SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the fiscal year ended:
June 30, 1998
Commission File Number
0-21151
PROFILE TECHNOLOGIES, INC.
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(Name of small business issuer in its charter)
DELAWARE 91-1418002
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1077 NORTHERN BLVD.
ROSLYN, NY 11576
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(Address of Principal Executive Offices) (Zip Code)
Issuer's telephone number: (516) 365-1909
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock $.001 Par Value
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Title of Class
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. X
State issuer's revenues for the most recent fiscal year. $45,000.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was $45,621,900, based on the closing bid and ask prices as reported
by the NASDAQ SmallCap market on September 9, 1998.
There were 4,273,846 shares of common stock $.001 par value outstanding as of
September 9, 1998.
Documents incorporated by reference:
Definitive Proxy material for annual shareholder meeting to be held November 14,
1998 filed pursuant to Regulation 14A.
Transitional Small Business Format (check one): Yes ; No X
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Item 1. Description of Business.
Introduction
The Company was originally incorporated in Washington in 1988 but has been
a Delaware corporation since 1995. Since its inception the Company has been
engaged in the business of researching and developing a high speed scanning
process, which is nondestructive and noninvasive, to remotely test buried and
above ground pipelines for corrosion and coating problems. The Company's
process, called a dual pulse propagation analyzer ("PPA") is a patented process
of analyzing the waveforms of electrical impulses in a way that extracts
point-to-point pipeline integrity information. This process involves sending an
electrical pulse along the pipe being tested from each of two locations toward
an intersecting location between the two locations. At least one of the modified
pulses is analyzed to determine whether an anomaly exists at the intersecting
location. This process is designed to detect external corrosion of pipeline
which occurs under pipe insulation without the need for taking the line out of
service, physically removing the coating, and then visually inspecting the
outside of the pipe for corrosion. The most common forms of corrosion under
insulation ("CUI") are localized corrosion of carbon steel and chloride stress
corrosion cracking of stainless steel. Refineries, chemical plants, utilities,
natural gas transmission companies and the petroleum industry have millions of
miles of corrosion protected pipeline. Much of this piping is exposed to harsh
and severe environments. As a result, there is an on-going effort by these
industries to ensure that the quality of the pipe meets standards set by
regulatory bodies and the industry to protect operating personnel and the
environment. While the Company continues to develop and refine its PPA process,
the technology has evolved to the point where it is now being used in the field
on a commercial basis. In July, 1998, the Company began and completed its first
commercial contract on the North Slope of Alaska, testing approximately 100 road
and caribou crossings on British Petroleum pipelines under a contract with ASCG
Inspection, Inc. The contract was completed ahead of schedule.
Corrosion Protection
Virtually all pipeline systems are required to have some type of corrosion
protection applied to extend the useful life of the pipeline and to prevent
pipeline failures due to corrosion. The effect of such failures ranges from a
few drops of a toxic substance on the surface of the pipeline to catastrophic
explosions which result in extensive damage of property and loss of human life.
Although there are many special techniques used to protect pipeline
systems, two are most common. The first is to apply a coating to the pipeline
which will keep the pipeline isolated from its environment. This is a
fundamentally sound approach, but it is complicated by the fact that coatings
can become damaged during the installation process. Most coatings also degrade
over time so the effectiveness of protection is reduced.
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The second technique, used to protect predominantly buried and submersed
pipelines, is designed to protect bare pipeline or pipeline which has damaged or
missing coating. This technique is called Cathodic Protection. Simply stated,
the technique uses the flow of electric current to polarize the pipeline and
prevent corrosion. The polarization process attempts to maintain the pipeline at
some negative voltage with respect to an external reference voltage, called a
"half-cell". That reference level is called a Pipe-to-Soil-Potential and is
commonly referred to as a "PSP". The polarization process basically uses an
electrochemical process to prevent the pipe from corroding in the ground. Many
years of experience and extensive experimentation have generated a PSP level
which is generally considered to represent "protected" pipe. To determine the
effectiveness of the cathodic protection system, it is necessary to measure the
PSP at sufficient locations along the segment of pipeline so that a protection
profile can be viewed.
A combination of federal, state, local and industry jurisdictions combine
to regulate corrosion protection. For example, regulations covering the
operation of natural gas transmission systems promulgated by the U.S. Department
of Transportation's Office of Pipeline Safety has required steel pipelines to be
equipped with cathodic protection since the early 1970's. In addition, the U.S.
Department of Labor, operating through the Occupational Safety and Health
Administration ("OSHA") has jurisdiction over numerous plants and facilities
containing corrosion protected pipeline that, if breached, could cause serious
bodily injury or death to on-site workers. Finally, the American Petroleum
Institute ("API") has promulgated a comprehensive Piping Inspection Code which
requires that extensive corrosion testing be done by all members (which includes
the vast majority of the petroleum and petrochemical industries). As a result of
the extensive regulation and testing requirements as described above, the
industry is faced with the requirement to engage in extensive testing for
corrosion.
In 1993, the API imposed even stricter test standards regarding the problem
of CUI. When pipeline is uninsulated and above ground, external corrosion can be
identified visually. The petroleum and other related industries, however,
insulate much of their piping to conserve energy and/or to prevent injury to
personnel from high temperature levels on the pipelines. As soon as piping is
insulated, a very complex situation is created. Corrosion can occur underneath
the insulation due to moisture or corrosive products that find their way through
broken or poorly sealed insulation. This CUI is very difficult to locate
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economically. In the past, testing for this problem had been on a limited sample
basis and relied upon inspection processes that were very cumbersome and costly.
Two prevalent testing methods used to detect CUI are X-ray and eddy current
methods, which are methods of detecting defects in pipe by analyzing visual
image and decay. After physically stripping away coating for visual inspection,
depth gauges, ultrasonics and X-ray could then be used to determine the severity
of CUI on questionable pipe. However, the stripping of insulation to determine
corrosion is a costly testing method for the industry because it often meant the
assembly of scaffolding for testing otherwise inaccessible above ground pipe
(particularly in refineries and petrochemical plants) or an actual dig-up on
below ground pipe. The Company's technology enables it to test pipe segments in
a refinery setting as long as one hundred feet to three hundred feet and to use
"cherry pickers" instead of costly scaffolding. CUI is also a very complicated
problem to test for because it cannot be easily identified by statistical
sampling. If, for example, a segment of pipe has a small insulation part removed
every ten feet and is visually inspected using eddy current or x-ray techniques,
there is no statistical basis to assume that the external condition of the
piping between the removed insulation parts is good or bad. The API testing
standard adopted in 1993, in essence, mandates either stripping even larger
amounts of coating or using an alternate system that will identify CUI without
stripping the coating on suspected (or unsuspected) pipe. Because of the
enormous cost involved in using the stripping and visual testing process, the
industry is enthusiastically searching for an alternate testing system that is
reliable and less costly. The Company believes that its PPA process provides an
alternate testing system that the industry is looking for. However, the
Company's technology is just now being commercially accepted for such purpose
and there can be no assurance that such acceptance will continue to grow.
The Company's Dual Pulse Propagation Analyzer Process
The PPA process extracts corrosion related information from segments of
both accessible and inaccessible pipelines underneath the entire insulation
barrier by analyzing the intersection of two electrical current pulses traveling
in opposite directions along the pipeline. This corrosion related information is
extracted without the need for removing the insulation protecting the pipeline.
The Company established by laboratory and field testing that the electrical
response, called characteristic transfer function (CTF), of two intersecting
pulses traveling along the pipeline is uniquely defined with location specific
information that relates to the integrity of the pipeline at the point of
intersection. Constructive interference occurs when the two current impulses run
into and interfere with each other at the point of intersection on a pipeline.
The CTF is determined, not only by the nature and characteristics of the
original pulses, but by the physical characteristics of the pipeline segment in
its environment at the point of intersection.
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The PPA process was developed to evaluate the condition and integrity of
pipelines. Electro-magnetic pulses are applied at both ends of the pipe segment
being tested. Under computer control, the timing of the pulses is controlled so
that the intersection point of the two pulses moves sequentially from one end of
the pipe to the other end. A unique CTF is obtained for each intersection point
of the pipeline segment being tested on some predetermined interval; such as, in
one foot intervals. When this data is geophysically displayed, it provides a
visual display of data related to the physical condition of the pipe at each
point of intersection. Additional electromagnetic inspection of the pipeline,
using an external calibrator developed by the Company, provides a second
alternative application of the Company's technology to inspect the questionable
pipe locations found during the PPA process. This alternative application, which
the Company is refining its development of, is used as a verification of the PPA
process. It is more time consuming to use and it is doubtful that it would be
the initial method selected for testing. This alternative application involves
the use of an antenna assembly to scan the pipe under analysis in those areas
where suspected anomalies have been located using the PPA process. Thus far, the
Company has used this alternative application as confirmation of potential
anomalies. The Company is in the process of evaluating whether there is a
sufficient interest in this second alternative application to justify a second,
separate product for the Company. Information can also be derived using the PPA
process to determine the condition of the coating and the effectiveness of the
existing corrosion protection system which is being used to protect each point
of intersection. Where there are indications of problems, closer interval
inspection can be performed and/or one of the other location specific processes
used in the industry may be utilized before the insulation is removed to inspect
the pipe condition.
As simple as the concept may appear, the PPA process is not intuitively
obvious. The petroleum industry has spent large sums trying to solve the problem
of finding corrosion under insulation. Correlating pipeline corrosion
information using the Company's technology requires a combination of
state-of-the-art instrumentation plus an understanding of the physical phenomena
that are being measured. Although the principles of the PPA process are simple
to explain, management believes that the measurement and analysis of the effect
are pushing the leading edge of technology.
The Company believes that the principal advantage to using the PPA is that
it provides a method for the operating companies to do a visual equivalent
inspection on inaccessible pipe without the need to remove insulation. Research
and development efforts will continue in the development of new applications for
the Company's technology and to develop new products for the petroleum industry
and other industries.
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Patents, Proprietary Technology and Other Intellectual Property
The Company pursues a policy of generally obtaining patent protection both
in the United States and abroad for patentable subject matter in its proprietary
technology. As of June 30, 1998, the Company had five issued U.S. patents, four
issued foreign patents, seven U.S. patent applications pending, six foreign
patent applications pending and three patent applications filed under the patent
cooperation treaty which enables the Company to file additional foreign patent
applications in the future.
The Company's success depends in large part upon its ability to protect its
process and technology under United States and international patent laws and
other intellectual property laws. U.S. patents have a term of 17 years from date
of issuance or, for more recently filed patent applications, 20 years from the
filing of such applications, and patents in most foreign countries have a term
of 20 years from the proprietary filing date of the patent application. The
first U.S. patent was issued in 1990, three patents were issued in 1993 and one
patent was issued in 1998.
The Company believes that it owns and has the right to use or license all
proprietary technology necessary to license and market its process under
development. The Company is not aware of the issuance of any patents or the
filing of any patent applications which relate to processes or products which
utilize the Company's proprietary technology in a manner which could be similar
to or competitive with the Company's products or processes. The Company has no
knowledge that it is infringing on any existing patent such that it would be
prevented from marketing or licensing products or services currently being
developed by the Company.
The Company may decide for business reasons to retain a patentable
invention as a trade secret. In such event or if patent protection is not
available, the Company must rely upon trade secrets, internal knowledge and
continuing technological innovation to develop and maintain its competitive
position. The Company employees and consultants have access to the Company's
proprietary information and have signed confidentiality agreements.
Research and Development Spending
During the two most recent fiscal years ended June 30, 1998 and June 30,
1997, the Company spent $316,876 and $272,240 respectively on research and
development activities. In addition, certain non-cash expenses were incurred in
connection with research and development activity. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations".
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Development of Business
Up through the year ended June 30, 1994, all revenues earned by the Company
were derived from research and development contracts with a large public utility
and a large independent natural gas company. These contracts focused on
evaluating below ground pipe for cathodic protection and coating defects.
However, by late 1994, the Company, as a result of its activities up to that
point in time, came to the realization that its technology had the potential to
identify the location of actual corrosion, as opposed to simply identifying
locations which might have insufficient cathodic protection or defective
coating, and therefore a likelihood of corrosion. The Company believed that the
identification of actual corrosion was of even greater importance to the
petroleum, petrochemical and utility industries because these industries'
resources could be used more efficiently in correcting actual corrosion
locations. Once corrosion locations have been identified and corrected, the
Company's technology could still be used to identify lack of cathodic protection
and coating defects as part of a preventive maintenance program.
In early 1995, the Company spent three months at the refinery of a large
multi-national oil company, researching and developing test procedures for
identifying corrosion of above ground refinery pipe as part of a shift in
emphasis away from testing of underground pipe for cathodic protection and
coating defects. An important factor in this shift in emphasis had to do with
verification. Potential customers could more easily and less expensively verify
the accuracy and dependability of the Company's technology in an above ground
environment that doesn't involve time consuming and costly dig ups. The Company
believes that once potential customers have satisfied themselves that the
technology is accurate and cost effective, they would be more likely to expand
the use of the technology to difficult to reach below ground environments. The
Company also believes that this shift in emphasis was a significant step forward
because major oil companies were willing to provide detailed data concerning
pipe quality and testing standards. Beginning in 1995, the Company began
conducting research and development activities at the research facilities of
another large multinational oil company to develop the Company's technology to
the point where it could identify corrosion locations. As part of this process,
numerous segments of pipe in various conditions ranging from excellent to
extremely corroded were assembled in various configurations and covered with
insulation. The Company then used its technology to evaluate the various pipe
segments without prior knowledge of the condition of the pipe segments. After
obtaining data, the Company evaluated the results and then submitted a report
which summarized its findings. In late July of 1996, representatives of the
Company traveled to the Prudhoe Bay area of Alaska and met with operating
personnel from three large multi-national oil companies with operations in the
area to discuss the feasibility of conducting a field demonstration and test of
the Company's technology on operating pipelines in that area. The Company
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subsequently conducted a field demonstration and test on a 24 inch line in
September of 1996 and then submitted a report summarizing its activities and
findings. In August of 1997, the Company completed a second field demonstration
using refined hardware and software that the Company had developed since its
previous field demonstration. In July of 1998, the Company completed its first
commercial contract on the North Slope of Alaska, testing approximately 100 road
and caribou crossings on British Petroleum pipelines under a contract with ASCG
Inspection, Inc. The contract was completed ahead of schedule.
Competition
The Company believes that the nondestructive testing industry is highly
fragmented and comprised of numerous companies, many of whom are larger and have
greater financial resources than does the Company. However, the Company believes
that these competitors are offering non-destructive testing services that rely
on technologies which are different from the technology offered by the Company.
These other technologies, including x-ray, ultrasonic and eddy current, have
been in existence for many years and have gained wide acceptance within the
industry. In addressing the requirements of the large national companies that
would be expected to have an interest in the Company's services, the Company
expects to compete on the basis of technical performance, delivery capability,
service quality and price.
Substantially all of the Company's competitors have, and potential future
competitors could have, substantially greater technical, financial, marketing,
and other resources than the Company and have, or could have, greater name
recognition and market acceptance of their products and technologies. No
assurance can be given that the Company's competitors will not develop new
technologies or enhancements to existing services or introduce new services that
will offer superior price or performance features. In such case, the Company may
experience significant price competition, which could have a material adverse
effect on gross margins.
Marketplace
Nondestructive corrosion testing services are required across a broad
market. Customers are expected to be generally the owners of, or engineering
firms associated with, major processing facilities and pipeline systems. The
Company's services are expected to be provided to the refining, petrochemical
and pipeline segments of the petroleum industry and to the utilities industry,
and demand for these services is typically driven by safety and environmental
considerations.
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The Company will seek to obtain business through ongoing contractual
relationships and competitive and sole source bidding. The Company's officers
are presently responsible for sales and marketing and will continue to have such
responsibility in the foreseeable future.
Most refineries, petrochemical plants and other similar facilities have
ongoing maintenance programs which may require one or more crews performing
corrosion control testing on a continuous basis. Typically, these services are
provided by an outside contractor under a blanket service agreement, rather than
by the employees of the refineries and plants. The Company expects that if it is
successful in obtaining contracts with major oil refineries (of which there is
no assurance), such contracts will be of this type.
The Company also will seek to perform testing services for the utility
industry. Utilities have thousands of miles of underground gas transmission
lines that are constantly being monitored and tested for corrosion.
Employees
The Company presently has five employees. In preparation for the hiring of
field crews, the Company anticipates that it will have three to five additional
employees, who will be in the areas of administration, accounting, marketing,
promotion and clerical. Field crews will, in all likelihood, consist of two
field technicians per crew. The number of crews employed by the Company at any
given time will be dependent upon the Company's level of business activity. In
addition, the Company will continue to retain independent consultants to render
advice with respect to technical and scientific matters.
Compliance With Environmental Laws
Because of the nature of the Company's business, it does not believe that
the costs and effects of compliance with environmental laws, whether federal,
state or local, would be significant or even material.
Item 2. Description of Property
The Company's executive offices are located at 1077 Northern Blvd., Roslyn,
NY 11576. The Company leases approximately 1,400 sq. feet of office space at the
address from a non-affiliate. The rental payment is twenty-two thousand eight
hundred dollars per year ($1,900 per month). The lease expires in approximately
one year and has a two year renewal option.
The Company's research and development facility is located in Ferndale,
Washington. The Company leased 1,800 sq. feet of space under a one year lease
from a non-affiliate at a monthly rental rate of $1,400. The Company is
currently leasing the facility on a month to month basis since the lease has now
expired and the Company is negotiating an extension of the lease.
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The Company does not own any real estate.
The Company does not invest in, nor does the Company intend in the future,
to invest in real estate or interests in real estate, real estate mortgages or
securities of or interests in persons primarily engaged in real estate
activities.
Item 3. Legal Proceedings.
The Company is not a party to any material pending legal proceedings nor is
any of its property subject to any such legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth
quarter of the Company's fiscal year ended June 30, 1998, either through the
solicitation of proxies or otherwise.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's common stock has been traded on the NASDAQ SmallCap market
since it began public trading in February of 1997, under the symbol PRTK. The
following table sets forth the high and low bid prices for the Company's common
stock, by quarter, since the commencement of public trading, as reported by
Nasdaq.
Quarter Ended High Bid Low Bid
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March 31, 1997 $7.25 $5.75
June 30, 1997 $10.75 $6.00
September 30, 1997 $12.25 $6.25
December 31, 1997 $12.25 $11.00
March 31, 1998 $21.00 $10.00
June 30, 1998 $19.50 $14.00
The above prices are believed to be representative interdealer quotations,
without retail markup, markdown or other fees or commissions, and may not
represent actual transactions.
At September 9, 1998, the bid price of the Company's common stock was
$15.25 per share. On such date the Company had 125 holders of record of the
Company's common stock and the Company estimates that it has approximately 450
beneficial shareholders.
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The Company has not paid any dividends on its common stock and the Board of
Directors presently intends to continue a policy of retaining earnings, if any,
for use in the Company's operations and to finance expansion of its business.
The declaration and payment of dividends in the future, of which there can be no
assurance, will be determined by the Board of Directors in light of conditions
then existing, including earnings, financial condition, capital requirements and
other factors. There are no restrictions that currently materially limit the
Company's ability to pay dividends or which the Company reasonably believes are
likely to limit materially the future payment of dividends on common stock.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
GENERAL
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The Company is a development stage enterprise and has recently completed
development of its pulse propagation analyzer process and is further refining
the technology associated therewith to the point where initial commercial
utilization began in July, 1998. The Company has not, as of yet, obtained
significant revenues from its planned primary source of revenues. The goal of
the Company has been the establishment of commercial viability associated with
services to electronically measure corrosion in piping of all kinds. The
Company's product identifies areas of corrosion, areas that lack cathodic
protection and areas that may have defective coating on both below ground and
above ground pipes. The pulse propagation analyzer consists of a computer,
software to enhance collection and processing of data, a precision multi-channel
pulse generator and a signal analyzer. During fiscal 1996, the Company began to
see rapid progress in the development of its technology and its ability to meet
the expectations of potential customers. By that time, the Company had begun to
accelerate its efforts and expend more resources to develop its technology
faster. Thus, expenses and purchases of equipment have been generally increasing
at a faster pace than in prior periods. This trend accelerated in the fiscal
year ended June 30, 1997, particularly after completion of the Company's initial
public stock offering in February of 1997. The Company believes that it attained
technological feasibility of its product with the completion of its research and
development activity in a controlled environment in July of 1996. A field
demonstration of the Company's service capabilities utilizing its pulse
propagation analyzer process was performed for two multinational oil companies
at Prudhoe Bay, Alaska in September of 1996. A further demonstration using
updated and more sophisticated hardware and software was completed in Prudhoe
Bay, Alaska in August of 1997. This work led to an initial commercial contract
to test 100 road and caribou crossings, which began and was completed in July of
1998.
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In order for the Company to obtain significant revenues from the use of its
technology, the Company must establish a sales and marketing organization that
is effective and obtains customers for its pulse propagation analyzer. The
Company must also be able to supply and train work crews in sufficient numbers
to satisfy the requirements of its customers. From inception through June 30,
1998, the Company has incurred losses of $3,145,684 and losses are expected to
continue at least through the second quarter of the year ending June 30, 1999;
no assurances can be given that losses will not be incurred thereafter.
In the opinion of management, significant progress has been made to date in
developing its technologies, gaining credibility with its markets and building
its board of directors and investor base, without spending inordinate sums to
achieve these goals. As of June 30, 1998, the Company had been issued five
patents covering its unique technology. An additional seven provisional patent
applications have been filed, and the Company may file for additional patents in
the future.
RESULTS OF OPERATIONS
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Years Ended June 30, 1998 and June 30, 1997
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The Company incurred a net loss of $712,827 in the year ended June 30, 1998
compared to a net loss of $1,035,003 in the year ended June 30, 1997. Revenues
for the year ended June 30, 1998 were $45,000, which represented a decrease of
$5,000, or 10% as compared to revenues of $50,000 for the year ended June 30,
1997. Revenues for the year ended June 30, 1998 were earned from one major
multi-national oil company for demonstrations of the Company's technology both
in the field and in a controlled setting at one of such oil company's research
and development facilities. Interest income increased to $246,706 for the year
ended June 30, 1998 from $97,703 for the year ended June 30, 1997. This increase
is the result of the Company's investment of the net proceeds of its public
stock offering for a full fiscal year in short term interest bearing accounts
and interest bearing instruments.
Total expenses for the Company for the year ended June 30, 1998 decreased
slightly over the year ended June 30, 1997. Total expenses of $1,004,533 were
recorded in the year ended June 30, 1998 compared to total expenses of
$1,182,706 for the year ended June 30, 1997. This represented a decrease in
expenses of $178,173 or 15%. However, $559,154 of the total expenses incurred in
the year ended June 30, 1997 were attributed in large part to the issuance of
common stock purchase warrants to outside consultants. Before taking into
account this nonrecurring noncash expense, expenses for the year ended June 30,
1997 were actually $380,981 less than the expenses incurred in the year ended
June 30, 1998. The increase in cash expenses for the year ended June 30, 1998 is
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attributed in part to increased expenditures associated with the research and
development involving the Company's technology. General and administrative
expenses increased to $687,657 for the year ended June 30, 1998 from $351,312
for the year ended June 30, 1997 and reflects the payment of salaries and
outside consulting fees incurred in connection with the Company's field
demonstrations as well as an increase in personnel, including the hiring of a
field operations supervisor. Research and development expenses increased to
$316,876 for the year ended June 30, 1998 from $272,240 for the year ended June
30, 1997, an increase of $44,636 or 16%.
Management believes that both revenues and expenses of the Company will
increase during the fiscal year ending June 30, 1999 if it is able to secure
additional contracts with customers, of which there is no assurance. The
revenues earned by the Company to date principally relate to research and
development activities that were sponsored by large multi-national oil companies
and large utilities. These activities include field research and development at
such companies' facilities.
These activities are likely to continue during the year ending June 30,
1999 and for the foreseeable future. Management is also vigorously working
towards obtaining additional fee for service contracts, which are hoped to be
the major source of the Company's revenues. If additional fee for service
contracts are obtained, management expects its expenditures associated with
personnel and testing equipment will begin to rise. In addition, as the Company
provides additional fee for service work, additional administrative support
activities will increase together with related expenses.
LIQUIDITY AND CAPITAL RESOURCES
Revenues for the period from July 1, 1988 (inception) through June 30,
1998, were $527,189 while expenses were $4,028,122, resulting in a loss from
operations, since inception, of $3,500,933. Net cash used in operating
activities from inception through June 30, 1998 was $2,008,655. For the year
ended June 30, 1998, cash used in operations was $637,321. Thus, while the
revenues derived from research and development activities funded by
multi-national oil companies and major utilities were indicative of financial
support for the Company's efforts to develop its technology, they were not
sufficient to cover expenses. Accordingly, the Company historically maintained
adequate liquidity and cash reserves through the private placement of its common
stock. Such offerings, from inception through March of 1996, totaled $1,471,567.
No private placements have occurred since that date.
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In February 1997 the Company completed an initial public offering of its
common stock which involved the sale of 1,050,000 shares of common stock at an
offering price of $6.00 per share. The Company derived net proceeds of
$5,171,687 (including the issuance of 50,000 shares of common stock at $6.00 per
share pursuant to a partial exercise of the underwriter's overallotment option).
The Company has no material long term commitments or material commitments
for capital expenditures.
At June 30, 1998 Compared to June 30, 1997.
At June 30, 1998, the Company had cash and cash equivalents of $4,167,951
as compared to the June 30, 1997 cash and cash equivalent balances of
$4,936,600. The principal reason for the decrease in cash and cash equivalents
was the expenditure of $637,321 used in operating activities. At June 30, 1998,
the Company's working capital was $4,051,984. As of June 30, 1997, there was
working capital of $4,858,223. The Company's principal assets at June 30, 1998,
apart from the cash and cash equivalents mentioned above, consisted of property,
equipment and capitalized patent costs. Property and equipment at June 30, 1998,
was $113,173, up over the balance of property and equipment at June 30, 1997 of
$34,941. Patents had a balance of $204,037, compared to the June 30, 1997
balance of $189,037. Total assets as of June 30, 1998 were $4,548,336 as
compared to $5,236,726 at June 30, 1997 (a decrease of $688,390). The decrease
in total assets was primarily due to the Company's expenditure of funds used in
operating activities.
Year 2000 Compliance
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "Year 2000" problem
is concerned with whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Year 2000 problem is pervasive and complex as virtually
every company's computer operation will be affected in some way. The Company's
computer programs which process it's field data as well as operational and
financial transactions, were designed and developed without considering the
impact of the upcoming change in century. Nevertheless, as a result of the
Company's analysis of it's computer programs and operations, it has reached the
conclusion that "Year 2000" problems will not seriously impact or have a
material adverse effect on the Company's expenses, business, including data
gathering and interpretation, or it's operations.
13
<PAGE>
It is possible, however, that "Year 2000" problems incurred by the
customers or suppliers of the Company could have a negative impact on future
operations and financial performance of the Company, although the Company has
not been able to specifically identify any such problems among its suppliers.
The Company believes that it will not be dependent upon any single supplier for
its equipment or machinery in the Year 2000, and therefore has made a
determination not to contact its primary suppliers to determine if they are
developing plans to address processing transactions which may impact the Company
in the year 2000. However, there can be no assurance that Year 2000 problems
will not occur with respect to the Company's computer systems. Furthermore, the
Year 2000 problem may impact other entities with which the Company transacts
business and the Company cannot predict the effect of the Year 2000 problem on
such entities or the resulting effect on the Company. The Company has not yet
developed a contingency plan to operate in the event that any non-compliant
customer or supplier systems that materially impact the Company are not remedied
by January 1, 2000 and has not yet determined a time table for developing such a
plan. As a result, if preventative and/or corrective actions by the Company or
those entities with which the Company does business are not made in a timely
manner, the Year 2000 issue could have a material adverse effect on the
Company's business, financial condition and results of operations.
14
<PAGE>
Item 7. Financial Statements.
15
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Financial Statements
June 30, 1998
(With Independent Auditors' Report Thereon)
<PAGE>
PROFILE TECHNOLOGIES, INC.
Table of Contents
Page
----
Independent Auditors' Report F-1
Balance Sheet F-2
Statements of Operations F-3
Statements of Cash Flows F-4
Statements of Stockholders' Equity F-5
Notes to Financial Statements F-7
<PAGE>
Independent Auditors' Report
The Board of Directors
Profile Technologies, Inc.:
We have audited the accompanying balance sheet of Profile Technologies, Inc. (a
development stage enterprise) as of June 30, 1998, and the related statements of
operations, stockholders' equity, and cash flows for each of the years in the
two-year period ended June 30, 1998 and for the period from July 1, 1988
(inception) through June 30, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. 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 financial statements referred to above present fairly, in
all material respects, the financial position of Profile Technologies, Inc. (a
development stage enterprise) as of June 30, 1998, and the results of its
operations and its cash flows for each of the years in the two-year period ended
June 30, 1998 and for the period July 1, 1988 (inception) through June 30, 1998,
in conformity with generally accepted accounting principles.
Seattle, Washington
August 18, 1998
F-1
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Balance Sheet
June 30, 1998
Assets
Current assets:
Cash and cash equivalents $ 4,167,951
Prepaid expenses 59,645
-----------
Total current assets 4,227,596
Property and equipment, net 113,173
Patents 204,037
Other assets 3,530
-----------
Total assets $ 4,548,336
===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable - stockholder $ 21,737
Other accounts payable 19,553
Other accrued liabilities 134,322
-----------
Total current liabilities 175,612
-----------
Stockholders' equity:
Common stock, $0.001 par value. Authorized 10,000,000 shares;
issued and outstanding 4,262,600 shares 4,263
Additional paid-in capital 7,514,145
Deficit accumulated during the development stage (3,145,684)
-----------
Total stockholders' equity 4,372,724
-----------
Commitments
-----------
Total liabilities and stockholders' equity $ 4,548,336
===========
See accompanying notes to financial statements.
F-2
<PAGE>
<TABLE>
<CAPTION>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Statements of Operations
Period from
July 1, 1988
(inception) Years ended June 30
through -------------------------------
June 30, 1998 1997 1998
------------- ----------- -----------
<S> <C> <C> <C>
Revenues - testing services and research and
development fees $ 527,189 50,000 45,000
----------- ----------- -----------
Costs and expenses:
Research and development 1,674,566 272,240 316,876
General and administrative 1,494,402 351,312 687,657
Excess of fair market value over exercise price of
extended and assigned existing common stock
purchase warrants 350,000 50,000 --
Fair value of common stock purchase warrants granted
to consultants 509,154 509,154 --
----------- ----------- -----------
Total costs and expenses 4,028,122 1,182,706 1,004,533
----------- ----------- -----------
Loss from operations (3,500,933) (1,132,706) (959,533)
Interest income 355,149 97,703 246,706
Other income 100 -- --
----------- ----------- -----------
Net loss $(3,145,684) (1,035,003) (712,827)
=========== =========== ===========
Basic and diluted net loss per share $ 0.29 0.17
Shares used to calculate basic and diluted net loss
per share 3,587,532 4,262,600
See accompanying notes to financial statements
F-3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Statements of Cash Flows
Period from
July 1, 1988
(inception) Years ended June 30
through ----------------------------
June 30, 1998 1997 1998
------------- ----------- -----------
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $(3,145,684) (1,035,003) (712,827)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 155,438 20,822 38,096
Services received in exchange for common stock 10,000 -- --
Excess of fair value over exercise price of extended and
assigned existing common stock purchase warrants 350,000 50,000 --
Fair value of common stock purchase warrants granted to
consultants 509,154 509,154 --
Changes in assets and liabilities:
Contract work in progress -- (20,000) 20,000
Accounts receivable/payable - stockholder 21,737 (12,154) 19,237
Prepaid expenses (59,645) (52,549) (6,847)
Other assets (3,530) (3,350) (180)
Other accounts payable 19,553 1,379 13,634
Accrued wages -- 20,614 (20,614)
Other accrued liabilities 134,322 69,443 12,180
----------- ----------- -----------
Net cash used in operating activities (2,008,655) (451,644) (637,321)
----------- ----------- -----------
Cash flows from investing activities:
Patents (184,037) (70,676) (15,000)
Purchase of property and equipment (264,510) (21,320) (116,328)
----------- ----------- -----------
Net cash used in investing activities (448,547) (91,996) (131,328)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs 6,643,254 5,267,551 --
Repurchase of common stock (14,000) -- --
Organization costs (4,101) -- --
----------- ----------- -----------
Net cash provided by financing activities 6,625,153 5,267,551 --
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents 4,167,951 4,723,911 (768,649)
Cash and cash equivalents at beginning of period -- 212,689 4,936,600
----------- ----------- -----------
Cash and cash equivalents at end of period $ 4,167,951 4,936,600 4,167,951
=========== =========== ===========
Supplemental disclosures of noncash financing and investing activities -
patent costs in exchange for common stock $ 20,000 -- --
See accompanying notes to financial statements.
F-4
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Statements of Stockholders' Equity
Common stock
------------------------
Shares Amount
---------- ----------
<S> <C> <C>
Sale at inception (July 1, 1988), $.0005 per share 1,000,000 $ 500
Sale of common stock in July, $.0005 per shares 600,000 300
Sale of common stock in September, $.25 per share 400,000 1,200
Net loss -- --
---------- ----------
Balance at June 30, 1989 2,000,000 2,000
Sale of common stock in September, $.25 per share 80,000 80
Net loss -- --
---------- ----------
Balances at June 30, 1990 2,080,000 2,080
Sale of common stock in October, $.25 per share 114,000 114
Issuance of common stock for services in November, $.25 per share 40,000 40
Net loss -- --
---------- ----------
Balances at June 30, 1991 2,234,000 2,234
Sale of common stock in September, $.625 per share 296,000 296
Sale of common stock in May, $1.50 per share 141,268 141
Net loss -- --
---------- ----------
Balances at June 30, 1992 2,671,268 2,671
Sale of common stock in January, $1.50 per share 51,000 51
Net loss -- --
---------- ----------
Balances at June 30, 1993 2,722,268 2,722
Net loss -- --
---------- ----------
Balances at June 30, 1994 2,722,268 2,722
Repurchases of common stock in October (16,000) (16)
Sale of common stock in December, $1.75 per share, net of issuance
costs of $22,115 268,332 269
Excess of fair value over exercise price of existing common stock
purchase warrants extended in December -- --
Net loss -- --
---------- ----------
Balances at June 30, 1995 2,974,600 2,975
Issuance of common stock for services in October, $1.00 per share 20,000 20
Sale of common stock in December-March, $2.00 per share, net of
issuance costs of $34,600 218,000 218
Excess of fair value over exercise price of existing common stock
purchase warrants extended in March -- --
Net loss -- --
---------- ----------
Balances at June 30, 1996 3,212,600 3,213
Fair value of common stock purchase warrants granted to consultants -- --
Excess of fair market value over exercise price of existing common
stock purchase warrants assigned by principal stockholder to others -- --
Sale of common stock in February-March, $6.00 per share, net of
issuance costs of $1,238,313 1,050,000 1,050
Net loss -- --
---------- ----------
Balances at June 30, 1997 4,262,600 4,263
Net loss -- --
---------- ----------
Balances at June 30, 1998 4,262,600 $ 4,263
========== ==========
F-5
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Statements of Stockholders' Equity
(Continued)
Deficit
accumulated
Additional during the Total
paid-in development stockholders'
capital stage equity
---------- ---------- ----------
Sale at inception (July 1, 1988), $.0005 per share -- -- 500
Sale of common stock in July, $.0005 per shares -- -- 300
Sale of common stock in September, $.25 per share 98,800 -- 100,000
Net loss -- (85,749) (85,749)
---------- ---------- ----------
Balance at June 30, 1989 98,800 (85,749) 15,051
Sale of common stock in September, $.25 per share 19,920 -- 20,000
Net loss -- (13,683) (13,683)
---------- ---------- ----------
Balances at June 30, 1990 118,720 (99,432) 21,368
Sale of common stock in October, $.25 per share 28,386 -- 28,500
Issuance of common stock for services in November, $.25 per share 9,960 -- 10,000
Net loss -- (30,593) (30,593)
---------- ---------- ----------
Balances at June 30, 1991 157,066 (130,025) 29,275
Sale of common stock in September, $.625 per share 184,704 -- 185,000
Sale of common stock in May, $1.50 per share 211,761 -- 211,902
Net loss -- (267,186) (267,186)
---------- ---------- ----------
Balances at June 30, 1992 553,531 (397,211) 158,991
Sale of common stock in January, $1.50 per share 76,449 -- 76,500
Net loss -- (132,905) (132,905)
---------- ---------- ----------
Balances at June 30, 1993 629,980 (530,116) 102,586
Net loss -- (13,503) (13,503)
---------- ---------- ----------
Balances at June 30, 1994 629,980 (543,619) 89,083
Repurchases of common stock in October (13,984) -- (14,000)
Sale of common stock in December, $1.75 per share, net of issuance
costs of $22,115 447,196 -- 447,465
Excess of fair value over exercise price of existing common stock
purchase warrants extended in December 210,000 -- 210,000
Net loss -- (453,382) (453,382)
---------- ---------- ----------
Balances at June 30, 1995 1,273,192 (997,001) 279,166
Issuance of common stock for services in October, $1.00 per share 19,980 -- 20,000
Sale of common stock in December-March, $2.00 per share, net of
issuance costs of $34,600 401,182 -- 401,400
Excess of fair value over exercise price of existing common stock
purchase warrants extended in March 90,000 -- 90,000
Net loss -- (400,853) (400,853)
---------- ---------- ----------
Balances at June 30, 1996 1,784,354 (1,397,854) 389,713
Fair value of common stock purchase warrants granted to consultants 509,154 -- 509,154
Excess of fair market value over exercise price of existing common
stock purchase warrants assigned by principal stockholder to others 50,000 -- 50,000
Sale of common stock in February-March, $6.00 per share, net of
issuance costs of $1,238,313 5,170,637 -- 5,171,687
Net loss -- (1,035,003) (1,035,003)
---------- ---------- ----------
Balances at June 30, 1997 7,514,145 (2,432,857) 5,085,551
Net loss -- (712,827) (712,827)
---------- ---------- ----------
Balances at June 30, 1998 7,514,145 (3,145,684) 4,372,724
========== ========== ==========
See accompanying notes to financial statements.
F-6
</TABLE>
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
(1) Nature of Development Stage Activities and Summary of Significant
Accounting Policies
(a) Nature of Development Stage Activities
Profile Technologies, Inc. (Company), formerly Pipeline Profiles,
Ltd., was incorporated in 1986 and commenced operations in fiscal year
1989 (inception). The Company is in the business of developing and
commercializing potential processes for the nondestructive,
noninvasive testing of both above ground and buried pipelines for the
effectiveness of pipeline cathodic protecting systems and coating
integrity. The Company believes that the first commercial applications
of this process will likely be in the refining and petro-chemical
segments of the industry, although the utilities industry has also
expressed interest in the Company's process. The Company's future
revenues are currently dependent upon the market's acceptance of its
sole developed process. In July 1998, the Company commenced work on
its initial commercial contract for corrosion inspection services of
pipeline at approximately one hundred road and caribou crossings in
Alaska. There can be no assurance that the Company will be able to
obtain additional commercial contracts in the future. As of June 30,
1998, the Company is considered to be in the development stage as the
Company has not generated significant revenues from its research and
development efforts and related service contracts with respect to the
above process, and operations have primarily been financed through the
issuance of common stock.
(b) Contract Revenue Recognition
Earned revenue from research and development service contracts
primarily related to testing of industrial pipeline integrity is
recognized on the percentage-of-completion method of contract
accounting. Contract revenues earned are recorded using the
percentage-of-contract costs incurred to date to total estimated
contract costs.
Anticipated losses on contracts are charged to earnings as soon as
such losses can be estimated. Changes in estimated profits on
contracts are recognized during the period in which the change in
estimate is known.
The Company records claims for additional compensation on contracts
upon revision of the contract to include the amount to be received for
the additional work performed. Contract costs include all direct
material and labor costs and those indirect costs related to contract
performance, such as indirect labor, supplies, tools and repairs, and
depreciation costs. Selling, general and administrative costs are
charged to expense as incurred. Service contracts generally extend no
more than six months.
(c) Research and Development
Research and development costs are expensed when incurred.
F-7
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
(d) Property and Equipment
Property and equipment are stated at cost and are depreciated using
the straight-line method over their estimated useful lives of three to
seven years.
(e) Patents
Patent and related application costs will be amortized using the
straight-line method over the shorter of the patents' estimated useful
lives or their legal lives (seventeen years). Amortization will
commence once the Company has emerged from development stage
activities. The Company assesses the recoverability of this intangible
asset by determining whether the balance can be recovered through
forecasted future operations. The amount of impairment, if any, is
measured based on projected future results using a discount rate
reflecting the Company's assumed average cost of funds.
(f) Income Taxes
Deferred income taxes are provided based on the estimated future tax
effects of temporary differences between 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 that are 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 operations in the period that includes
the enactment date. A valuation allowance is recorded for deferred tax
assets when it is more likely than not that such deferred tax assets
will not be realized.
(g) Major Customers
As the Company is still in the development stage, all of the Company's
revenues were from two domestic customers for the years ended June 30,
1997 and 1998.
(h) Cash Equivalents
The Company considers all short-term investments with a maturity date
at purchase of three months or less to be cash equivalents.
F-8
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
(i) Net Loss Per Share
The Financial Accounting Standards Board (FASB) recently issued
Statement of Financial Accounting Standards (SFAS) No. 128, Earnings
Per Share, which became effective for the Company in the second
quarter of its 1998 fiscal year. SFAS No. 128 requires the
presentation of basic earnings per share, and for companies with
complex capital structures, diluted earnings per share. Basic earnings
per share is computed using the weighted average number of common
shares outstanding during the period. Diluted earnings per share is
computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period. The Company
has presented basic and diluted net loss per share and has restated
previously reported amounts in compliance with the requirements of
SFAS No. 128. As the Company had a net loss in each of the periods
presented, basic and diluted net loss per share is the same.
On February 3, 1998, the Securities and Exchange Commission issued
Staff Accounting Bulletin (SAB) No. 98 which superseded SAB No. 83.
SAB 83 required that all common and common equivalent shares issued
during the twelve months immediately preceding the initial filing of a
registration statement for the Company's IPO be included in the
calculation of earnings per share as if they were outstanding for all
periods presented, including loss years where the impact is
antidilutive. The Company has presented basic and diluted net loss per
share using the provisions of SAB No. 98 and antidilutive common
equivalent shares previously included pursuant to SAB No. 83 have been
excluded in all periods presented.
Excluded from the computation of diluted loss per share for 1997 are
warrants to acquire 1,120,000 shares of common stock with a weighted
average exercise price of $3.41 because their effect would be
antidilutive. Excluded from the computation of diluted loss per share
for 1998 are warrants to acquire 1,140,000 shares of common stock with
a weighted average exercise price of $3.59 because their effect would
be antidilutive.
(j) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 period. Actual results could differ
from those estimates.
F-9
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
(k) Patents, Proprietary Technology and Other Intellectual Property
The Company pursues a policy of generally obtaining patent protection
both in the United States and abroad for patentable subject matter in
its proprietary technology. The Company's success depends in a large
part upon its ability to protect its products and technology under
United States and international patent laws and other intellectual
property laws. U.S. patents have a term of 17 years from date of
issuance and patents in most foreign countries have a term of 20 years
from the proprietary filing date of the patent application.
The Company believes that it owns and has the right to use or license
all proprietary technology necessary to license and market its
products under development. The Company is not aware of the issuance
of any patents or the filing of any patent applications which relate
to processes or products which utilize the Company's proprietary
technology in a manner which could be similar to or competitive with
the Company's products or processes. The Company has no knowledge that
it is infringing on any existing patent such that it would be
prevented from marketing or licensing products or services currently
being developed by the Company.
(l) Financial Instruments and Concentrations of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk include cash and cash equivalents. The
fair value of these instruments approximates their financial
statements carrying amount. The Company regularly invests funds in
excess of its immediate needs in money market accounts with Citibank
(Accounts). Funds invested in these Accounts are uninsured and subject
to investment risk. Included with cash and cash equivalents were
amounts held in the Accounts totaling $2,606,000 and $1,544,000,
respectively, at June 30, 1998. Amounts held in these Accounts are
insured up to $100,000 by the Federal Depository Insurance
Corporation.
(m) Product Development Costs and Software Developed for Internal Use
Product development costs are charged to operations as incurred.
Statement of Financial Accounting Standards No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed,
requires capitalization of certain software development costs
subsequent to the establishment of technological feasibility.
Based on the Company's product development process, technological
feasibility is established upon completion of a working model. Costs
incurred by the Company between completion of the working model and
the point at which the product is ready for general release have been
insignificant. All product development costs have been expensed.
In March 1998, the AICPA issued Statement of Position (SOP) No. 98-1,
Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use, which requires capitalization of certain software
development costs for software developed for internal use. The Company
plans on adopting SOP No. 98-1 beginning July 1, 1998 and does not
anticipate a material impact upon adoption of this standard.
F-10
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
(n) Stock-Based Compensation
The Company accounts for its stock-based compensation arrangement in
accordance with provisions of Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense under fixed plans would
be recorded on the date of grant only if the fair value of the
underlying stock at the date of grant exceeded the exercise price.
SFAS No. 123, Accounting for Stock-Based Compensation, requires
entities that continue to apply the provisions of APB Opinion No. 25
for transactions with employees to provide pro forma net income and
pro forma earnings per share disclosures for employee stock option
grants made in 1995 and future years as if the fair-value-based method
defined in SFAS No. 123 had been applied to these transactions.
(2) Property and Equipment
Property and equipment at June 30, 1998 consist of the following:
Trailer $ 11,670
Equipment 252,840
--------
264,510
Less accumulated depreciation 151,337
--------
$113,173
========
Depreciation expense totaled $151,337, $20,822 and $38,096 for the period
from July 1, 1988 (inception) through June 30, 1998 and the years ended
June 30, 1997 and 1998, respectively.
(3) Services Received in Exchange for Common Stock
The Company values common stock issued in payment for services provided to
the Company based either on third-party billings or the estimated fair
value of the common stock issued. During fiscal year 1991, two individuals
(one a board member) each received 20,000 shares of common stock in payment
for services provided to the Company. These services were valued at $10,000
based on the estimated fair value of the common stock issued.
In October 1995, the Company issued 20,000 shares of common stock for legal
services provided to the Company valued at $20,000 based on third-party
billings.
F-11
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
(4) Related Parties
(a) Accounts Payable - Stockholder
At June 30, 1998, the Company owed $21,737 to a stockholder of the
Company for business expenses.
(b) Consulting Services and Wages
The Company's policy is to pay wages and consulting fees to two key
stockholders on a basis consistent with available cash flows. Wages
and consulting fees to these individuals, Gale Burnett, President, and
Henry Gemino, Executive Vice-President, were approximately $1,121,000,
209,000 and $242,000 for the period from July 1, 1988 (inception)
through June 30, 1998 and the years ended June 30, 1997 and 1998,
respectively.
Additional consulting fees were paid to a stockholder of the Company,
Dr. John Kuo, totaling approximately $267,000, $80,000 and $118,000
for the period from July 1, 1988 (inception) through June 30, 1998 and
the years ended June 30, 1997 and 1998, respectively. Included in
other accrued liabilities are amounts owing to the stockholder
totaling $60,000 at June 30, 1998.
(c) Royalty Arrangement
In July 1988, the primary technology rights used by the Company were
contributed by Northwood Enterprises Inc. (NEI), a company
wholly-owned by certain Company stockholders. In exchange for
contributing the technology, the Company agreed to pay a royalty of 4%
of the Company's net earnings before taxes to certain Company
stockholders. When the Company becomes profitable, royalties will be
due quarterly. In March 1996, an additional 1% was given to a director
of the Company in exchange for his expertise, technological know-how
and proprietary information and trade secrets.
(d) Facilities
Since 1991, two of the Company's officers/stockholders have provided
the use of their homes for office facilities and research development
activity at no additional charge to the Company.
(5) Income Taxes
Federal income taxes reported by the Company differ from the amount
computed by applying the statutory rate due primarily to limitations on
utilizing net operating losses.
F-12
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
The tax effect of temporary differences that give rise to significant
portions of Federal deferred tax assets are comprised of the following at
June 30, 1998:
Deferred tax assets:
Net operating loss carryforwards $ 742,000
Stock compensation 292,000
Research and experimentation credit carryforwards 75,000
----------
Gross deferred tax assets 1,109,000
Less valuation allowance 1,109,000
----------
Net deferred tax assets $ --
==========
The net increase in the valuation allowance for deferred tax assets was
$436,145 and $253,000 for the years ended June 30, 1997 and 1998,
respectively. The increases were primarily due to increases in the amount
of net operating loss carryforwards that could not be utilized and stock
compensation.
For Federal income tax purposes, the Company has net operating loss
carryforwards at June 30, 1998 available to offset future Federal taxable
income, if any, of approximately $2,182,000 which begin to expire in 2003.
In addition, the Company has research and experimentation tax credit
carryforwards of approximately $75,000 at June 30, 1998 which are available
to offset income taxes and begin to expire in 2003.
The utilization of the tax net operating loss carryforwards may be limited
due to ownership changes that have occurred as a result of the sale of
common stock.
(6) Stockholders' Equity
(a) Stock Split
In December 1995, the Company authorized a 2-for-1 stock split of the
Company's common stock and a change in par value to $.001. All share,
par value and per share information has been adjusted for all periods
presented to reflect the stock split and par value change.
(b) Stock Warrants and Stock-Based Compensation
The Company has granted stock warrants to compensate key employees,
consultants and board members for past and future services. The stock
warrants are generally exercisable immediately at the date of the
grant. The Company extended the exercise period on certain warrants to
October 2001 from October 1999 which resulted in compensation expense
in the amount of $210,000 in December 1994. The related warrants were
originally granted in November 1991 and September 1993.
F-13
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
In March 1996, the Company extended the exercise period on all stock
warrants to October 2004 which resulted in compensation expense of
$90,000.
In November 1996, the Company recorded noncash compensation expense
totaling $559,154 related to warrant transactions. The Company issued
a warrant to purchase 285,000 shares of common stock to a consultant
at an exercise price of $3.50 per share and a warrant to its attorney
to purchase 10,000 shares of common stock at an exercise price of
$7.20 per share. The Company also agreed to issue warrants to purchase
25,000 shares of common stock with an exercise price of $7.20 to each
of its two of its nonemployee directors. In addition, the Company's
principal shareholder agreed to assign warrants to purchase 50,000
shares of common stock at $3.00 per share to other employees,
directors and shareholders of the Company. In connection with the IPO,
the Company issued warrants to the underwriter to purchase 100,000
shares of common stock at $8.40 per share.
The following is a summary of warrants outstanding at June 30, 1998:
Warrants oustanding
-----------------------------------------------------------------
Weighted-average Number of
Number remaining warrants
Exercise prices outstanding contractual life exercisable
--------------- ----------- ---------------- -----------
$ 1.125 320,000 6.33 320,000
1.500 40,000 6.33 40,000
3.000 270,000 6.33 270,000
3.500 285,000 6.33 285,000
7.200 105,000 6.33 105,000
8.400 100,000 4.67 100,000
13.500 20,000 6.33 20,000
--------------- ----------- --------------- -----------
3.59 1,140,000 6.18 1,140,000
=============== =========== =============== ===========
F-14
<PAGE>
PROFILE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1998
The Company applies APB Opinion No. 25 and related interpretations in
accounting for warrant grants to employees. Had compensation cost for
the Company's warrant awards been determined consistent with SFAS No.
123, the Company's net loss would have been increased to the pro forma
amounts indicated below:
Years ended June 30
----------------------------
1997 1998
------------- ------------
Net loss:
As reported $ 1,035,003 712,827
Pro forma 1,171,003 800,827
Net loss per share:
As reported $ .29 .17
Pro forma .33 .19
The weighted average fair value per share of the warrant grants or
extensions made during the years ended June 30, 1997 and 1998, where
the fair value of the underlying stock equaled the exercise price, was
approximately $1.27 and $0, respectively, and the number of warrants
were 60,000 and 0, respectively.
The weighted average fair value per share of the warrant grants or
extensions made during the years ended June 30, 1997 and 1998, where
the exercise price was above the fair value of the underlying stock
was $0 and $4.40, respectively, and the number of warrants were 0 and
20,000, respectively.
The weighted average fair value per share of the warrant grants or
extensions made during the years ended June 30, 1997 and 1998, where
the exercise price was below the fair value of the underlying stock,
was approximately $1.85 and $0, respectively and the number of
warrants were 335,000 and 0, respectively.
The fair value of warrant grants is estimated using the Black-Scholes
option pricing model with the following weighted average assumptions
used for grants in fiscal years 1997 and 1998: expected volatility of
50%, risk-free interest rate of 6%, expected lives ranging from three
to six years; and a 0% dividend yield.
(7) Operating Leases
The Company leases office facilities in Washington State and New York State
under operating lease agreements that expire at various dates. Aggregate
minimum rental payments on operating leases as of June 30, 1998 are $17,100
in fiscal year 1999.
Total rent expense under the operating leases was $5,700 and $39,600 during
the years ended June 30, 1997 and 1998, respectively.
F-15
<PAGE>
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
With Section 16(a) of the Exchange Act.
The Company will file with the Securities and Exchange Commission a
definitive Proxy Statement to be distributed in connection with the Company's
Annual Meeting of Shareholders to be held on November 14, 1998. Such Proxy
Statement will be filed with the Securities and Exchange Commission not later
than October 15, 1998. The information required by this Item 9 is incorporated
by reference from the Proxy Statement.
Item 10. Executive Compensation.
The information required by this Item 10 is incorporated by reference from
the Proxy Statement.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item 11 is incorporated by reference from
the Proxy Statement.
Item 12. Certain Relationships and Related Transactions.
The information required by this Item 12 is incorporated by reference from
the Proxy Statement.
Item 13. Exhibits and Reports on Form 8-K.
(a) Exhibits
(3)
(i) Articles of Incorporation(1)
(ii) Bylaws(2)
(10.1) Royalty Agreement(3)
(10.2) Assignment of Patent Rights(4)
(10.3) Consulting Agreement with Dr. John Kuo(5)
(23.1) Consent of Independent Certified Public Accountants
(27.1) Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended June 30,
1998.
16
<PAGE>
(1) Incorporated by reference to Exhibit 3.1 to the Registration Statement
on Form SB-2 of Profile Technologies, Inc. filed with the Securities and
Exchange Commission on May 10, 1996. (333- 4714-NY)
(2) Incorporated by reference to Exhibit 3.3 to the Registration Statement
on Form SB-2 of Profile Technologies, Inc. filed with the Securities and
Exchange Commission on May 10, 1996 (333- 4714-NY)
(3) Incorporated by reference to Exhibit 10.1 to the Registration Statement
on Form SB-2 of Profile Technologies, Inc. filed with the Securities and
Exchange Commission on May 10, 1996. (333- 4714-NY)
(4) Incorporated by reference to Exhibit 10.2 to the Registration Statement
on Form SB-2 of Profile Technologies, Inc. filed with the Securities and
Exchange Commission on July 31, 1996 (333- 4714-NY)
(5) Incorporated by reference to Exhibit 10.3 to the Registration Statement
on Form SB-2 of Profile Technologies, Inc. filed with the Securities and
Exchange Commission on July 31, 1996. (333- 4714-NY)
17
<PAGE>
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, thereunto duly
authorized.
PROFILE TECHNOLOGIES, INC.
By: /s/ G.L. Scott
----------------------------------
G.L. SCOTT
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signatures Title Date
---------- ----- ----
/s/ G.L. Scott Chairman, Principal Sept. 18, 1998
- - ---------------------- Executive Officer,
G.L. SCOTT Director
/s/ Henry Gemino Executive Vice- Sept. 18, 1998
- - ---------------------- President, Chief
HENRY GEMINO Operating Officer,
Chief Financial Officer,
Principal Accounting
Officer, Director
/s/ Gale D. Burnett President, Director Sept. 18, 1998
- - ----------------------
GALE D. BURNETT
/s/ Murphy Evans Director Sept. 18, 1998
- - ----------------------
MURPHY EVANS
/s/ John Tsungfen Kuo Director, Chief Sept. 18, 1998
- - ---------------------- Technical Consultant
John Tsungfen Kuo
/s/ Allen G. Reeves Director Sept. 18, 1998
- - ----------------------
ALLEN G. REEVES
18
Consent of Independent
Certified Public Accountants
The Board of Directors
Profile Technologies, Inc.:
We consent to incorporation by reference in the registration statement (No.
333-53575) on Form S-3 of Profile Technologies, Inc. of our report dated August
18, 1998, relating to the balance sheet of Profile Technologies, Inc. as of June
30, 1998, and the related statements of operations, stockholders' equity, and
cash flows for each of the years in the two-year period ended June 30, 1998 and
for the period from July 1, 1988 (inception) through June 30, 1998, which report
appears in the June 30, 1998, annual report on Form 10-KSB of Profile
Technologies, Inc.
Seattle, Washington
September 18, 1998
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