferred stock authorized of which 2,763,699 shares of $0.50 stated value Series A convertible preferred stock ("Series A Preferred") are issued and outstanding as of September 30, 2008. The Series A Preferred have the following characteristics:
DIVIDENDS Each holder is entitled to receive preferential quarterly dividends equal to the prime interest rate as quoted in the Wall Street Journal when and if declared by the Board of Directors, out of any assets that are legally available. If the Board of Directors declares that such dividends may only be payable in shares of common stock for any quarter, holders of Series A preferred stock have the option of accepting the dividend paid in shares of common stock of the Company, or letting the dividend accrue for a cash payment. No dividends have been declared, accrued or paid.
CONVERSION Each holder has the option to convert each share of Series A Preferred into common stock at a rate of one share of common stock for each share of preferred stock tendered
VOTING The holders have no voting rights.
LIQUIDATION PREFERENCE Each holder is entitled to be paid the stated value of their holdings out of the assets of the Company, prior and in preference to any payment or distribution out of the assets of the Company to the holders common stock or any other class or series of capital stock.
12. COMMON STOCK
STOCK OPTIONS In November 2002, the Company enacted a stock option plan (the "2002 Plan") to provide additional incentives to selected employees, directors and consultants. Two million shares were authorized for grant. The purchase price of the common stock subject to each Incentive Stock Option shall not be less than the fair market value or in the case of a grant of an incentive stock option to a principal shareholder, not less than 110% of the fair market value of such common stock at the time each option is granted. The 2002 Plan terminates in November 2012. The options are fully-vested when granted and are exercisable for a period of ten years from the date of grant and are subject to cancellation upon termination of employment. The Company has granted options to purchase 1,010,000 shares and 300,000 shares with exercise prices of $0.50 and $0.25, respectively. The market price at the date of grant was $0.12. At September 30, 2008, 690,000 stock options are available for grant.
On January 6, 2005, the Company enacted the 2005 Stock Option/Stock Issuance Plan (the "2005 Plan"). The 2005 Plan provides for the issuance of up to 10,000,000 shares of common stock to our directors, officers, employees and consultants in the form of stock options and shares of common stock. The 2005 Plan has two separate components: the option grant program and the stock issuance program.
Grants under the option grant program may be structured as installment options which become exercisable for vested shares over the optionee's period of service or as immediately exercisable options for unvested shares which will be subject to repurchase by the Company, at the option exercise price paid per share, upon the optionee's termination of service prior to vesting in those shares. All option grants must have an exercise price not less than 100% of the fair market value of the option shares on the grant date.
The stock issuance program allows eligible persons to purchase shares of common stock at fair market value or at a discount of up to 15% of fair market value. The shares may be fully vested when issued or may vest over time as the recipient provides services or as specified performance objectives are attained. In addition, shares of common stock may be issued as bonus awards in recognition of services rendered, without any cash outlay required of the recipient.
Upon stock option exercise, the Company issues new shares of common stock.
The following table summarizes stock option activity under the above stock option plans:
The fair value of stock options awarded during the year ended September 30, 2008 and the period ended September 30, 2007 were estimated at the date of grant using the Black-Scholes option-pricing model. The expected option term was estimated based upon the contractual term of the underlying stock option. The expected volatility of the Company's stock price was based upon the historical daily changes in the price of the Company's common stock. The risk-free interest rate was based upon the current yield on U.S. Treasury securities having a term similar to the expected option term. Dividend yield is estimated at zero because the Company does not anticipate paying dividends in the foreseeable future.
The following table summarizes the weighted-average assumptions used and the resulting fair value of options granted:
2008 2007 ---- ---- Weighed-average fair value of options granted $0.11 n/a Weighted-average assumptions: Expected volatility 145% n/a Dividend yield 0% n/a Expected option life 5.0 n/a Risk-free interest rate 4% n/a
WARRANTS TO PURCHASE COMMON STOCK The following tables summarize the issuances of warrants to purchase shares of the Company's common stock:
Number of Shares ------- Outstanding at September 30, 2006 100,000 Granted 734,000 Exercised -- Cancelled -- ------- Outstanding at September 30, 2007 834,000 Granted 50,000 Exercised -- Cancelled -- ------- Outstanding at September 30, 2008 884,000 =======
13. RELATED PARTY TRANSACTIONS
YEAR ENDED SEPTEMBER 30, 2008 On August 18, 2008, Ms. Visco converted $41,383 of outstanding notes payable into 1,379,428 shares of common stock based on the closing stock price on the date of conversion.
On May 8, 2008, Ms. Visco loaned the Company an additional $85,000 which is due August 31, 2008. Interest is payable monthly based on the prime rate.
In August 2008, the Company executed a promissory note for all amounts due and payable at that time to Ms. Visco in the amount of $600,000, which is due on September 30, 2009; interest is payable monthly based on the prime rate. Due to the funding status of the Company, the interest is accruing, however is not being paid.
On March 9, 2008, Ms. Visco converted $20,000 of convertible notes into 40,000 shares of common stock at the original stated conversion price of $0.50 per share.
On October 29, 2007, FLD Corporation, an entity partially controlled by Ms. Visco converted $800,000 of notes payable into 1,757,143 shares of common stock at the original stated conversion prices ranging from $0.28 to $0.50 per share.
Rent expense incurred in connection with an entity partially controlled by Ms. Visco was $7,061 for the year ended September 30, 2008.
Interest expense incurred in connection with outstanding loans and notes payable to Ms. Visco or entities partially controlled was $30,344 for the year ended September 30, 2008.
PERIOD ENDED SEPTEMBER 30, 2007
DIRECTORS AND OFFICERS Diana Visco, the Company's Corporate Secretary, has a $600,000 note payable bearing interest at the "prime" rate, due September 20, 2009. In March 2008, Ms. Visco converted $61,383 of principle debentures into common stock at the original conversion prices. Interest incurred on this debenture and notes was $3,087 and $9,277 during the periods ended September 30, 2007 and December 31, 2006, respectively.
The holders of the two $25,000 convertible debentures and the $178,508 convertible debenture are personally related to Louie Visco. Interest incurred on these debentures during the nine months ended September 30, 2007 and the year ended December 31, 2006 were $16,890 and $24,032, respectively.
Louie Visco, a former director of the Company and the director of FLD Corporation is the holder of two $250,000, one $200,000 debentures convertible at $0.50 per share with interest at 8%, maturing in the first calendar quarter of 2009. In addition, there is one $100,000 debenture convertible at $0.50 per share with interest at 8% that matures in the third quarter of 2009 and a
$460,012 note payable at 8.25% which matures December 2009. During the six months ended June 30 2007, notes payable and accrued interest and payables due to this entity totaling $652,738 were converted at a rate of $0.176 per share for a total of 2,380,952 shares of common stock. On June 1, 2007, $628,012 of outstanding notes together with $23,473 of accrued interest into 3,708,740 shares of common stock. On September 28, 2007, an additional $423,000 note payable and $40,211 of interest due to this entity totaling $463,211 were converted at a rate of $0.09 per share for a total of 5,146,787 shares of common stock. Interest incurred on these debentures and notes during the nine months ended September 30, 2007 was $70,603 and $100,567.
Rent expense incurred in connection with an entity partially controlled by Ms. Visco was $5,124.
Interest expense incurred in connection with outstanding loans and notes payable to Ms. Visco or entities partially controller was $73,690.
14. SUBSEQUENT EVENTS
As described in Note 8, certain notes payable became due subsequent to September 30, 2008. Such amounts have not been repaid and became in default due to nonpayment subsequent to September 30, 2008.