U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-KSB
(Mark one)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No Fee Required)
For the transition period from _________ to _________
Commission file number 0-29192
Puradyn Filter Technologies, Incorporated (formerly T/F Purifiner, Inc.)
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(Name of small business issuer in its charter)
Delaware 14-1708544
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3020 High Ridge Road, Suite 100
Boynton Beach, Florida 33426
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (561) - 547-9499
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
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Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.001 par value
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(Title of class)
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(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the 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 its most recent fiscal year. $1,352,663.
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days.
Common stock, par value $.001 per share ("Common Stock"), was the only class of
voting stock of the Registrant outstanding on August 15, 1998. Based on the
closing price of the Common Stock quoted on the OTC Bulletin Board as reported
on August 15, 1998 ($.375), the aggregate market value of the 1,683,406 shares
of the Common Stock held by the persons other than officers, directors and
persons known to the Registrant to be the beneficial owner (as that term is
defined under the rules of the Securities and Exchange Commission) of more than
five percent of the Common Stock on that date was approximately $631,000. By the
foregoing statements, the Registrant does not intend to imply that any of these
officers, directors or beneficial owners are affiliates of the Registrant or
that the aggregate market value, as computed pursuant to rules of the Securities
and Exchange Commission, is in any way indicative of the amount which could be
obtained for such shares of Common Stock.
(ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PAST FIVE YEARS)
Check whether the issuer has filed all documents and reports required to be
filed by Section12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes _____ No _____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: May 20, 1998: 5,206,379.
This report contains a total of 69 pages.
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PART I
All discussions herein give effect to a 2.5:1 forward stock split for all
stockholders of record as of January 1, 1997, except as otherwise specifically
set forth. Unless the context otherwise implies, the term "Company" refers to
Puradyn Filter Technologies, Incorporated (formerly known as T/F Purifiner,
Inc.) and T/F Systems, Inc., as described more fully below.
ITEM 1. DESCRIPTION OF BUSINESS
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Other than historical and factual statements, the matters and items discussed in
this Annual Report on Form 10K-SB are forward-looking statements that involve
risks and uncertainties. Actual results of the Company may differ materially
from the results discussed in the forward-looking statements. Certain factors
that could contribute to such differences are discussed with the forward-looking
statements throughout this report.
Recent Events and Strategy
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In late March 1998, several key employees and Directors were either
terminated or resigned from their positions with the Company. These individuals
included the Company's Executive Officer, who was also a Director, Vice
Presidents of Sales and Marketing, and Technology, its Controller and two
members of the Board of Directors. Subsequent to these actions, the Company's
sole Director is Richard C. Ford.
At or about the same time, the Company curtailed its operations and
reduced its remaining workforce to key personnel. These actions were taken for a
number of reasons, of primary importance was reducing the amount of cash
required to maintain operations of the Company while it continues to seek to
arrange additional financing and replace certain personnel who are no longer
with the Company. There can be no assurance that such financing or other
alternatives, such as selling the Company, will be accomplished. Without further
financing it is unlikely that the Company will be able to sustain operations.
As a result of the Company's performance and in light of the recent
events discussed above, the Company is in the process of reevaluating its
strategy as discussed below.
As the Purifiner has had limited acceptance in the marketplace, the
Company's strategy has been to obtain product credibility by disproving the
long-held conviction that oil must be changed regularly in accordance with
manufacturers' recommended guidelines. Gradually, the credibility of the
Purifiner and the concept of extended oil replacement intervals is becoming more
readily accepted. The Company believes that this increasing acceptance is due to
successful third-party testing of the product, awards and other recognition the
Purifiner has received and the increased awareness of consumers as well as
vehicle, engine and oil companies that oil, if kept continually clean, will have
a significantly longer, useful life resulting in significant cost and
environmental benefits.
The Company is currently working with certain original equipment
manufacturers ("OEM's") to enable them to evaluate the benefits of the Purifiner
with the goal of obtaining their approval of the Purifiner and eventually to
install the Purifiner on their products at their
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factories and distribute the Purifiner throughout their dealer networks (See
"Marketing"). These OEM's are mindful of the significant competitive benefits of
extended drain intervals and the environmental and related regulatory
considerations of the use of an oil purification system such as the Purifiner.
Currently, the Company is refocusing its new distribution network and
direct sales activities, primarily in the heavy-duty truck marketplace,
primarily in the United States, although it does have some international
distributors to which it allocates limited amounts of resources. The Company
also formed a foreign joint venture effective January 1, 1996, to market the
Purifiner through Europe, the Middle East, the former Soviet Union, Egypt, and
South Africa. (See "Distribution" for recent events related to this joint
venture). In the future, the Company plans to expand its distribution channels
worldwide, as well as the number of market segments on which it focuses.
The Company had employed direct sales personnel to help establish and
service its aftermarket distributors and to directly sell its products to
certain major national accounts. Additionally, the Company employed technical
and installation personnel to assist customers in analyzing the benefits of the
Purifiner through oil analysis, as well as answering technical questions and
assisting with the training and installation on the use of the Purifiner. In the
future, the Company may also consider additional joint ventures to manufacture
and/or market its products in various parts of the world.
There can be no assurance that the Company will be able to successfully
implement its strategies.
Risk Factors
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Potential for Continuing Losses; Accumulated Deficit; Explanatory Paragraph in
Independent Auditors' Report
Prior to 1993, the Company was engaged in limited sales activities.
Consequently, the Company has had a limited operating history upon which an
evaluation of the Company's prospects and performance can be made. The Company's
prospects must be considered in light of risks, expenses, difficulties and
delays frequently encountered in connection with the formation and early phase
of operation of a new business, the development and commercialization of new
products based on innovative technology and the high level of competition in the
industry in which the Company operates. The Company has had significant losses
in each year of its operations. In addition, the Company has an accumulated
deficit, which amounted to approximately $10,300,000 as of June 30, 1998.
Significant losses continued for the second quarter of the Company's fiscal
year, and it is likely that significant losses will continue until such time, if
ever, as the Company is able to generate a level of revenue sufficient of offset
these continuing early-phase expenditures. There can be no assurance that the
Company will be able to successfully implement its business strategy, that its
revenues will increase in the future or that it will ever be able to achieve
profitable operations.
The Company's independent auditors have included an explanatory
paragraph in their report on the Company's financial statements stating that the
Company's recurring operating
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losses and negative cash flows from operating activities raise substantial doubt
about its ability to continue as a going concern.
Dependence on Significant Customers
During 1997, fourteen of the Company's customers accounted for
approximately 56% of the Company's revenues, and one customer accounted for 11%
of the Company's revenues. Termination of the arrangements with any of these
significant customers could have a material adverse effect on the Company's
financial condition or operations. There can be no assurance that the Company
will retain any or all of these customers or, if such customers are not
retained, that the Company would be able to attract and retain new customers to
replace the revenues currently generated by these significant customers.
Uncertainty of Product and Technology Development; Technological Factors
The Company has not completed development and testing of certain of its
proposed products and proposed enhancements to its products, some of which are
still in the planning stage or in relatively early stages of development. The
Company's success will depend in part upon the ability of its proposed products
to meet targeted performance and cost objectives, and will also depend upon
their timely introduction into the marketplace. The Company will be required to
commit considerable time, effort and resources to finalize development of its
proposed products and product enhancements. Although the Company anticipates
that the development of its products and technology will be successfully
concluded, its product development efforts are subject to all of the risks
inherent in the development of new products and technology (including
unanticipated delays, expenses and difficulties, as well as the possible
insufficiency of funding to complete development). There can be no assurance as
to when, or whether, such product development efforts will be successfully
completed. In addition, there can be no assurance that the Company's products
will satisfactorily perform the functions for which they are designed, that they
will meet applicable price or performance objectives or that unanticipated
technical or other problems will not occur which would result in increased costs
or material delays in their development. There can be no assurance that, despite
testing by the Company and by current and potential end users, problems will not
be found in new products after the commencement of commercial shipments,
resulting in loss of or delay in market acceptance.
Limited Marketing Activity; Uncertainty of Market Acceptance
The Company has only recently commenced limited marketing and sales
activities relating to its products and has limited financial, personnel and
other resources to undertake extensive marketing, sales and advertising
activities. To date, the Company has generated limited revenues from the sale of
its products, which have achieved only limited market acceptance. Demand for the
Company's products and the Company's proposed products will depend principally
upon consumer demand for the Purifiner. The oil filtration industry has
historically been competitive, and as is typically the case with innovative
products, the ultimate level of demand for the Company's products is subject to
a high degree of uncertainty. Developing market acceptance for the Company's
existing and proposed products will require substantial marketing and sales
efforts and the expenditure of a significant amount of funds to inform consumers
of the benefits and cost advantages of its products and achieve name
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recognition. There can be no assurance that the Company will be able to
penetrate existing markets on a wide scale basis or position its products to
appeal to mainstream consumer markets or that any marketing efforts undertaken
by the Company will result in increased demand for or market acceptance of the
Company's existing and proposed products. The Company relies, and intends to
continue to rely, in part, on arrangements with third parties for the marketing
of its products, including arrangements with distributors and other strategic
partners. There can be no assurance that they or the company will be able to
successfully market the Company's products or that their efforts will result in
any significant increase in revenues.
Dependence on Suppliers
A substantial portion of the Company's products' component parts are
manufactured by various suppliers for assembly by the Company. The Company
believes its relationships with its suppliers are satisfactory and that
alternative suppliers are available if relationships falter or existing
suppliers are unable to keep up with the Company's requirements. However, there
can be no assurance that the Company's current or future suppliers will be able
to meet the Company's requirements on commercially reasonable terms or within
scheduled delivery times. An interruption of the Company's arrangements with
suppliers could cause a delay in the production of the Company's products for
timely delivery to distributors and customers. The absence of suitable
manufacturing arrangements would have a material adverse effect on the Company's
operations.
Dependence on Distributors
The Company currently sells its products through distributors for
resale to other distributors or customers, and is highly dependent upon
acceptance of its products by such distributors, customers and their active
marketing and distribution efforts relating to the Company's products. Most of
the distributors to whom the Company sells it products, including those that are
contractually obligated to purchase the Company's products in order to maintain
their distribution territories, could discontinue carrying the Company's
products at any time. Due to increasing competition, distributors are
increasingly in a stronger position to negotiate favorable terms of sale,
including price discounts and product return policies. There can be no assurance
that the Company will be able to increase or maintain its distribution, and as a
result, the Company's operating results could be adversely affected.
Competition; Technological Obsolescence
Although there is limited competition in the electric mobile oil
purification system market, the market for full-flow oil filters, in general,
and by-pass oil filters, in particular, is characterized by intense competition.
To the extent that the Company's products reduce oil consumption, full-flow oil
filter sales and disposal costs and extend engine life, the Company's products
compete with, or affect the sales of, many well established companies. These
companies have substantially greater financial, technical, personnel and other
resources than the Company and have established reputations for success in the
development, licensing and sale of their products and technology. Certain of
these competitors have the financial resources necessary to enable them to
withstand substantial price competition or downturns in their markets. In
addition, certain companies may be expected to develop technologies or products
which may be functionally similar to some or all of those being developed by the
Company.
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Industry standards with respect to the markets for the technology and products
being developed by the Company may be characterized as evolving, which often
results in product obsolescence or short product life cycles. Accordingly, the
ability of the Company to compete will depend on its ability to complete
development and introduce into the marketplace in a timely manner its proposed
products and technology, to continually enhance and improve such products and
technology, to adapt its proposed products to be compatible with specific
products manufactured by others, and to successfully develop and market new
products and technology. There can be no assurance that the Company will be able
to compete successfully, that its competitors or future competitors will not
develop technologies or products that render the Company's products and
technology obsolete or less marketable or that the Company will be able to
successfully enhance its proposed products or technology or adapt them
satisfactorily.
Dependence on Key Personnel
The success of the Company will be largely dependent on the efforts of
the members of the management of the Company. The Company has not as yet entered
into employment agreements with various members of the management of the
Company, and there can be no assurance that such persons will continue their
employment with the Company. The loss of the services of one or more of such key
personnel would have a material adverse effect on the Company's ability to
maximize its use of its products and technologies or to develop related products
and technologies. The success of the Company also in dependent upon its ability
to hire and retain additional qualified executive, engineering and marketing
personnel. There can be no assurance that the Company will be able to hire or
retain such necessary personnel. The Company does not presently have "key man"
life insurance with respect to members of its management.
Product Concentration
Although the Company has taken steps to broaden its product offerings,
sales of the Purifiner and related products and enhancements are expected to
continue to account for a substantial portion of the Company's sales for the
foreseeable future. Future growth will depend upon acceptance of the Purifiner
by a broader group of customers. Failure to achieve broader acceptance would
have a material adverse effect on the Company's financial condition and results
of operations. In addition, any factors adversely affecting the Purifiner, such
as the introduction of superior products or shifts in the needs of the
marketplace, would have a material adverse effect on the Company's financial
condition and results of operations.
Significant Outstanding Payables
At March 31, 1998, the Company owed approximately $473,000 in current
liabilities to various trade and other unrelated creditors. The inability to
obtain credit on commercially reasonable terms, or at all, resulting in an
interruption of supplies or services, would have a material adverse effect on
the Company's operations.
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Risks Associated With Proposed International Operations and International
Distribution
The Company may enter joint ventures with foreign partners, and the
Company has already entered into one joint venture at this time. Although there
can be no assurances that this will occur on a large scale, if they were to
occur, such operations would be subject to a number of risks, including longer
payment cycles, unexpected changes in regulatory requirements, import and export
restrictions and tariffs, difficulties in staffing and managing foreign
operations, the burden of complying with a variety of foreign laws, greater
difficulty in accounts receivable collection, potentially adverse tax
consequences, currency fluctuations and political and economic instability.
Additionally, the protection of intellectual property of the Company may be more
difficult to enforce outside of the United States. In the event that the Company
is successful in expanding its international operations, the imposition of
exchange or price controls or other restrictions on foreign currencies could
materially affect the Company's business, operating results and financial
condition.
Part of the company's sales are made through distributors in foreign
countries. Sales through these distribution channels are also subject to a
number of risks, including unexpected changes in regulatory requirements, import
and export restrictions and tariffs, and currency fluctuations and political and
economic instability.
Product Protection, Expiration of Patents and Patents Pending Infringement
The Company's success is heavily dependent upon its proprietary
technology. The Company relies on a combination of contractual rights, patents,
trade secrets, trademarks, non-discloure agreements and technical measures to
establish and protect its proprietary rights. There can be no assurance that the
steps taken by the Company to protect its proprietary rights will be adequate to
prevent misappropriation of the technology or independent development by others
of products with features based upon, or otherwise similar to, those of the
Company's products. In addition, although the Company believes that its
technology has been independently developed and does not infringe on the
proprietary rights of others, there can be no assurance that the Company's
technology does not and will not so infringe or that third parties will not
assert infringement claims against the Company in the future. In the case of
infringement, the Company would, under certain circumstances, be required to
modify its products or obtain a license. There can be no assurance that the
Company would be able to do either in a timely manner or upon acceptable terms
and conditions, and such failure could have a material adverse effect on the
Company. In addition, there can be no assurance that the Company will have the
resources to defend a patent infringement or other proprietary rights
infringement action.
One patent licensed by the Company expired on November 18, 1997; two
other patents will expire September 15, 1998 and June 6, 2008. The expiration of
these patents may have an adverse competitive effect on the Company. The Company
has obtained U.S. patents and/or some foreign patents for its Filter Plus
Filter, a redesigned Purifiner and a new oil flow meter based on patents filed
in 1994 through 1996. There can be no assurance that the patents pending for
these new products in various foreign countries will be issued or that they will
provide meaningful proprietary protection.
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Possible Fluctuations in Operating Results
The Company's operating results may fluctuate significantly from period
to period as a result of a variety of factors, including product returns,
purchasing patterns of consumers, the length of the Company's sales cycle to key
customers, distributors and other strategic partners, the timing of the
introduction of new products and product enhancements by the Company and its
competitors, technological factors, variations in sales by product and
distribution channel, and competitive pricing. Consequently, the Company's
product revenues may vary significantly by quarter, and the Company's operating
results may experience significant fluctuations.
Limited Market for the Company's Securities
There is currently only a limited trading market for the Common Stock
of the Company. The Common Stock of the Company trades on the OTC Bulletin Board
under the symbol "PFTI", which is a limited market and subject to substantial
restrictions and limitations in comparison to the NASDAQ System. While the
Company expects to apply for inclusion of its Common Stock on NASDAQ (Small Cap)
at such time as its securities comply with applicable criteria for inclusion,
there can be no assurance the Company's Common Stock will ever qualify for
inclusion within the NASDAQ System or that more than a limited market will ever
develop for its Common Stock.
Certain Legal Proceedings
Certain legal matters that may present risks to the Company relating to
patent infringements, license agreements and other claims can be found below in
"Item 3, Legal Proceedings".
Introduction
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The Company owns the rights to manufacture, market and distribute
worldwide the Purifiner(R), a bypass oil purification system for use with
substantially all internal combustion engines, generators and other types of
equipment that use lubricating oil. The Purifiner cleans oil by continually
removing solid and liquid contaminants from the oil through a sophisticated and
unique filtration and evaporation process. The Purifiner has been used
successfully to substantially extend oil-drain intervals and to extend the time
between engine overhauls to up to three times longer than traditional intervals.
The Company also manufactures (with one exception) and sells disposable
replacement filter elements ("Elements") for the Purifiner.
By keeping the oil continually clean, the Purifiner effectively extends
engine life and dramatically reduces new oil purchases as well as maintenance
time and the costs and environmental concerns involved in the storage and
disposal of waste oil. In addition, according to customer statements, extensive
testing done by Southwest Research Institute (an independent third party testing
laboratory) on an improved heavy duty engine oil that supports improved fuel
efficiency from the use of this new oil, and the growing industry recognition
that operating an engine with cleaner oil will reduce engine energy losses due
to friction, wear, and oil viscosity fluctuations, the Company believes that end
users will experience improved fuel economy.
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Background and Formation of Puradyn Filter Technologies, Incorporated
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The patents issued on the oil purification system that, after further
development, has evolved into the current Purifiner units, were issued in the
early 1980's. The owners of such patents attempted to market and sell the
original system under various other tradenames, but were not successful. The
factors to which that could be attributed, include (a) the failure of potential
customers to understand the importance or possibility of continually clean oil
and belief that extended drain interval could be practical; (b) lack of consumer
awareness of the importance of the environmental benefits inherent in the
Purifiner; (c) the absence of acceptance and endorsement by engine and vehicle
manufacturers; (d) general disbelief that the product would perform as claimed
and could provide benefits in a cost-effective manner; (e) inadequate
capitalization, and (f) limited management experience.
In 1987, T/F Systems, Inc., a Delaware corporation ("Systems") , of
which Richard C. Ford and Willard H. Taylor (deceased) were equal stockholders,
obtained certain limited distribution rights to the Purifiner in several states
from Refineco Manufacturing Company, Inc. ("Refineco"), then located in Oakland
Park, Florida (Byron Lefebvre, currently an employee of the Company, was then
the President of Refineco). In 1988, Systems obtained an option to acquire the
exclusive manufacturing and marketing rights to the Purifiner in the event
Refineco, and subsequently, Purifiner Distribution Corporation of Chicago,
Illinois, were unable to meet their commitments to supply Purifiners to Systems.
As a result of a default, a failure of the manufacturer to meet this supply
commitment, Systems obtained the worldwide manufacturing and marketing rights to
the Purifiner in 1990.
In February 1988, Puradyn Filter Technologies, Incorporated (formerly
T/F Purifiner, Inc.) was incorporated in Delaware under the name "Econology
Systems, Inc." On October 16, 1990, the name was changed to "T/F Purifiner,
Inc." The Company was inactive until 1991, when it obtained the distribution and
marketing rights to the Purifiner by virtue of an assignment from Systems (at
the time owned equally by Messrs. Ford and Taylor) . However, System's ownership
of the rights to the Purifiner were contested in court by other third parties
who were also manufacturing and marketing a device similar to the Purifiner and
using the Purifiner trademark. Eventually, the court ruled in favor of Systems
with respect to its manufacturing and marketing rights, and in May 1993 all
appeals by the other parties were exhausted. During the period of this
litigation, the Company continued to market the Purifiner, but success was
limited due to various factors including the pending litigation and the actions
by these other parties in the marketplace.
Prior to December 31, 1995, Puradyn Filter Technologies, Incorporated
("Puradyn"), was the exclusive distributor and Systems was the exclusive
manufacturer of the Purifiner. On December 31, 1995, in exchange for any claims
Puradyn had in the delay damage award, Puradyn purchased all operating assets
and assumed all operating liabilities of Systems, except for (a) any benefits
and/or liabilities related to a delay damage judgment awarded in December 1994
against the other parties discussed above, and (b) liabilities related to
certain stockholder advances made to Systems by Ford and Taylor. Accordingly,
Puradyn currently owns all manufacturing rights previously owned by Systems.
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Prior to Mr. Taylor's death in May 1993, Mr. Taylor and Mr. Ford had
each contributed equal amounts of working capital to the Company and each owned
50% of the issued and outstanding capital stock. Following Mr. Taylor's death,
despite Mr. Ford's subsequent investments in the Company, the business
activities and growth of the Company had been hampered by, among other things,
insufficient capital. Commencing in early 1996 through January 1998, the Company
has raised net proceeds of approximately $6.6 million through the issuance of
debt or equity securities to finance its operations. The Company is continuing
to incur operating losses, which has resulted in cash flow difficulties and the
continuing need for additional financing. The inability of the Company to obtain
adequate financing when needed, will have a material adverse effect on the
Company, including requiring the Company to significantly curtail or cease its
operations.
On February 4, 1998, the Company filed a Certificate of Amendment to
its Certificate of Incorporation which changed its name from T/F Purifiner, Inc.
to Puradyn Filter Technologies Incorporated.
Products
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The Purifiner Oil Purification System dramatically extends the life of
lubricating oil in gas and diesel engines as well as hydraulic fluid used in
industrial machinery. The core product, the Purifiner, can be attached to any
engine. In essence, it works like a dialysis machine that filters blood to rid
it of impurities, so it keeps the oil in engines continually clean. Whenever the
engine or machinery is operating, the Purifiner is extracting from the oil solid
particles down to less than one micron (1/39 millionth of an inch), as well as
liquid contaminants (water, fuel and antifreeze). As the Purifiner dramatically
extends the useful life of the oil, it also protects engines from the harmful
wear caused by contaminants in oil. As dirty, damaging oil does not come in
contact with the engine, the result is less down time for maintenance and longer
engine life. Further, not only are oil purchases drastically reduced, but as
used hydraulic fluids are recovered and no waste oil is generated, the need for
and cost of disposal decline dramatically.
Thus, the Purifiner reduces maintenance costs by decreasing oil
consumption, engine wear, increased fuel economy, and the necessity for
overhauls and certain other types of general maintenance. All these savings are
achieved from utilizing the Purifiner which has a relatively short payback
period, which in some cases is less than one year. Accordingly, the Purifiner
achieves great savings and, therefore, increased profits for its end users.
The Purifiner is manufactured in six different sizes suitable for
placement on engines or equipment with oil sump capacities ranging from 5 to 240
quarts. The Purifiner also can be used in multiples for larger oil sumps.
Qualified personnel can usually install the Purifiner on engines and other
equipment in approximately 1 1/2 to 2 hours.
The Company also has developed and sells a Hydraulic Batch System
("HBS") which is mounted on a hand cart for mobility. The HBS was developed to
clean 55-gallon drums of used hydraulic oils, which substantially reduces oil
purchases as well as the high costs of storing and disposing of used oil in
compliance with environmental regulations. The HBS consists primarily of two
60-quart Purifiners, a preheater, a pump and other miscellaneous parts.
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All Purifiners are compatible with virtually all standard and synthetic
oils on the market and they work with engines using gasoline, diesel, propane or
natural gas. Except for the HBS, the Purifiner cannot be used on engines without
a pressurized lubricating system, and neither can be used on an outboard boat
motor, which mixes oil with the fuel.
The Purifiner consists of a canister that can be mounted on the
firewall, fender well, frame of a vehicle or on other convenient locations,
depending on the particular application. The canister inlet is connected either
to the engine's oil-pressure sending unit or, for hydraulic applications, a
pressure line. The outlet is connected to the sump. The canister houses the
Element and an evaporation chamber heated by an enclosed heating element. Under
pressure from the engine or equipment, engine oil enters the canister via a
metering jet that regulates the flow of oil to approximately three and six
gallons per hour, depending on the size of the Purifiner. The oil passes slowly
through the Element, where solid contaminants in the oil are trapped. The
Element includes compacted long-strand natural cotton fibers that retain solid
particles as small as approximately one micron. A conventional paper oil filter
will typically remove particles down to 15-30 microns. According to a paper
published by the Society of --Automotive Engineers in its SAE Paper No. 660081,
dated January 1966, "filtering the used oil through a 5-micron filter did not
significantly reduce the wear rate; however, when the oil was filtered through a
1 micron filter, there was a significant reduction." The natural cotton
filtering media in the Element also absorbs water, traps sulfur and neutralizes
the acids which are left in the oil by conventional paper filters. The slow rate
at which the oil passes through the Element helps ensure maximum contaminant
retention.
After filtration the oil flows slowly over the diffuser plate located
in the dry-heated evaporation chamber where it is heated to a temperature of
approximately 200 degrees Fahrenheit (slightly higher on the HBS model) to
enable the removal of the liquid contaminants including water, fuel and coolant.
The stainless steel heating element is sealed in aluminum and, for safety is,
completely isolated from direct contact with the oil. The liquid contaminants
are evaporated and then vented out of the Purifiner before they can recondense
in the oil. These gases and water vapor are vented back into the induction
system and are consumed in the combustion process or vented to atmosphere. (On
hydraulic applications, the water vapor is vented into the atmosphere.) The
cleaned oil then flows back to the engine crankcase via gravity. These processes
continue whenever the equipment or engine is operating.
The Company also manufactures and distributes its replacement Elements
for the Purifiner with the exception of the TF8SP. The Company generally
recommends that the Element be replaced at the engine manufacturer's
recommended/approved periodic oil change interval (with one exception for one
model currently used for gasoline applications only, the Company generally
recommends that the Element be replaced every ten thousand miles or 250 hours
when used for gasoline powered automobiles and vans or as oil analysis
dictates). The Company recently introduced a U.S. patent approved oil-flow meter
which enables the user to visually confirm that the oil is flowing through the
Purifiner. The useful life of oil and the Element is dependent on several
factors, including the quality of the oil used, type of fuel, condition of
engine, and the type and operating environment of the equipment. Accordingly,
the change intervals mentioned above may vary. Elements can be changed and an
oil sample taken in approximately five to fifteen minutes by the customer.
11
<PAGE>
The Company estimates that the current cost of an oil and full
flow-filter change (assuming a person does not do the oil change himself or
herself) is approximately $100 or more for heavy duty trucks. The cost varies
depending on, among other things, the type of engine and application, labor and
oil costs, and costs of waste oil disposal. Depending on the size of the
Purifiner Element, the current suggested prices for retail end-users of the
Elements range from approximately $8.75-29.50 and the cost of an oil analysis
purchased through the Company currently costs approximately $8.50 per sample.
The Company has recently received patents from the United States Patent
Office and certain other countries for a new Element (the "TFP Filter Plus"), in
which pelletized chemicals are added to the filtering media. The chemicals are
antioxidants which will reduce the amount of oxidation, stabilize the alkalinity
and further help reduce the acid build-up of the oil. This is especially
important on new engines built since enactment of the Clean Air Act of 1992,
which requires tighter specifications for diesel engines. As these engines
consume less oil, the amount of makeup oil that is added, which also replenishes
the consumed additives in older engines, has decreased. The TFP Filter Plus
helps compensate for this factor.
When the Element is changed, make-up oil is added to replace any oil
retained in the used Element or consumed in the normal engine combustion
process. The Company's performance warranties for product used in the United
States and Canada requires the user to take a small sample of the used oil for
submission to an oil testing laboratory at the same intervals that the OEM
recommends/approves for an oil change, but at least once a year. (See
"Warranties.") The Purifiner has an oil sample valve to expedite the taking of
the oil sample. The current customer cost of testing an oil sample ranges from
de minimis (if a customer has access to a testing facility) to approximately
$8.50. The cost of an oil sample may exceed $8.50 in certain foreign countries.
Users must maintain a record of the laboratory oil analysis results in
order for the Company's warranties to remain in effect. Management believes that
the risk of losing the Purifiner's warranties encourages customers to complete
the oil analysis and replace Elements in a timely manner, making the Purifiner
more effective and stimulating recurring Element sales. The oil analysis also
helps the Company monitor customer satisfaction, and should a problem arise with
a particular application, the Company and the customer can work together to
address the problem and find a solution on a timely basis. Finally, oil analysis
has been analogized to blood samples for humans, in that through proper analysis
other problems occurring within the engine or equipment, apart from oil
contamination, can be diagnosed and corrected before incurring significant
problems. To date, there have been no material warranty claims, although there
can be no assurances that such a trend will continue. Due to the sometimes
prohibitive cost of oil analyses and generally more frequent
recommended/approved oil change intervals for engines used in certain countries
outside the United States and Canada, primarily due to the poorer quality of oil
and fuel used, not all performance warranties for Purifiner products (whether
offered by the Company or by the Company's distributors) used outside the United
States and Canada require oil analyses at the OEM recommended/approved oil
change intervals.
The Purifiner has no moving parts and consequently requires no
significant ongoing maintenance. The Purifiner has an in-line pre-strainer to
prevent the metering jet from becoming clogged by large contaminant particles.
As long as the Elements are changed at the recommended/approved intervals, and
other standard preventive maintenance procedures are
12
<PAGE>
performed, the Company believes that the Purifiner will perform as designed.
Purifiners used for hydraulic applications do not require as frequent Element
changes since hydraulic oil applications typically do not contain the level of
contaminants as other oil applications. In order to maintain the Company's
performance warranties, users must, among other things, change the full flow
filters once a year or every 50,000 to 60,000 miles or 1500 hours, depending on
the particular application of the Purifiner. The cost of changing a full flow
filter is part of the cost of an oil change, as discussed above.
The Company has received acknowledgments from Deere & Company, Detroit
Diesel Corporation, Caterpillar, Inc., Ford Motor Company, Mack Trucks, Inc.,
Cummins Engine Company, Inc., Chrysler Motors Corporation, Mercedes Benz of
North American, Inc. and others, who have all stated that the installation and
use of the Purifiner does not void their manufacturer's warranties. Most engine
manufacturers will accept oil analyses as alternatives to their recommended oil
change intervals. Management believes that the existence of other longer-life
oils in the marketplace which allow for extended oil drains has been and will
continue to exert continuing pressure on the use of oil analysis as an
acceptable alternative to engine manufacturer's recommended oil change
intervals, as will the cost, environmental and other benefits obtained from
extended oil drain intervals.
Marketing
- ---------
The Company' s products are eventually expected to be marketed to
numerous market segments, including trucking, marine, agricultural, bus,
recreational vehicle, generator, construction, mining, industrial and hydraulic
applications, and other users of engines or equipment that utilize up to 50
weight oil for lubrication. Currently, the primary focus is on the on-highway
segment.
To date, the Company has not expended any material amounts to advertise
its products in the marketplace and has relied upon editorials, trade shows and
other methods to promote its products. However, the Company has expended
material amounts in its selling efforts. During 1994 and subsequently, the
Company's products have achieved recognition from well-known sources, including
(i) certification by the California Environmental Protection Agency's Department
of Toxic Substances as a "Pollution Prevention Technology", (ii) receipt of the
State of Florida' s 1995 Governor' s New Product Award (Small Business
Category), (iii) receipt of the National Society of Professional Engineers 1996
New Product Award "for innovative use of engineering principals and materials,
improved function and savings in use and benefit to the national economy" (Small
Business Category) ; and (iv) receipt of the World Trade Center's (Ft.
Lauderdale, Florida) 1996 Award for Outstanding Achievement in International
Trade (Manufacturing) . Management believes that such recognition has and will
continue to enable the Company to increase the credibility and acceptance of its
products.
In February 1996, the Purifiner gained the support of the American
Oceans Campaign ("AOC"), a not-for-profit organization devoted to ensuring the
earth's waters are kept free of contamination and pollution. Management believes
that the association with AOC and similar groups will be a cost-effective way to
promote the Purifiner and increase its sales. However, no assurance can be given
that such associations will be successful in promoting the Company's products.
13
<PAGE>
In April 1996, the Company made arrangements to help facilitate
retrofit sales of the product at the end user level. Leasing Services,
Incorporated ("LSI") , with principal offices located in Solana Beach,
California and Boston, Massachusetts, is a national leasing company that will
provide lease financing to certain of the Company's users, subject to normal
credit considerations with respect to the user. Many customers have found the
up-front cost of purchasing the Purifiner to be prohibitive for large scale
retrofits. Lease financing will enable the user to immediately benefit from
reduced maintenance expenses and to pay for the Purifiner from such savings over
variable terms. The Company has no written agreement with LSI, receives no
consideration from LSI and merely provides its customers with LSI's brochure
which explains LSI's services.
With this arrangement, the Company and its distributor network are able
to provide to its customers a complete product package, that includes the
Purifiner, installation assistance and third party financing. Management
believes the ability to provide a turnkey program should provide the Company
with a competitive edge. However, no assurance can be given that this approach
will result in increased revenues to the Company and to date this arrangement
with LSI has not resulted in any material increase in revenues.
The Company relies on management's ability to determine the existence
and extent of available markets for its product. Company management and
consultants had considerable sales and marketing backgrounds and devoted a
significant portion of their time to sales related activities. The Company has
marketed its products at various national trade shows, including the
International Truck Show in Las Vegas, Nevada, Mid-America Truck Show in
Louisville, Kentucky, the Maintenance Council Show in Orlando, Florida, the
ConAgra Show in Las Vegas, Nevada and others.
Management believes that the ultimate success of its product will
depend on the approval of and sales directly to OEMs and through their
distribution networks. A number of international and domestic engine and truck
OEMs are currently evaluating the Company' s products, such as Mack Trucks,
Freightliner Trucks (trucks), and Detroit Diesel Corporation (engines). There
can be no assurance that these or other OEMs will accept the Company's products
for original placement on their equipment or directly approve the use of the
Purifiner with their equipment. The Company's joint venture has recently entered
into a supply contract with an international engine manufacturer and expects to
sell a private label Purifiner to them commencing in 1998. To date, the
Company's customers have requested that the Purifiners be installed at a Volvo
USA factory (North Carolina), Navistar International factory and a Mack Truck
factory on a very limited number of vehicles.
14
<PAGE>
Distribution
- ------------
The Company currently distributes its products through several channels
under the Purifiner trademark. To date, purchasers of the Company's products
have included USF Dugan, Carroll's Foods, Cyprus Bagdad Corporation, Dade County
Schools, Fort Worth Carriers, Coca Cola Enterprises, Sysco Foods, Vulcan
Chemicals and others.
The Company currently does not have written distribution agreements
with its smaller domestic and Canadian distributors, however the Company did
require these domestic and Canadian distributors to make an initial purchase of
a minimum dollar amount of the Company's Products. All distributors (domestic
and foreign) must pay in a timely fashion. With substantially all its
international distributors, the Company has entered into written distribution
agreements which typically memorialize the minimum dollar amount or units to be
purchased and the shipping terms.
The Company has warehouse distributors located in the United States and
Canada, primarily in the heavy-duty trucking industry. The remaining
distributors are located primarily in South America, England (See
"Distribution") and the Far East. These distributors purchase product directly
from the Company and sell to their existing or new customers. Late in 1997, the
Company decided to curtail the use of substantially all U.S. manufacturers
representatives, except for one primarily industrial agent in the Mid-Central
U.S., whose job it was to establish and service warehouse distributors and
introduce the Company's products to selected fleets. These responsibilities are
now performed primarily by direct employees. The Company does utilize
manufacturers representatives in the recreational vehicle market, and in Canada,
to enable the Company's personnel to focus its efforts on the US on-highway
segment. The Company pays its manufacturer's representatives negotiated
commission rates, depending on the level of services provided. The
manufacturer's representative contracts can be canceled by either party on 30 to
60 days notice.
During 1997, 31 customers accounted for approximately 73% of the
Company's net sales, 14 of which accounted for approximately 56% of the
Company's net sales and one customer accounted for approximately 11% of Company
net sales. There are no assurances that each or all of these customers will
continue to do business with the Company and the loss from one or a combination
of the Company's significant customers could have a material adverse affect on
the Company's revenues.
TF Purifiner Ltd. Pursuant to a joint venture agreement (the "Centrax
Agreement") dated December 18, 1995 (but effective January 1, 1996), the Company
became a stockholder in TF Purifiner Ltd. ("Ltd."), an English company limited
by shares and formed under England's Company's Act 1985. The other stockholders
and parties to the agreement include Centrax, Ltd., the Barr family (the "Barr
Family") who includes Messrs. Richard H.H. Barr, C. Robert Barr, the Chief
Executive Officer of Centrax, and Richard A. Barr, Albert N. Davies, of Devon,
England (who is not an affiliate of Centrax or the Barr Family). Centrax,
located in Devon, England, had sales of approximately $87 million for 1997 from
its worldwide activities in power generation and specialist aero-engine
components. The principal stockholders of Centrax include Richard H. H. Barr, C.
Robert Barr and Richard A. Barr (the Barr Family), who are also directors of
Centrax.
15
<PAGE>
Ltd.'s primary purpose is to market and establish distribution for the
Purifiner throughout Europe, the Middle East, the former Soviet Union, Egypt and
South Africa (the "Territory"). In this regard, the Company has granted to Ltd.
its rights under existing licenses, trademarks, and patents with respect to
existing products and its rights with respect to future products to allow for
the marketing and distribution of the products in the Territory. Ltd. also had
the option to manufacture the products based upon market acceptance and other
factors which it exercised in 1997.
Puradyn owns approximately 45% of Ltd. and has a 50% voting interest,
however, the Board of Directors is controlled by Centrax representatives.
Forty-five (45%) percent is owned by Centrax and the remaining approximately 10%
is owned by Mr. Davies. Puradyn is not obligated to fund any of the operations
of Ltd., which, pursuant to the Centrax Agreement, may be provided (i) by
borrowings by Ltd. from a bank; (ii) from Centrax; or (iii) from the Barr
Family, such borrowings or guarantees by the Barr Family or Centrax shall be
made until such time as Ltd. is self-funding. If the Barr Family does not fund
Ltd.'s operations, the Company has the right to take back Ltd.'s manufacturing,
marketing and distribution rights, as well as any patent and trademark rights
assigned or to be assigned to Ltd. by the Company for this Territory. To date,
Ltd. is negotiating to establish, and/or has established distributors or taken
over the servicing of existing Company distributors in various countries,
including the United Kingdom, Italy, France, Turkey, the Czech and Slovak
Republics, Norway, Denmark, Bahrain, The Netherlands, Sweden, Hungary, Republic
of Ireland, Poland, Finland, Spain and Portugal. There can be no assurance that
such distributors will be successful in introducing the Purifiner in their
territories as they will face obstacles similar to those the Company and its
other distributors have encountered in introducing an innovative technology in
their territories. Further, there can be no assurance that Ltd's other 45% owner
(Centrax), which is responsible for the ultimate funding of Ltd., will continue
to fund Ltd.'s operations; discontinuing such funding could have a material
adverse effect on the Company's operations in this Territory. Ltd. has also
commenced or completed various Purifiner evaluation programs, including those on
a large United Kingdom ("U.K.") based fleet. This U.K. test was recommended by a
large international engine manufacturer and has been successfully completed,
however, this fleet has decided not to purchase the Purifiner, even though the
engine company has approved its use. In 1998, Ltd. entered into a supply
contract with this international engine manufacturer and expects to sell a
private label Purifiner to them commencing in 1998.
Centrax has filed patents pending on a product consisting of a full
flow and bypass oil filter, all housed in one Purifiner unit, as well as a
side-by-side full-flow and Purifiner bypass filter design. These patent pending
products were designed primarily for original equipment placement by OEMs. The
Company is commencing to negotiate with Centrax regarding the
ownership/licensing of these pending patents and the rights to distribute these
products within and outside the Territory. There can be no assurance that such
negotiations can be successfully completed. The Company has the right to
distribute any new products developed by Ltd. everywhere other than the
Territory. Additionally, the Company is negotiating with Centrax concerning
other matters, including the possible discontinuation of the joint venture with
Centrax. The ultimate outcome of the negotiations cannot be determined at this
time.
16
<PAGE>
Navistar International Dealers
- ------------------------------
In 1995, the Company entered into aftermarket programs with Navistar in
the United States and Canada as part of its agreement to provide Navistar
dealers with the Company's product line. The aftermarket program has provided
the Company with the opportunity to be invited to participate in Navistar trade
fairs, but that program is not part of any written agreement between the Company
and Navistar. However, the Company's Products are included in Navistar's catalog
programs for the United States and for Canada which are sent to Navistar
dealers. Finally, the Company may be given the opportunity to participate in
advertising programs initiated by Navistar, but to date has only done so on a
limited basis in Canada. These aftermarket programs are administered by Navistar
and, to date, have not resulted in a significant number of new Navistar dealers
purchasing Product from the Company.
Navistar is the first major truck manufacturer that has agreed to an
aftermarket program with the Company. Management plans to work with other truck
manufacturers, in addition to Navistar, to establish additional aftermarket
programs. No assurance can be made that such programs will be established or if
established that they will be successful. No assurance can be given that these
sales efforts will result in significant sales for the Company.
Sales
- -----
Direct Sales. The Company directly and/or with the assistance of its
manufacturer's representatives, warehouse distributors or other agents markets
its products directly to national accounts. Typically these larger customers,
and some smaller customers, have required an evaluation period, usually ranging
from three to twelve months, to ensure that the Company's products perform as
advertised. Management believes that this evaluation period will continue to be
shortened as the Company's products gain wider acceptance and support from
well-known customers and OEM's, such as Ford Motor Company, Perkins Engine
Company and others.
Currently, the Company' s products are being evaluated by numerous
potential end users, including Ford Motor Company, Metro Dade and Broward County
Transit, Murphy Farms, CF Motor Freight, City of San Francisco, Pepsi-Cola
Company, Motor Cargo, United States Air Force, United States Postal Services,
Wal~Mart, Waste Management, Tyson Foods and others. There can be no assurance
that such evaluations will be successful and, even if successful, that they will
result in sales for the Company.
In July 1995, the Company' s products were issued National Stocking
Numbers by the General Services Administration pursuant to a contract which
expires in June 1998; the Company believes this will enable the Company to more
efficiently sell its products to the U.S. Government and its agencies. The
Company intends to enter into a new long term contract prior to September 1998.
International Sales. The Company directly and/or with the assistance of
commission based manufacturer's representatives have primarily non-exclusive
distributors in various countries, including Australia, Thailand, Colombia,
Panama, Pakistan, China, Hong Kong, Brazil and other countries. The majority of
these distributorships were established in 1995 and later; therefore, the
ultimate success of these and the other distributors depends upon, among other
things, their abilities to successfully introduce and sell the product in their
territories, including
17
<PAGE>
obtaining local evaluations, establishing distribution and other factors similar
to those faced by the Company in the United States. The Company's sales to its
Asia/Pacific distributors in 1997 was $200,000 ($249,000 in 1996) and has been
adversely affected by the weakened local economies of these nations and future
sales to these distributors are expected to be adversely effected due to these
continuing economic problems. Additionally, sales to Ltd. in 1997 were only
$55,000 versus $254,000 in 1996, and it is anticipated that if the joint venture
continues, sales by the Company to Ltd. will decrease as a result of Ltd.
commencing its own manufacturing operation. Finally, sales to South America in
1997 amounted to $151,000 versus $159,000 in 1996. Due to the focus of the
Company on the US marketplace and other factors, it is anticipated that sales in
this and other international regions may also decrease in 1998. See "TF
Purifiner Ltd." There can be no assurance that the Company's international
distributors will be successful in distributing the Company's products in their
territories.
Manufacturing and Production.
- ----------------------------
The Company subcontracts for the manufacture of component parts for its
Purifiners and manufactures substantially all of its Elements. The component
parts are assembled, packed and shipped from the Company's facility in Boynton
Beach, Florida.
The Company currently single sources (i.e. purchases each raw material
and component part from a specific vendor) substantially all of its raw
materials and component parts from various vendors in the United States.
Substantially all the tools and dies used by certain of the Company's vendors
are owned by the Company. The Company believes that there are alternative
sources of supply, and the Company does not anticipate that the loss of any
single supplier would have a material long term adverse effect on its business,
operations or financial condition. However, as the Company is currently
experiencing cash difficulties, it is especially subject to the possibility, on
the short term, that a critical unpaid vendor will cease doing business with the
Company. Management intends, subsequent to obtaining sufficient financing and as
its volume of sales increase, to obtain additional tooling and dies and to
upgrade certain of its existing manufacturing equipment and may expand its
vendor network for the purpose of limiting its exposure to its single source
suppliers. However, there can be no assurances that its volume of sales will
increase or that such additional financing will be obtained or will be
obtainable, on terms that are in the best interest of the Company or its
stockholders. The Company is in the early process of implementing QS 9000 to
ensure that the Company's product quality will consistently meet the
requirements of the trucking and automotive industries.
Warranties.
- ----------
The Purifiner carries a six-month performance warranty, and is
currently generally warranted to the original user to be free of defects in
material and workmanship for five years (previously 10 years), except for the
heating element which is currently warranted for two years (previously five
years). The Company also offers limited 250,000-mile and 100,000-mile continuous
oil purification performance warranties for Class VII and VIII trucks in the
United States and Canada and limited performance warranties for recreational
vehicles, including a twelve-month performance warranty, as well as some limited
performance warranties with a specific industrial user. The Company maintains
$2,000,000 aggregate ($1,000,000 per occurrence) product liability insurance
coverage in both the US and certain foreign markets.
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<PAGE>
Competition.
- -----------
Although the Company believes it is the largest supplier of bypass oil
purification systems (see "Legal Proceedings - Premo Litigation") , the Company
effectively competes with other bypass oil filtration products such as the
Spinner II unit of T.F. Hudgins, Inc., and the bypass filter made by Luberfiner,
Inc., The Donaldson Company, Parker Hannifin Corporation - Racor division, and
others. The Company's products affect the sales of full-flow filters,
maintenance services, replacement parts, original oil sales and oil disposal, as
well as sales of new engines.
All of these products and services are provided by companies that have
significantly greater financial, marketing and operating resources than does the
Company. Additionally, the Company's other direct competitors include Premo
Lubrication Technologies, Incorporated and Certified Technologies, Corp.
Patents and Trademarks.
- ----------------------
The Company has a license and royalty agreement (See Item 3 - "Legal
Proceedings") with the owner of two of the U.S. patents covering the Company's
existing Purifiners. These patents expire in September 1998 and June 2008. This
agreement also covers several foreign issued and pending patents in several
other countries, the earliest of which will expire in June 2004. The term of the
agreement is for the life of the patents and any improvements thereto and
requires the payment of a 5% royalty based on the net sales price, as defined,
of the covered products. This agreement also covers the U.S. Purifiner trademark
for which the Company pays a 1% royalty based on net Element sales, as defined.
The Company is primarily responsible for maintaining and defending the integrity
of these patents and trademark.
The Company has registered its product trademark ("Purifiner") in
substantially all the countries of the industrialized world (other than in the
United States, where the Company's licensor has registered the trademark) and is
registering the Puradyn trademark in the United States.
The Company has patents pending for the TFP Filter Plus and a redesigned
Purifiner in substantially all industrialized countries of the world; these were
filed by the Company in 1994 through 1996, and to date have been issued in the
United States and certain other foreign countries (See "Distribution - TF
Purifiner Ltd.). In 1996, the Company filed for U.S. patent protection for its
new oil flow meter which will enable the user to visually determine that the oil
is flowing through the Purifiner. The oil flow meter patent was approved in the
U.S. in early 1997. The Company has also been issued a US patent in 1997 on
another method of introducing additives into the oil. There can be no assurance
that such patents pending will be issued or that issued patents will be
developed into commercially viable products or withstand competitive threats to
their patentability.
Governmental Approval.
- ---------------------
The Company's products typically do not require any governmental
approvals. As part of the certification process under the California
Environmental Protection Agency's Department of Toxic Substances, in July of
1994, the Company has obtained an Executive Order issued by the
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<PAGE>
State of California Air Resources Board stating that the Purifiner does not
reduce the effectiveness of applicable vehicle pollution control systems, and
may be installed on all 1993 and older model year vehicles with pressure oil
systems.
Engineering and Development.
- ---------------------------
The Company had four employees who focused primarily on engineering and
development, prior to the termination of its Vice-President of Technology and
reassignment of his administrative assistant. One is the inventor and originator
of four U.S. patents issued to the Company in 1996 and 1997, as well as of the
most recently issued patent licensed to the Company. During the last two years
the inventor has devoted substantially all of his time to the engineering,
development and enhancement of the Company's products. The other three
employees, included the Company's former Vice President of Technology, who was
hired in September 1997 and a mechanical designer who was hired in January 1998,
who devoted substantially all their time to the engineering, development and
enhancement of the Company's products, with a current emphasis on requirements
of OEM's, and researching, developing and engineering various product
enhancements which will enable the current and future generation of Purifiners
to compete more effectively in the marketplace, and an administrative assistant.
Specifically, during 1997, the Company's engineering resources have focused on
improving product quality, including redesigning the Purifiner lid, improving
sealing and heating characteristics, improving mounting and other hardware and
banjo fittings. Certain of these improvements were required in order to
eliminate leaks from the Purifiner which occurred under certain circumstances
and resulted in various of the Company's product evaluations being extended, or
in some cases, curtailed. The Company's engineering department has focused on
the underlying reasons for these leaks and have implemented product enhancements
to resolve this problem.
Employees.
- ---------
At March 31, 1998, the Company had 14 employees, 3 of whom were engaged
in manufacturing, assembly, quality control, warehousing and shipping, 5 in
marketing, technical and installation assistance and sales, 2 in engineering and
development and 4 in administrative positions. None of the employees are
represented by a labor union. The Company believes its employee relations are
good.
ITEM 2. DESCRIPTION OF PROPERTY.
-----------------------
Substantially all of the Company's operations are conducted from its
14,500 square foot facility located in Boynton Beach, Florida. The facility is
leased for a term ending March 31, 1999 at a current annual rate of
approximately $90,000.
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<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
-----------------
Legal Proceedings.
- -----------------
Premo Litigation.
On December 8, 1994, the Company, and Robert C. Malt, filed a patent
infringement action against Premo Lubrication Technologies, Incorporated
("Premo") and Charles Borzarelli (collectively the "Defendants") in the United
States District Court for the Southern District of Florida. The Defendants
subsequently filed certain counterclaims, as amended, against Plaintiffs
including that the Company and certain of its employees have libeled the
Defendant's business and unlawfully interfered with its business relationships.
During February 1998, this case was settled with no adverse effect to the
Company.
Malt Litigation:
On January 13, 1997, Robert C. Malt, as owner of certain patents
licensed to the Company, filed an action against Puradyn Filter Technologies,
Incorporated and T/F Systems, Inc. (collectively the "Defendants") in the
Circuit Court of the 15the Judicial Circuit of Florida in Palm Beach County. Mr.
Malt has alleged that the Defendants are in breach of their license agreement
with Malt. Malt is seeking a (1) permanent injunction to enjoin the Defendants
from manufacturing and marketing the covered Purifiner products and use of the
U.S. trademark and (2) approximately $21,000 for alleged past-due breaches of
the license agreements. The Company has filed an answer to this case and is
proceeding to trial. The Company believes it has meritorious defenses with
respect to the monetary amounts alleged by the licensor patent owner, which
amount relates primarily to the timing of the royalty payment and legal fees
regarding defending certain patents pending of the licensor. The Company, upon
advice of counsel, does not believe that the Plaintiffs will be in a position to
obtain an injunction against the Company's selling of the Purifiner products. In
1998, the Company unsuccessfully attempted to settle this case in order to avoid
the costs related to ongoing litigation. This case is scheduled to go to trial
in December of 1998.
Searcy, Denny, Scarola et. al and Related Claims:
On June 24, 1997, Searcy, Denny, Scarola, Barnhardt & Shipley, P.A.
("Plaintiff") filed an action in the Circuit Court of the Fifteenth Judicial
Circuit in and for Palm Beach County, Florida, against Systems, the Company,
Richard C. Ford, individually, and Controlled Fuel Systems, Inc., an inactive
Company controlled by Richard C. Ford ("Defendants") for unpaid legal fees and
costs of approximately $313,000 plus interest and attorney's fees.
In late 1990 and early 1991, the Plaintiff was engaged by Systems to
represent it in obtaining the manufacturing and marketing rights to the
Purifiner and to perform other general matters for Systems. The Plaintiff was
ultimately successful in assisting Systems in obtaining such rights. TFS was
awaiting the judgment of an appellate court which, if adjudicated in TFS's
favor, would have provided TFS with sufficient funds to pay such legal fees and
other possible legal fee claims aggregating approximately $75,000, and thereby
remove the possibility of the Company being held liable for such fees. On
February 26, 1997, the appellate court ruled against Systems and, accordingly,
the funds discussed above are not currently available to Systems to
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<PAGE>
satisfy such claims and the case involving these funds has been remanded to the
trial court for a retrial. Puradyn did not assume these obligations as part of
its purchase of Systems, and was indemnified by Systems with regard to these
claims and related expenses. Management believes such amounts are not the
responsibility of Puradyn Filter Technologies, Incorporated and intends to
vigorously defend against this action. However, Systems is an inactive company
whose only asset is the claim that was reversed on appeal and maybe retried by
Systems. Accordingly, the ability to collect such funds, as required, from
Systems is uncertain. The ultimate outcome of this litigation against the
Company cannot be determined at this time, however, based on the opinion of
counsel, a favorable outcome is likely.
Other Matters:
In addition, in the ordinary course of business, the Company has been
named in an action concerning a balance due to a vendor.
On September 8, 1998 the Company received notice from a stockholder
regarding a potential stockholders' derivative action and/or a direct negligence
action against the prior Directors and Officers. The Company advised the
stockholder that it is not pursuing any potential claim at this time. The
impact of this contingent matter is not resonably determinable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
As of February 28, 1998, there were approximately 278 stockholders of
record of the Company's stock. The closing bid price quoted on the OTC Bulletin
Board sheets for the Company's Common Stock at April 2, 1998 was $.375. Prior to
its name change the Company traded under the symbol "TFPU" and currently trades
under the symbol "PFTI".
The transfer agent for the Company's Common Stock is Florida Atlantic
Stock Transfer, Inc., 5701 N. Pine Island road, Tamarac, Florida 33321.
The Company has never declared or paid cash dividends on its Common
Stock and is restricted in doing so without the approval of Quantum Industrial
Partners LLC ("Quantum"). The Company presently intends to retain future
earnings, if any, to finance the expansion of its business and does not
anticipate any cash dividends will be paid in the foreseeable future. The future
dividend policy will depend on the Company's existing agreement with Quantum,
earnings, capital requirements, expansion plans, financial condition and other
relevant factors.
The following table sets forth for the period indicated, the high and
low closing prices for the period from October 2, 1996 (the date first quoted)
through December 31, 1996, quarterly periods in 1997, and from January 1, 1998
through March 31, 1998.
Common Stock
High Low
---- ---
October 2, 1996 - December 31, 1996 $9.05 $6.30
January 1, 1997 - March 31, 1997 10.00 7.90
April 1, 1997 - June 30, 1997 9.25 4.75
July 1, 1997 - September 30, 1997 7.75 3.25
October 1, 1997 - December 31, 1997 4.38 2.00
January 1, 1998 - March 31, 1998 3.12 1.10
April 1, 1998 - June 30, 1998 1.63 .38
July 1, 1998 - August 31, 1998 .69 .38
22
<PAGE>
The above quotation reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Other than historical and factual statements, the matters and items discussed in
this Annual Report on Form 10-KSB are forward-looking statements that involve
risks and uncertainties. Actual results of the Company may differ materially
from the results discussed in the forward-looking statements. Certain factors
that could contribute to such differences are discussed with the forward-looking
statements throughout this report.
General
The Company was formed in 1987, and commenced limited operations in 1991 when it
obtained worldwide manufacturing and marketing rights to the Purifiner(R)
products. The acceptance of the Purifiner products is the result of various
factors, including the growing desire of users to extend oil change intervals,
reduce maintenance costs, extend engine life and preserve the environment. In
1997, the Company had been unable to significantly increase its revenues through
its current distribution network. Accordingly, the Company had recently
refocused certain of its resources on the development of commercial
relationships with original equipment manufacturers ("OEM's"), which the Company
believes will result in the increasing acceptance of the Purifiner products in
the marketplace and, accordingly, increase revenues and was also in the process
of establishing a U.S. master distributor network to be formed with larger
distributors than the Company currently deals with. The Company believed these
master distributors would be in a better position, based upon their size and
experience, to expand the Purifiner sales. There can be no assurance that such
efforts to develop commercial OEM relationships and establish a successful
master distributorship organization will be successful. As previously discussed,
the Company is currently reevaluating its overall strategy, including its
allocation of resources.
Recent Events and Strategy
- --------------------------
In late March 1998, several key employees and Directors were either
terminated or resigned from their positions with the Company. These individuals
included the Company's Executive Officer, who was also a Director, Vice
Presidents of Sales and Marketing, and Technology, its Controller and two
members of the Board of Directors. Subsequent to these actions, the Company's
sole Director is Richard C. Ford.
At or about the same time, the Company curtailed its operations and
reduced its remaining workforce to key personnel. These actions were taken for a
number of reasons, of primary importance was reducing the amount of cash
required to maintain operations of the Company while it continues to seek to
arrange additional financing and replace certain personnel who are no longer
with the Company. There can be no assurance that such financing or other
alternatives, such as selling the Company, will be accomplished. Without further
financing it is unlikely that the Company will be able to sustain operations.
23
<PAGE>
As a result of the Company's performance and in light of the recent
events discussed above, the Company is in the process of reevaluating its
strategy as discussed below.
As the Purifiner has had limited acceptance in the marketplace, the
Company's strategy has been to obtain product credibility by disproving the
long-held conviction that oil must be changed regularly in accordance with
manufacturers' recommended guidelines. Gradually, the credibility of the
Purifiner and the concept of extended oil replacement intervals is becoming more
readily accepted. The Company believes that this increasing acceptance is due to
the third-party testing of the product, awards and other recognition the
Purifiner has received and increasing awareness of consumers as well as vehicle
and engine manufacturers and oil companies of the cost benefits, the Company's
warranties, as well as environmental benefits of conserving oil and reducing the
disposal of waste oil.
The Company is currently working with certain original equipment
manufacturers ("OEM's") to enable them to evaluate the benefits of the Purifiner
with the goal of obtaining their approval of the Purifiner and eventually to
install the Purifiner on their products at their factories and distribute the
Purifiner throughout their dealer networks (See "Marketing"). These OEM's are
mindful of the significant competitive benefits of extended drain intervals and
the environmental and related regulatory considerations of the use of an oil
purification system such as the Purifiner.
Currently, the Company is refocusing its new distribution network and
direct sales activities, primarily in the heavy-duty truck marketplace,
primarily in the United States, although it does have some international
distributors to which it allocates limited amounts of resources. The Company
also formed a foreign joint venture effective January 1, 1996, to market the
Purifiner through Europe, the Middle East, the former Soviet Union, Egypt, and
South Africa. (See "Distribution" for recent events related to this joint
venture). In the future, the Company plans to expand its distribution channels
worldwide, as well as the number of market segments on which it focuses.
The Company had employed direct sales personnel to help establish and
service its aftermarket distributors and to directly sell its products to
certain major national accounts. Additionally, the Company employed technical
and installation personnel to assist customers in analyzing the benefits of the
Purifiner through oil analysis, as well as answering technical questions and
assisting with the training and installation on the use of the Purifiner. In the
future, the Company may also consider additional joint ventures to manufacture
and/or market its products in various parts of the world.
There can be no assurance that the Company will be able to successfully
implement its strategies.
Results of Operations
The following table sets forth for the periods indicated the percentage of
revenues represented by certain items reflected in the Company's statements of
operations.
24
<PAGE>
Percentage of Revenues
----------------------
Year
Ended December 31,
------------------
1996 1997
---- ----
Net sales 100% 100%
Operating costs and expenses:
Cost of sales (72) (75)
Selling expenses (97) (203)
General and administrative expenses (71) (83)
Engineering and development (6) (13)
Impaired assets -- (24)
Other (1) 1
----- ------
Total operating costs and expenses (247) ( 397)
----- ------
Operating loss (147)% (297)%
===== ======
Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
Net Sales. Net sales increased by 2% from $1,327,230 in 1996 to
$1,352,663 in 1997. This small increase was primarily attributable to the effect
of the Company's increased direct US selling efforts offset by the effect of the
Company's price reductions implemented in the last quarter of 1996, reduced
international sales in 1997, inability to turn material evaluations into sales
in 1997 and the overall market resistance seen in 1997 to purchase the Purifiner
in large volume amounts without long term evaluation periods and the acceptance
of the Purifiner by major engine and truck manufacturers. The Company believes
this market resistance will turn around in 1998 as major engine and truck
manufacturers are currently evaluating extended drain intervals and bypass
filtration methods, including the Purifiner, as a means to help meet various
federal emissions regulations, as well as for competitive advantage in the
marketplace. The approach by which the Company was dealing with its minimal
revenue growth is discussed below. Additionally, during 1996, the Company had
approximately $254,000 of sales to Ltd., the Company's joint venture formed in
1996 compared to approximately $55,000 in 1997. Approximately $8,000 of
intercompany profit on these sales to Ltd. have been deferred at December 31,
1997.
Effective October 15, 1996, the Company implemented a new product
pricing strategy to reduce the Company's selling prices to enable end users to
obtain a significantly improved return on investment. The Company believed this
new strategy would promote the sale of the Company's products and result in
increased long-term revenues from unit and replacement filter sales and also
provide the Company with the ability to reduce its product costs, primarily
through 1) volume purchase discounts, 2) utilization of excess fixed
manufacturing capacity and 3) improved production processes. To date, the
Company has not realized the significant increase in revenues it had anticipated
as a result of lowering its selling prices and, accordingly, also did not
realize the anticipated cost savings related thereto. Therefore, the Company's
gross margin was adversely affected. Accordingly, effective November 1, 1997,
the Company revised its pricing strategy and substantially increased the U.S.
prices of substantially all the Purifiner units
25
<PAGE>
in order to recapture various cost increases from product improvements, material
cost increases and to position the Purifiner pricing to be in alignment with the
Company's strategy to sell Purifiners to Original Equipment Manufacturers
("OEM's"). The Company was currently refocusing certain of its resources in an
effort to sell the Purifiner directly to OEM's, as well as establishing a new
master distributor network There can be no assurance that the OEM's will
eventually purchase the Purifiner from the Company or that the new master
distributors will be successful in increasing Purifiner sales. The Company's
November 1997 price increase will not affect certain ongoing evaluations which
have been quoted at October 15, 1996 prices and certain international
distributors for a limited time period.
Cost of Sales. Cost of sales increased by 7% from $956,628 in 1996 to
$1,019,317 in 1997. The Company's gross margin decreased slightly from 27.9% to
24.6%. The gross margin decrease from years prior to 1996 was due to the
significant price reductions implemented in 1996, cost increases to the product
incurred primarily for improvements and material price increases and excess
fixed cost manufacturing capacity offset by the reduction of sales made to Ltd.
at substantially lower sales prices than the Company's international distributor
pricing. Unless the Company can increase its revenues, it gross margins will
continue to be adversely affected by its excess fixed cost manufacturing
capacity.
Selling Expenses. Selling expenses increased by 112% from $1,290,563 in
1996 to $2,740,188 in 1997. The primary reasons for this increase were the
increases in various selling expenses such as salaries for new personnel and
consultants, compensatory stock options, office and related expenses,
advertising, product evaluation and installation expenses, recruiting and
restructuring expenses related to the severance of various direct salespeople in
1997, and travel and related expenses in 1997 versus 1996 offset by a $200,000
write off of patent costs in 1996. As a percentage of revenues, selling expenses
increased from 97% in 1996 to 203% in 1997.
Commencing in late 1996, but primarily in the first two quarters of
1997, the Company began implementing a product evaluation program, whereby it
would supply Purifiner units, replacement filters and installation services at
no cost to certain potential customers or to assist its distributors potential
customers, to evaluate the effectiveness of the Purifiner. The costs related to
this evaluation program have been charged to selling expenses and no revenues
have been recognized. To the extent these evaluations are not successful or the
Company is unable to consummate these potential sales, the Company's future
revenues will be adversely effected. To date, only a limited number of these
evaluations have been converted to actual sales. A primary reason for the
Company's inability to convert these evaluations into actual sales and the
extension of the evaluation periods, or in some cases their curtailment, has
been the fact that under certain circumstances the Purifiner has leaked. The
Company's engineering department has focused on the underlying reasons for these
leaks and have implemented product enhancements to resolve this problem.
General and Administrative Expenses. General and administrative
expenses increased by 18% from $947,417 in 1996 to $1,121,888 in 1997 and, as a
percent of revenues, G & A increased from 71% to 83%. This dollar increase was
generally due to the increased level of business activity, specifically
including increases in salaries for new personnel and consultants, office and
related expenses, travel, and professional fees offset by a reduction in
contributions and compensatory stock option and warrant expenses. The Company's
significant computer programs are Year 2000 compliant.
26
<PAGE>
Engineering and Development Expenses. Engineering and development
expenses increased by 144% from $75,078 in 1996 to $183,468 in 1997 and, as a
percent of revenues, increased from 6% to 13%. This increase was primarily the
result of increased personnel costs, compensatory stock options and a refocusing
on the reengineering of the Purifiner.
Impairment. In the fourth quarter of 1997, the Company wrote down the
unamortized amount of costs in excess of net assets acquired and wrote down to
$1 each the amount of patents and trademarks due to impairment of the respective
amounts based on anticipated cash flows. Such costs amounted to $324,330 for the
year ended December 31, 1997.
Operating Loss. As a result of the foregoing, the Company's operating
loss increased from $1,959,759 in 1996 to $4,026,921 in 1997.
Interest Expense and Income. Interest expense increased from $25,354 in
1996 to $460,050 in 1997. This increase resulted from an increase in average
short and long term borrowings outstanding in 1997 versus the comparable period
in 1996, specifically the $2,000,000 short term loan from QIP, which resulted in
$447,000 of interest expense. Interest income increased from $1,843 in 1996 to
$62,846 in 1997 as a result of investing idle cash balances and interest earned
on a note receivable from its former president, which note was repaid in June
1997.
Net Loss. As a result of the foregoing, the Company's net loss
increased from $1,983,270 for 1996 to $4,424,125 for 1997.
Year Ended December 31, 1996 Compared with Year Ended December 31, 1995
Net Sales. Net sales decreased by 10% from $1,480,037 in 1995 to
$1,327,230 in 1996. This decrease was primarily attributable to the effect of
the Company's price reductions implemented in 1996 and related merchandise
credits. During 1996, the Company had approximately $254,000 of sales to Ltd.,
the Company's newly formed joint venture in 1996 compared to approximately
$85,000 to one of Ltd.'s shareholders in 1995. Approximately, $17,000 of
intercompany profit on these sales to Ltd. have been deferred at December 31,
1996.
Effective October 15, 1996, the Company implemented a new product
pricing strategy to reduce the Company's selling prices to thus enable end users
to obtain a significantly improved return on investment. The Company believed
this new strategy would promote the sale of the Company's products and result in
increased long-term revenues from unit and replacement filter sales and also
provide the Company with the ability to reduce its product costs, primarily
through 1) volume purchase discounts, 2)utilization of excess fixed
manufacturing capacity and 3) improved production processes. If the Company does
not realize these cost savings, its gross margin will be adversely effected. In
the fourth quarter of 1996, as a result of this price reduction, various
merchandise credits were issued by the Company, to those of its distributors who
met certain conditions. These merchandise credits have had an adverse effect on
the Company's results of operations in such period.
Cost of Sales. Cost of sales increased by 34% from $712,714 in 1995 to
$956,628 in 1996. The Company's gross margin decreased from 51.8% to 27.9%,
substantially all due to the
27
<PAGE>
19% of 1996 sales made to Ltd. at substantially lower sales prices than the
Company's existing exclusive international distributor pricing, and the
significant price reductions implemented in 1996. To the extent that additional
sales are made by the Company to Ltd., or if its international distributors
account for an increasing proportion of sales, the Company's aggregate gross
margin will be adversely affected as compared to prior periods.
Selling Expenses. Selling expenses increased by 109% from $616,569 in
1995 to $1,290,563 in 1996. The primary reasons for this increase were the
increases in other selling expenses such as salaries for new personnel,
compensatory stock options, commissions, brochures and catalogs, consulting,
travel and trade show expenses in 1996 versus 1995. Additionally, in the fourth
quarter of 1996, the Company received approval of its United States patent for
the next generation of the Purifiner. Accordingly, the Company wrote off
approximately $200,000 of patent costs related to its prior generation of
Purifiners. As a percentage of revenues, selling expenses increased from 42% in
1995 to 97% in 1996.
General and Administrative Expenses. General and administrative
expenses increased by 101% from $470,565 in 1995 to $947,417 in 1996 and, as a
percent of revenues, increased from 32% to 71%. This dollar increase was
generally due to the increased level of business activity, specifically
including increases in personnel, compensatory stock options, travel and
professional fees.
Engineering and Development Expenses. Engineering and development
expenses increased by 23% from 61,081 in 1995 to $75,078 in 1996 and, as a
percent of revenues, increased from 4.1% to 5.7%. This increase was primarily a
result of increased personnel and supply expenses.
Operating Loss. As a result of the foregoing, the Company's operating
loss increased from $380,892 in 1995 to $1,959,759 in 1996.
Interest Expense. Interest expense decreased by 12% from $28,915 for
1995 to $25,354 for the 1996. This change resulted from a decrease in average
short and long term borrowings outstanding in 1996, versus the comparable period
for 1995. The loans were used to finance a portion of the Company's activities
in 1995 and 1996.
Net Loss. As a result of the foregoing, the Company's net loss
increased from $409,807 for 1995 to $1,983,270 for 1996.
28
<PAGE>
Liquidity and Capital Resources
To date, the Company's capital requirements in connection with its
business activities have been and will continue to be significant. To fund its
activities, the Company has been dependent upon available cash generated from
operations, the proceeds of sales of its securities to investors and
stockholders, and other loans, including the June 1997 $2,000,000 borrowing from
QIP and the January 1998 $500,000 borrowing from QIP. The Company's independent
auditors' report includes an explanatory paragraph which states that because the
Company has sustained recurring operating losses and negative cash flows from
operating activities substantial doubt is raised about the Company's ability to
continue as a going concern.
In late March 1998, the Company curtailed its operations and reduced
its remaining workforce to key personnel. These actions were taken for a number
of reasons, of primary importance was reducing the amount of cash required to
maintain operations of the Company while it continues to seek to arrange
additional financing.
At December 31, 1997, the Company had working capital of $407,645 and
its current ratio (current assets to current liabilities) was 1.65 to 1, as
compared with a working capital of $1,727,933 and a current ratio of 3.1 to 1 at
December 31, 1996. At December 31, 1997, the Company had $252,874 of cash and
cash equivalents. Outstanding short-term debt from lenders and shareholders was
$144,849 at December 31, 1997 and included a former shareholder loan of $103,501
due to the Estate of Willard Taylor (See Note 4 to the Notes to Financial
Statements) which was repaid in January 1998. The balance of long term debt was
$2,337,167 at December 31, 1997, and included a former shareholder loan of
$295,024 due to the Estate of Willard Taylor and $2,008,000 due to QIP (see
Notes 4 and 10 to the Notes to Financial Statements). The proceeds from the QIP
loans shall be used solely for general operating expenses, repayment of current
Estate loan and to hire additional sales employees for the Company.
At December 31, 1997, the Company had approximately $337,000 in current
liabilities to various trade and other unrelated creditors. These creditors
continue to provide services to the Company; however, there can be no assurance
that they will continue to do so in the future while all or a portion of such
amounts remains outstanding. The Company has made certain payments and intends
to use a portion of existing funds and future financings, if any, to repay the
amounts due to creditors.
At June 30, 1998, the Company had a cash overdraft of approximately
$23,000, negative working capital of approximately $538,000 and owed
approximately $487,000 in current liabilities to various trade and other
unrelated creditors. Most of these creditors continue to provide services to the
company or have indicated a willingness to restructure these obligations, accept
Common Stock of the Company in exchange for a certain portion of these
obligations, or defer for the current time payment of these obligations.
However, one creditor, who claims to be owed approximately $72,000, has
initiated suit against the Company, and the Company is seeking to defend this
lawsuit based, in part, on what is believed to be excessive charges alleged by
this creditor. There can be no assurances that creditors will continue to
provide service to the Company or that other creditors will continue to refrain
from initiating lawsuits against the Company in the future.
29
<PAGE>
The Company continues to seek both short term and long term investment
commitments from various institutions and investor groups. The Company's
director, Richard C. Ford, has loaned to the Company $150,000 in May and June
1998 under one year notes payable at 12% interest. On August 21, 1998 the
Company entered into a Revolving Note Agreement with its bank for $250,000 with
interest at 8.75%. The Note is secured by substantially all of the Company's
assets and is guaranteed by Richard C. Ford, a shareholder and director of the
Company. The Note is due August 21, 1999. Management believes that such funding,
along with revenues the Company expects to generate from existing customers and
as a result of commitments from present and prospective customers will provide
the Company with sufficient cash resources through December 1998. There can be
no assurances, however, that such cash resources will be sufficient during that
time or that the Company will be able to obtain additional financing from either
members of management or other investors. In the absence of sufficient revenues
or financing, the Company may be unable to sustain its operations.
Consistent with industry practices, the Company may accept product
returns or provide other credits in the event that a distributor holds excess
inventory of the Company's products. The Company's sales are made on credit
terms which vary significantly depending on the nature of the sale. In addition,
the Company does not hold collateral to secure payment from its United States
and Canadian distributors. Therefore, a default in payment by one or more of the
Company's United States and Canadian distributors or customers could adversely
affect the Company's business, results of operations and financial condition.
The Company believes it has established sufficient reserves to accurately
reflect the amount or likelihood of product returns or credits and uncollectible
receivables. However, there can be no assurance that actual returns and
uncollectible receivables will not exceed the Company's reserves. Any
significant increase in product returns or uncollected accounts receivable
beyond reserves could have a material adverse effect on the Company's business,
results of operations and financial condition. The Company has not experienced
material product returns or uncollectible receivables in the past, however,
there can be no assurance that such trends will continue in the future.
Sales of the Company's products will depend principally on end user
demand for such products and acceptance of the Company's products by original
equipment manufacturers ("OEM's"). The oil filtration industry has historically
been competitive and, as is typically the case with innovative products, the
ultimate level of demand for the Company's products is subject to a high degree
of uncertainty. Developing market acceptance, particularly worldwide, for the
Company's existing and proposed products will require substantial marketing and
sales efforts and the expenditure of a significant amount of funds to inform
customers of the perceived benefits and cost advantages of its products.
Impact of Inflation
Inflation has not had a significant impact on the Company's operations.
However, any significant decrease in the price for oil or labor, environmental
compliance costs, and engine replacement costs could adversely impact the
Company's end users cost/benefit analysis as to the use of the Company's
products.
30
<PAGE>
Quarterly Fluctuations
The Company's operating results may fluctuate significantly from period
to period as a result of a variety of factors, including product returns,
purchasing patterns of consumers, the length of the Company's sales cycle to key
customers and distributors, the timing of the introduction of new products and
product enhancements by the Company and its competitors, technological factors,
variations in sales by product and distribution channel, and competitive pricing
and general economic conditions throughout the industrialized world.
Consequently, the Company's product revenues may vary significantly by quarter
and the Company's operating results may experience significant fluctuations.
Events
Management Focus
- ----------------
In addition to investing money in the company, Richard C. Ford,
Founder, Director and Largest single stockholder has returned on a full-time
basis and together with new management, the Company has set a course to
significantly reduce expenses. Concurrent with this priority, particular
attention will be focused on delivering a higher quality product while putting
into effect new marketing techniques aimed at developing systems for enhancing
customer service and developing profitable sales.
New Management
- --------------
The company has appointed Alan J. Sandler as its President/COO and
Chief Financial Officer effective June 29, 1998. He will be responsible for
leading the total management, planning and operation of the company. Most
recently, Mr. Sandler served as President,CEO and then consultant of Hood Depot,
Inc., a national restaurant supply manufacturer/distributor with offices in
Deerfield Beach. From 1979-1995, he was President/CEO of Sandler & Sons Dental
Supply Company, a regional Distributor of dental supplies and equipment, based
in St. Louis. Previous to this position, Mr. Sandler was a Vice-President of
Gardner Advertising Company in St. Louis.
Sales
- -----
Sales efforts by the Company have resulted in the following:
/bullet/ Contract negotiations with North Carolina and Florida school
districts for Puradyn unit installation to their buses.
/bullet/ Product purchases of 210 units by Metro Dade County during July,
August and September, 1998 and approximately an additional 400
Puradyn units during the last quarter of 1998 to the first
quarter of 1999.
/bullet/ A major waste hauler has given the approval for use of Puradyn
units and has provided the Company contacts for each of its
locations.
31
<PAGE>
/bullet/ Negotiations are in the process for an initial sale to a major
branch of the US Government following completion of a 14-month
successful field test evaluation.
/bullet/ A large engine manufacturer will complete the final phase of
on-going tests where Puradyn units appeared to have performed
effectively; a purchase decision is anticipated during the fourth
quarter of 1998 or the first quarter of 1999.
/bullet/ A major transit system in the US recently agreed to begin an
extensive test of Puradyn units lasting into the fourth quarter
of 1998.
/bullet/ Other numerous evaluations are in progress that management feels
should close in the last quarter of 1998 to the first quarter of
1999.
Options Granted
- ---------------
As a means of showing appreciation for past performance and in
anticipation of valuable future contribution, the company had awarded stock
options in the amount of 40% of base salaries to all employees other than
management employed as of July 2, 1998. Options will vest At 25% per year over a
period of four years with the first vestation occuring July 1, 1999.
32
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
--------------------
Puradyn Filter Technologies, Incorporated
Contents
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report..................................................................F-2
Audited Financial Statements
Balance Sheet as of December 31, 1997.........................................................F-3
Statements of Operations for the years ended December 31, 1996 and 1997.......................F-4
Statements of Changes in Stockholders Equity (Capital Deficiency)
for the years ended December 31, 1996 and 1997.............................................F-5
Statements of Cash Flows for the years ended December 31, 1996 and 1997.......................F-6
Notes to Financial Statements................................................................F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders of
Puradyn Filter Technologies, Incorporated
We have audited the accompanying balance sheet of Puradyn Filter
Technologies, Incorporated (formerly known as T/F Purifiner, Inc.) as of
December 31, 1997, and the related statements of operations, changes in
stockholders' equity (capital deficiency) and cash flows for each of the years
in the two-year period ended December 31, 1997. 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 enumerated above present
fairly, in all material respects, the financial position of Puradyn Filter
Technologies, Incorporated as of December 31, 1997 and the results of its
operations and its cash flows for each of the years in the two-year period ended
December 31, 1997 in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has sustained recurring operating losses and
negative cash flows from operating activities that raise substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
Richard A. Eisner & Company, LLP
New York, New York
February 20, 1998
With respect to Note 8
September 8, 1998
F-2
<PAGE>
Puradyn Filter Technologies, Incorporated
Balance Sheet
December 31, 1997
<TABLE>
<CAPTION>
<S> <C>
Assets
Current assets:
Cash and cash equivalents $252,874
Trade accounts receivable, net of allowance for doubtful
accounts of $50,000 87,142
Inventories 529,440
Prepaid expenses and other current assets 112,477
-------------
Total current assets 981,933
Property and equipment, net 362,898
Other assets 17,139
-------------
$1,361,970
=============
Liabilities and Capital Deficiency
Current liabilities:
Accounts payable - trade $206,995
Accrued expenses 175,859
Customer deposits and other 96,540
Current portion of note payable and capital lease obligations 41,393
Note payable to former shareholder 103,501
-------------
Total current liabilities 624,288
Note payable and accrued interest to shareholder 2,008,000
Note payable to former shareholder 295,024
Note payable and capital lease obligations 34,143
Deferred rent and liability to equity investee 4,063
-------------
Total liabilities $ 2,965,518
-------------
Commitments and contingencies
Capital Deficiency:
Preferred Stock, $.001 par value, 500,000 shares authorized -
Common Stock, $.001 par value, 20,000,000 shares
authorized, 5,205,879 issued and outstanding 5,206
Additional paid-in capital 7,297,522
Unearned compensatory options (17,320)
Loans and subscriptions receivable (73,931)
Accumulated deficit (8,815,025)
-------------
Total capital deficiency (1,603,548)
-------------
$1,361,970
=============
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
Puradyn Filter Technologies, Incorporated
Statements of Operations
Years ended December 31, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Net sales $1,327,230 $1,352,663
Cost of sales 956,628 1,019,317
------------ ------------
Gross profit 370,602 333,346
------------ ------------
Operating expenses:
Selling 1,290,563 2,740,188
General and administrative 947,417 1,121,888
Engineering and development 75,058 183,468
Deferred profit 17,323 (9,607)
Impaired assets - 324,330
------------ ------------
Total operating expenses 2,330,361 4,360,267
------------ ------------
Operating loss (1,959,759) (4,026,921)
Other income (expense):
Interest expense (25,354) (460,050)
Interest income 1,843 62,846
------------ ------------
Net loss $(1,983,270) $(4,424,125)
============ ============
Basic and diluted loss per common share $ (.60) $ (.86)
============ ============
Weighted average common shares outstanding 3,322,250 5,167,681
============ ============
</TABLE>
See accompanying notes to financial statements
F-4
<PAGE>
Puradyn Filter Technologies, Incorporated
Statements of Changes in Stockholders' Equity
(Capital Deficiency)
<TABLE>
<CAPTION>
Redeemable
Common Stock Common Stock Additional Unearned Loans and
---------------------- -------------------- Paid-In- Compensatory Subscription
Shares Amount Shares Amount Capital Options Receivable
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1996 - - 2,793,000 $2,793 $960,699 $ - $(7,000)
Proceeds from sale of
redeemable Common Stock, net 393,443 $ 594,000 - (23,163) - -
Issuance of Common Stock
to acquire D.B. Filters - - 90,773 91 136,909 - -
Accrued interest on
redeemable Common Stock - 30,335 - - (30,335) - -
Collection of subscriptions
receivable - - - - - - 7,000
Other issuances of
Common Stock - - 24,738 25 54,773 - -
Proceeds from sale of
Common Stock, net - - 1,331,453 1,331 3,085,671 - -
Issuance of Common Stock
in exchange for
notes payable - - 338,673 339 828,562 - -
Proceeds from exercise of
stock options, net - - 125,000 125 244,160 - -
Issuance of compensatory
stock options - - - - 442,287 (123,114) -
Expiration of redeemable
common stock put option (393,443) (624,335) 393,443 393 623,942 - -
Net loss - - - - - - -
------------------------------------------------------------------------------------------------------
Balance at
December 31, 1996 - - 5,097,080 5,097 6,323,505 (123,114) -
Cancellation of Common Stock - - (8,676) (9) (22,491) - -
Exercise of stock options, net - - 117,475 118 239,456 - (73,931)
Issuance of compensatory stock
options and warrants - - - - 357,052 (357,052) -
Amortization of unearned
compensation - - - - - 462,846 -
Issuance of stock purchase
warrant - - - - 400,000 - -
Net loss - - - - - - -
------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 - $ - 5,205,879 $5,206 $7,297,522 $(17,320) $(73,931)
======================================================================================================
(RESTUBBED TABLE)
Total
Stockholders'
Equity
Accumulated (Capital
Deficit Deficiency)
--------------------------------
<C> <C>
Balance at January 1, 1996 $(2,407,630) $(1,451,138)
Proceeds from sale of
redeemable Common Stock, net - (23,163)
Issuance of Common Stock
to acquire D.B. Filters - 137,000
Accrued interest on
redeemable Common Stock - (30,335)
Collection of subscriptions
receivable - 7,000
Other issuances of
Common Stock - 54,798
Proceeds from sale of
Common Stock, net - 3,087,002
Issuance of Common Stock
in exchange for
notes payable - 828,901
Proceeds from exercise of
stock options, net - 244,285
Issuance of compensatory
stock options - 319,173
Expiration of redeemable
common stock put option - 624,335
Net loss (1,983,270) (1,983,270)
--------------------------------
Balance at
December 31, 1996 (4,390,900) 1,814,588
Cancellation of Common Stock - (22,500)
Exercise of stock options, net - 165,643
Issuance of compensatory stock
options and warrants - -
Amortization of unearned
compensation - 462,846
Issuance of stock purchase
warrant - 400,000
Net loss (4,424,125) (4,424,125)
--------------------------------
Balance at December 31, 1997 $(8,815,025) $(1,603,548)
================================
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
Puradyn Filter Technologies, Incorporated
Statements of Cash Flows
Years ended December 31, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Operating activities
Net loss $(1,983,270) $(4,424,125)
Adjustments to reconcile net loss to net cash
used in operating activities:
Amortization 22,009 492,222
Provision for uncollectible notes receivable - 12,549
Write down of impaired assets 200,000 324,330
Issuances of Common Stock and compensatory options and warrants 341,628 462,846
Cancellation of Common Stock - (10,000)
Depreciation and amortization of property and equipment 39,365 79,534
Changes in operating assets and liabilities:
Trade accounts receivable, net (42,684) 39,664
Inventories (270,612) (89,201)
Prepaid expenses and other current assets (10,088) (94,440)
Other assets 10,691 (14,249)
Accounts payable-trade 121,049 (107,239)
Accrued expenses (88,281) 106,782
Customer deposits and other 121,638 (159,085)
Accrued interest and other payables - related parties (61,663) -
Deferred rent (8,903) (10,754)
------------- --------------
Net cash used in operating activities (1,609,121) (3,391,166)
Investing activities
Patents and trademarks (227,146) (60,092)
Purchases of property and equipment (89,920) (221,115)
Decrease (increase) in other assets, net (22,033) 10,100
Acquisition of DB Filters (1,275) -
Increase in note receivable from shareholder/officer - (200,000)
Decrease in note receivable from shareholder/officer - (200,000)
------------- --------------
Net cash used in investing activities (340,374) (271,107)
Financing activities
Decrease (increase) in deferred issuance and financing costs 4,224 (70,325)
Proceeds from issuances of Common Stock
and exercise of stock options, net 2,892,873 1,194,737
Collection of subscription receivables 7,000 -
Proceeds from notes payable 300,000 20,200
Payment on notes payable and capital lease obligations (312,407) (33,000)
Proceeds from shareholder loans 23,458 2,000,000
Payment on shareholder loans (58,671) -
Payment on former shareholder loans - (103,501)
Borrowing from investee 64,400 20,875
Repayment to investee (74,154) (42,799)
------------- --------------
Net cash provided by financing activities 2,846,723 2,986,187
------------- --------------
Increase (decrease) in cash and cash equivalents 897,228 (676,086)
Cash and cash equivalents at beginning of year 31,732 928,960
------------- --------------
Cash and cash equivalents at end of year $928,960 $252,874
============= ==============
Cash paid for interest $19,366 $52,050
============= ==============
</TABLE>
During 1996 and 1997, the Company entered into capital lease obligations in the
amount of approximately $27,200 and $49,000, respectively. See Notes 4, 5, 10,
14, and 15 for description of non-cash issuances of Common Stock and Stock
Purchase Warrant.
See accompanying notes to financial statements.
F-6
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements
December 31, 1996 and 1997
1. The Company and Summary of Significant Accounting Policies
The Company
Puradyn Filter Technologies, Incorporated (formerly known as T/F Purifiner,
Inc.) ("Puradyn" or the "Company"), a Delaware corporation, is engaged in the
manufacturing, distribution and sale of oil purification systems under the
trademarks Purifiner(R) and Puradyn(TM).
The Company holds the exclusive worldwide manufacturing and marketing rights for
the Purifiner products pursuant to licenses for two patents (see Note 7) and
through direct ownership of various patents.
The Company has incurred losses from operations since inception, which has
resulted in cash outflows and the continuing need for additional financing.
These factors raise substantial doubt about the Company's ability to continue as
a going concern. In order to continue as a going concern, the Company must
obtain additional financing, which it is endeavoring to do through the issuance
of additional securities.
The Company has completed several private placements of its Common Stock in
1996, obtained debt financing in 1997 and January 1998 and needs to complete
additional financings in early 1998 to continue its operations. However, there
is no assurance that the Company can complete these financings or that
profitable operations can be sustained. The inability to obtain adequate
additional financing when needed, would have a material adverse effect on the
Company, including requiring the Company to significantly curtail or cease its
operations. The financial statements do not include any adjustments relating to
the recoverability or classification of recorded asset amounts or the amounts or
classification of liabilities that might be necessary as a result of the above
uncertainty.
F-7
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
1. The Company and Summary of Significant Accounting Policies (continued)
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.
Revenue Recognition
Sales are recognized upon shipment. Cash received by the Company prior to
shipment is recorded as a customer deposit. Sales are made to certain customers
under terms allowing certain limited rights of return and other limited product
and performance warranties for which provision has been made in the accompanying
financial statements. Management believes, based on past experience and future
expectations, that such limited return rights and warranties will not have a
material adverse effect on the Company's financial statements.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
Property and Equipment
Depreciation is provided using the straight-line method over the estimated
useful lives of the related assets, including assets held under capital leases.
Leasehold improvements are amortized over the shorter of the useful lives of the
improvement or the term of the related lease. The estimated useful lives of
property and equipment is 5 years.
Patents and Trademarks
Patents and trademarks are stated at cost and are amortized using the
straight-line method over 10 to 20 years.
Engineering and Development
Engineering and development costs are expensed as incurred.
Impairment
Management reviews long lived assets and intangible assets for impairment
whenever events or changes in circumstances indicate the carrying amount of such
assets may not be recoverable. Recoverability of these assets is determined by
comparing the forecasted undiscounted net cash flows estimated to be generated
by those assets to the asset's carrying amount. In the fourth
F-8
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
1. The Company and Summary of Significant Accounting Policies (continued)
quarter of 1996 the Company received approval of its U.S. patent for the next
generation of Purifiner units. Accordingly, the Company wrote off approximately
$200,000 related to patent costs incurred primarily to defend the prior
generation patent rights which have been included in 1996 selling expenses. In
the fourth quarter of 1997, the Company wrote down the unamortized amount of
costs in excess of net assets acquired and wrote down to $1 each the amount of
patents and trademarks due to impairment of the respective amounts based on
anticipated cash flows.
Stock Based Compensation
During 1996, the Company adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (SFAS No.123). The provision of
SFAS No. 123 allow companies to either expense the estimated fair value of stock
options or to continue to follow the intrinsic value method set forth in APB
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25) but
disclose the pro forma effects on net income (loss) as if the fair value of the
options had been expensed. The Company has elected to continue to apply APB No.
25 in accounting for its employee stock option plan. Under the provisions of APB
No. 25, compensation cost for stock options is measured as the excess, if any,
of the quoted market price of the Company's Common Stock at the date of grant
over the amount the employee must pay to acquire the stock. (See Note 15).
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 129, "Disclosure of Information about Capital
Structure", No. 130, "Reporting Comprehensive Income", and No. 131, "Disclosures
about Segments of an Enterprise and Related Information". The above
pronouncements will not have a significant effect on the information presented
in the financial statements.
Credit Risk
The Company minimizes the concentration of credit risk associated with cash and
cash equivalents by maintaining its cash and cash equivalents with a high
quality federally insured financial institution. At December 31, 1997, deposits
in excess of federally insured limits were approximately $153,000. Cash
equivalents consist of investments with original maturities of three months or
less.
The Company performs ongoing evaluations of its significant trade accounts
receivable customers and generally does not require collateral. An allowance for
doubtful accounts is maintained against trade accounts receivable at levels
which management believes are sufficient to cover potential credit losses. (See
Note 9.)
F-9
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
1. The Company and Summary of Significant Accounting Policies (continued)
Basic and Diluted Loss Per Share
In 1997, the Company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share" and has retroactively applied the effects thereof for
all periods presented. Accordingly, basic and diluted loss per share is
calculated by dividing net loss by the weighted average number of common shares
outstanding during each period. The effect of the Company's stock options and
warrants have not been included in the Company's computation of diluted loss per
share since they are anti-dilutive. The affect of adoption has not required an
adjustment to previously reported per share amounts.
Income Taxes
Prior to April 1996, the Company had elected to be treated as an "S" corporation
under the provisions of the Internal Revenue Code ("IRC"). Accordingly, its
taxable income or loss was includable in the current taxable income of its
shareholders, and no federal or state income tax provision or benefit had been
recorded in the accompanying financial statements.
If the Company had been subject to corporate income taxes for the first quarter
of 1996, it would not have recorded any income tax expense or benefit in its
statements of operations. On April 1, 1996, the Company ceased to qualify under
Subchapter S of the IRC and, accordingly, is subject to corporate income taxes
commencing April 1, 1996.
Reclassification
Certain general and administrative expenses included in the 1996 statement of
operations were reclassified to Engineering and Development expenses in order to
conform to the 1997 presentation.
2. Inventories
At December 31, 1997, inventories consist of the following:
Raw materials $394,509
Finished goods 174,053
Supplies 10,878
--------
$579,440
========
F-10
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
3. Property and Equipment
At December 31, 1997, property and equipment at cost consists of the following:
Machinery and equipment $482,154
Furniture and fixtures 47,193
Leasehold improvements 41,286
---------
570,633
Less accumulated depreciation and
amortization (207,735)
---------
$362,898
=========
At December 31, 1997, machinery and equipment includes approximately $103,000 of
equipment held under capital leases with related accumulated amortization of
approximately $28,600.
4. Certain Shareholder and Other Notes Payable
During 1994, the Company and its then principal shareholder instituted legal
action against the estate of a former 50% owner of the Company ("the Estate").
Subsequently, the beneficiaries of the Estate filed counterclaims against the
Company and its then principal shareholder and his children. In September 1996,
the Company entered into an Agreement in partial settlement of the issues
("Agreement") which released the Company, with prejudice, from all litigation
pending or contemplated by the beneficiaries of the Estate, and individually,
against the Company related to any actions taken by the Company before the date
of the Agreement. In return, the Company agreed to repay the Estate's loans of
$502,026 as follows: $167,342 due 90 days after any equity financings which
raise in excess of $5,000,000 of gross proceeds; $167,342 on the first and
second anniversaries of such equity financings. If the equity financings are
less than $5,000,000 the amount of the periodic debt repayment will be reduced
and the term extended proportionately. The Estate has agreed not to commence any
action for loan repayment as long as the Company is in compliance with the
Agreement and raises gross proceeds of at least $2,000,000 within one year of
the Agreement. Since the Company has made all required payments to the Estate
and has raised in excess of $2,000,000, the appropriate amounts of former
shareholder loans due to the Estate on January 31, based upon equity raised
through December 31, 1997, are as follows:
1998 $103,501
1999 103,501
2000 103,501
2001 88,022
F-11
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
4. Certain Shareholder and Other Notes Payable (continued)
On July 31, 1996, a shareholder received 49,770 shares of Common Stock in
exchange for his loans and unpaid interest in the aggregate amount of $99,540.
These loans bore interest at 10% per annum ($6,132 in 1996). On August 1, 1996,
the Company's then principal shareholder received 251,013 shares of Common Stock
in exchange for his non interest bearing shareholder loans in the aggregate
amount of $502,026.
In 1996, the Company issued unsecured notes payable in the aggregate amount of
$275,000 to several parties, $125,000 of which bore interest at 10% per annum.
The principal and interest on these notes were repaid prior to December 31,
1996. At December 31, 1995, the Company had a total of $35,213 of unsecured
loans due to its then principal shareholder bearing interest at 10% per annum.
These loans were repaid in April 1996. During 1996, the Company incurred
approximately $500 of interest expense on these loans.
5. Common Stock
On July 1, 1996, the Board of Directors of the Company approved an increase in
authorized Common Stock from 100,000 to 20,000,000, approved a change in the par
value of Common Stock from $.01 par value to $.001 par value and approved a 57
to 1 stock split distribution for common stockholders of record on such date. In
July 1996, the Board of Directors of the Company approved the authorization of
up to 500,000 shares of preferred stock (none issued or outstanding at December
31, 1997). On January 1, 1997, the Board of Directors and shareholders approved
a 2.5:1 stock split distribution for common stockholders of record on such date.
All share and per share data presented in the accompanying financial statements
have been restated to reflect the above actions.
In 1996, the Company issued 17,500 shares of its Common Stock to one of its law
firms in payment for approximately $40,000 of professional services rendered.
In 1996, the Company issued 7,238 shares of its Common Stock for nominal
consideration to certain employees, distributors, a not-for-profit environmental
group, and other parties for past services and support given to the Company
which has been recorded based upon the estimated fair value of such Common Stock
($2.00 per share) as determined by the Board of Directors. During 1997, 5,000
shares issued to the not-for-profit environmental group were returned to the
Company and cancelled at a value of $2.00 per share, thereby recognizing no gain
on this transaction.
F-12
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
In 1996, the Company sold 1,331,453 shares of its Common Stock for net proceeds
(including December 31, 1996 subscription receivables collected in 1997) of
approximately $3,087,000 through various private placements at prices ranging
from $2.00 to $3.40 per share. During 1997, the issuance of 3,676 shares
($12,500) subscribed for at December 31, 1996 were cancelled.
In October 1996, a noteholder received 37,890 shares of Common Stock in exchange
for outstanding loan and unpaid interest, due at 10% per annum, in the aggregate
amount of $227,340.
See Notes 4, 13, 14 and 15 for discussions of additional Common Stock issuances.
6. Leases
In August 1993, Puradyn entered into a five-year noncancelable operating lease
agreement, as amended, for the Company's manufacturing, warehouse and office
facilities. The lease commenced on April 1, 1994, with payments commencing on
July 1, 1994 and increasing lease payments over the second through fourth years
of its term. The Company has accounted for these lease payments using the
straight-line method over the term of this lease and recorded a deferred rent
payable. At December 31, 1997, the schedule of future minimum lease payments
under this lease is as follows:
1998 90,000
1999 23,000
-----------
$113,000
===========
In 1997, the Company also entered into a month-to-month operating lease for
certain warehouse facilities for which it pays $1,590 per month.
Total rent expense was approximately $72,000 and $96,000 for 1996 and 1997,
respectively.
The Company also has entered into several obligations for certain office and
manufacturing equipment which have been accounted for as capital leases. At
December 31, 1997, future minimum commitments under these noncancelable capital
leases are as follows:
1998 $48,293
1999 21,880
2000 6,720
--------
Total minimum lease payments 76,893
Less amount representing interest at
approximately 16% (18,380)
Present value of minimum lease payments
($36,342 due in 1997) $58,513
========
F-13
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
7. Royalties
In connection with the Company being granted worldwide manufacturing and
marketing rights for certain of the Purifiner products, a royalty agreement was
entered into, the term of which mirrors the life of the related patents or any
improvements thereto. Pursuant to this royalty agreement, the owner of the
patents will receive 5% of the units net sale price, as defined, of all covered
Purifiner products, as defined. Additionally, 1% of the net sales price of
replacement oil filter elements will be paid as a royalty for the use of the
Purifiner U.S. trademark.
In May 1994, the Company and the patent owner entered into a settlement
agreement relating to royalties. As a result of this agreement, the patent owner
is entitled to a minimum annual royalty of $24,000, payable in monthly
installments of $2,000. The monthly royalty may exceed, but never be less than
$2,000, unless the current calendar year monthly average is more than $2,000.
Royalty expense for 1996 and 1997 was approximately $48,000 and $44,000,
respectively.
In January 1997, this patent holder filed an action against the Company for non
payment of approximately $21,000 of unpaid royalties claimed by him and seeking
a permanent injunction against the Company's manufacturing and selling of the
covered Purifiner products. The Company believes it has made an adequate
provision in connection with this matter. The case is scheduled for trial to the
court beginning December 14, 1998. Although the Company believes it has
meritorious defenses against the monetary amounts alleged by the licensor patent
owner, it had unsuccessfully offered to settle this litigation with the patent
holder, including the payment of such alleged unpaid royalties, which amount
relates primarily to the timing of the royalty payment and legal fees regarding
defending certain patents pending of the licensor. The Company, upon advice of
counsel, does not believe the license holder will be in a position to obtain an
injunction against the Company's manufacturing and selling of the Purifiner
products. However, the ultimate outcome of this matter cannot be determined at
this time.
8. Contingencies
On June 24, 1997, TF Systems, Inc.'s ("Systems") former law firm filed a
complaint against the Company, Systems, Richard C. Ford, individually and an
inactive company controlled by Richard C. Ford, demanding payment of
approximately $313,000 of legal fees and cost, plus interest and attorney fees,
related primarily to obtaining the manufacturing and marketing rights to the
Purifiner for Systems and the Company. Systems, a related party (previously
under common ownership with the Company), formerly owned the manufacturing and
marketing rights to the Purifiner and transferred or sold such rights to the
Company prior to January 1, 1996. Systems was awaiting the judgment of an
appellate court which, if adjudicated in Systems' favor, would have provided it
with sufficient funds to pay such legal fees and other possible legal fee claims
aggregating approximately $75,000 at December 31, 1997. On February 26, 1997,
the appellate court ruled against Systems and, accordingly, the funds discussed
above are not currently available to Systems to satisfy such claims. Puradyn did
not
F-14
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
assume these obligations as part of its purchase of Systems in 1995 and
management believes such amounts are not the responsibility of Puradyn. However,
Systems is an inactive company whose only asset is the claim that was reversed
on appeal and maybe retried by Systems. Accordingly, the ability to collect such
funds, as required, from Systems is uncertain. The ultimate outcome of this
litigation and other unasserted claims against the Company cannot be determined
at this time however, based upon the opinion of our counsel, a favorable outcome
is likely. No liability has been recorded for these claims in the accompanying
balance sheet.
In addition, in the ordinary course of business, the Company has been named in
an action concerning a balance due to a vendor.
On September 8, 1998 the Company received notice from a stockholder regarding a
potential stockholders' derivative action and/or a direct negligence action
against the prior Directors and Officers. The Company advised the stockholder
that it is not pursuing any potential claim at this time. The impact of this
contingent matter is not resonably determinable.
9. Major Customers and Export Sales
The Company currently operates in a single business segment and its products are
oil purification systems, substantially all of which are sold to distributors
and end users for use on transportation vehicles. This could unfavorably affect
the Company's overall exposure to credit risk in as much as these customers
could be affected by similar economic or other conditions.
During 1997, 31 customers accounted for approximately 73% of the Company's net
sales, 14 of which accounted for approximately 56% of the Company's net sales
and one customer accounted for approximately 11% of the Company's net sales. In
1997, export sales aggregated approximately $415,000 in geographic regions as
follows: South America ($151,000), Europe ($64,000), and Asia/Pacific
($200,000). During 1996, nine customers accounted for approximately 56% of the
Company's net sales, one of which accounted for approximately 19% of this amount
(See Note 12). In 1996, export sales amounted to approximately $662,000 in
geographic regions as follows: South America ($159,000), Europe ($254,000), and
Asia/Pacific ($249,000). The loss of business from one or a combination of the
Company's significant customers could adversely effect its operations.
10. Notes Payable to Shareholder
On June 19, 1997, the Company and members of the Ford Family and Taylor Family
entered into a Securities Purchase Agreement with Quantum Industrial Partners
LDC ("QIP") ("the Agreement"). Pursuant to the Agreement, the Company issued QIP
a $2,000,000 non-interest bearing promissory note due December 19, 1997 and
received gross proceeds of $2,000,000. This note was subject to mandatory
prepayment prior to its due date upon the Company's consummation of a public
offering of either debt or equity securities. As long as this note was
outstanding, the Company cannot, without the consent of QIP, declare or pay any
dividends, purchase, redeem or acquire any of its Common Stock or retire its
existing indebtedness other than required periodic payments. Effective December
19, 1997, the QIP Note began accruing interest at 12% per annum ($8,000 of
accrued interest at December 31, 1997).
F-15
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
10. Note Payable to Shareholder (continued)
Additionally, the Company issued a Common Stock Purchase Warrant to QIP for the
purchase of 500,000 shares of the Company's Common Stock, exercisable at $2.75
per share and expiring on December 31, 2000. The warrant is subject to
anti-dilution provisions under certain circumstances. These warrants have been
assigned a value of $400,000 (of which approximately $158,000 was recorded as a
fourth quarter adjustment) and, accordingly, such amount has been credited to
additional paid in capital and the $2,000,000 Note payable has been recorded net
of a $400,000 discount which was amortized to interest expense over the term of
the Note. The Company has also agreed to register securities of QIP under
certain circumstances and has reserved 500,000 shares of its Common Stock
underlying this warrant.
On January 26, 1998, the Company and QIP entered into a Note Exchange Agreement
whereby the above $2,000,000 promissory note, due December 19, 1997, was
exchanged for a $2,000,000 12% Senior Subordinated Convertible Note ("Note") due
2003. Interest shall be payable quarterly commencing April 1, 1998, provided
however that at the option of the Company, unpaid interest may be added to the
principal balance of the Note in lieu of a cash payment. The Note is senior to
all indebtedness of the Company, except bank or financial institution debt. The
Note will be redeemable at the option of QIP on or after the earlier of January
1, 2001 and the date on which the Company raises cash proceeds aggregating $10
million from the sale of debt or equity securities or assets. As long as this
Note is outstanding, the Company cannot, without the consent of QIP, declare or
pay any dividends, purchase, redeem or acquire any of its Common Stock, retire
its existing indebtedness other than existing required periodic payments or
enter into transactions with any affiliate.
Prior to January 1, 2003, the Note shall be convertible, at the option of QIP,
into Common Stock of the Company at a conversion price of $2.75 per share, which
was greater than the quoted market price of the Company's Common stock on the
date of issue. Accordingly, no charge to interest expense and offsetting credit
to additional paid-in capital will be made related to this transaction. The Note
is subject to anti-dilution provisions under certain circumstances. The Company
has also agreed to register the securities underlying the Note under certain
circumstances. Accordingly, the Company has classified the $2,008,000 due QIP at
December 31, 1997 as a long term liability.
F-16
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
Additionally, on January 26, 1998, the Company and QIP entered into a Note
Purchase Agreement whereby the Company issued QIP a 12% Senior Subordinated
Convertible Note in the aggregate principal amount of $500,000. The loan
proceeds can be used for general operating expenses of the Company and to repay
$103,501 due to a former shareholder. The terms and conditions of this $500,000
note are identical to the $2,000,000 Note described above.
At January 26, 1998, the Company has reserved 909,091 shares of Common Stock
underlying the $2,500,000 of 12% Convertible Notes discussed above.
11. Financial Instruments
At December 31, 1997, the carrying amounts and estimated fair values of the
Company's financial instruments which consist of cash, cash equivalents,
accounts and notes receivable, accounts payable and debt, excluding capital
leases, $398,525 of former shareholder loans and 70,931 of notes receivable,
approximated $840,000 due to the short-term maturity and/or interest rates of
these instruments. Management believes the carrying amount of the notes payable
of $2,008,000 is higher than the fair value, however Management is unable to
determine its fair value since a current market for a similar instrument does
not exist. The Company's noninterest bearing former shareholder loans and notes
receivable have a carrying amount of $469,456 and an estimated fair value of
approximately $405,000 (See Notes 4 and 15).
12. Joint Venture
Effective January 1, 1996, the Company entered into a joint venture agreement
whereby such venture, TF Purifiner Ltd. ("Ltd"), will sell and distribute the
Company's product in Europe, the Middle East and certain African countries. The
Company has an approximate 45% interest in Ltd's operations (50% voting
interest) and is accounting for Ltd using the equity method. The Company is not
required to fund Ltd and sold products to Ltd until such time as Ltd decided to
exercise its rights under the agreement to manufacture the Company's products in
1997. Ltd was initially capitalized with approximately $88,000 provided by one
of its shareholders. Through December 31, 1997, Ltd advanced the Company
approximately $137,000 to be used to fund certain patent and trademark filings
for the venture's exclusive territory. At December 31, 1997, approximately
$1,400 remained unexpended. In 1996 and 1997, the Company had sales of
approximately $254,000 and $55,000, respectively, to Ltd, at negotiated prices.
At December 31, 1997, approximately $8,000 has been recorded as unrealized
intercompany profit related to the inventory sold to Ltd which is included in
Ltd's inventory at December 31, 1997. The Company is commencing to negotiate
with Ltd's other 45% shareholder (Centrax Ltd.) relating to the
ownership/licensing of various pending patents filed by Centrax, as well as
other matters, including the possible discontinuation of the joint venture with
Centrax. The ultimate outcome of these negotiations cannot be determined at this
time.
At December 31, 1996 and 1997 and for the years then ended, summarized financial
information of Ltd is as follows:
F-17
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
12. Joint Venture (continued)
1996 1997
---- ----
Total assets $555,000 $582,000
Total liabilities (1) 1,059,000 1,312,000
Capital deficiency 504,000 730,000
Total revenues 198,000 394,000
Gross profit 76,000 170,000
Net loss (562,000) (447,000)
(1) Includes approximately $856,000 and $799,000 at December 31, 1996 and 1997,
respectively, of loans due to one of Ltd's foreign shareholders, collateralized
by substantially all the tangible assets of Ltd.
13. Redeemable Common Stock
During 1996, the Company sold 393,443 shares of its Common Stock for gross
proceeds of $594,000. The subscription agreements provided that if the Company
had not registered any amount of class of its Common Stock under the Securities
Act of 1933 or the Securities and Exchange Act of 1934, as amended, within two
years, the shareholders would have an option to put the shares back to the
Company at their original purchase price plus 10% per annum from the date of
issuance. Accordingly, such Common Stock was being treated as Redeemable Common
Stock until the expiration of the put options and the redemption price was being
accreted at the rate of 10% and charged to additional paid in capital. On
September 28, 1996, the Company registered Common Stock under the Securities Act
of 1934, as amended, and, therefore, the put option expired and such Common
Stock was no longer redeemable and has been reclassified to Common Stock.
14. Acquisition of DB Filters
On May 20, 1996, the Company acquired all the common stock of DB Filters, Inc.,
an inactive company which has been subsequently dissolved ("DB Filters"), for
$1,275 in cash and 90,773 shares of its Common Stock with an estimated fair
value of approximately $137,000. DB Filters was owned by two employees of the
Company, one of which was a former Director. DB Filter's only assets, at the
time of the acquisition, was the right to future royalties related to the
Company's then patent pending filter technology and certain restricted, as
defined, North American filter manufacturing rights. The Company accounted for
this acquisition using the purchase method of accounting and assigned all of its
purchase price to cost in excess of net assets acquired and is amortizing such
costs using the straight line method over 15 years. DB Filters had no material
assets or liabilities at December 31, 1995 and no material operations from
January 1, 1996 to May 20, 1996.
F-18
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
15. Stock Options and Warrants
On July 31, 1996, as amended the Company's Board of Directors approved the
adoption of a stock option plan (the "1996 Option Plan"), which provides for the
granting of up to 2,200,000 options, subject to stockholder approval, (increased
from 1,625,000 on July 17, 1997) for both incentive and non-qualified stock
options to key personnel, including officers, directors, consultants and
advisors to the Company, based upon the determination of the Board of Directors.
The exercise price of the options may be no less than fair value of the Common
Stock on the date of grant for incentive stock options and the option term may
not exceed five or ten years. Generally, options to employees vest over four
years at 25% per annum, except for certain grants to employees which vested 50%
upon grant with remaining amounts over two years at 25% per annum. At December
31, 1997 and 1996, 1,957,525 and 1,500,000 shares of Common Stock have been
reserved for issuance under the 1996 Option Plan, respectively.
Additional information concerning the activity in the 1996 Option Plan is as
follows:
<TABLE>
<CAPTION>
Number of Weighted Average
Shares Exercise Price
------ --------------
<S> <C> <C>
Options outstanding, January 1, 1996 - -
Granted 1,593,750 $2.67
Exercised (125,000) $2.00
Cancelled (108,750) $4.76
---------
Options outstanding, December 31, 1996 1,360,000 $2.57
Granted 566,625 $7.88
Exercised (117,475) (a) $2.05
Cancelled (139,330) $8.23
---------
Options outstanding at December 31, 1997 1,669,820 $3.93
=========
Options exercisable at December 31:
1996 524,898 $2.78
=========
1997 1,135,228 $3.24
=========
Options available for grant at December 31:
1996 140,000
=========
1997 287,705
=========
</TABLE>
(a) At December 31, 1997, $73,931 of loans receivable, substantially all
collateralized by underlying Common Stock, was substantially all due from
current and former employees who were allowed a cashless exercise of 45,375
stock options. As a result of allowing these cashless exercises the Company was
required to treat such options as newly granted and, accordingly, has expensed
$270,000 as a fourth quarter adjustment which was based on the difference
between the quoted market price and exercise price on the date of the cashless
exercise.
Summarized information with respect to 1996 Option Plan options outstanding at
December 31, 1997 is as follows:
F-19
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
15. Stock Options and Warrants (continued)
<TABLE>
<CAPTION>
1997
-------------------------------------------------------------------------------------------------
Options Outstanding Options
Exercisable
------------------------------------------------------------ -----------------------------------
Weighted Average Weighted Weighted
Range of Number Remaining Contractual Average Exercise Number Average Exercise
Exercise Price Outstanding Life (in Years) Price Exercisable Price
- -------------- ----------- --------------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$2.00 - $2.75 1,048,420 4.93 $2.03 837,953 $2.01
$3.94 - $6.00 295,775 5.86 5.54 191,650 5.61
$7.50 - $10.00 325,625 9.09 8.59 105,625 8.68
--------- ---------
1,669,820 1,135,228
========= =========
</TABLE>
The effect of applying SFAS No. 123 on 1996 and 1997 proforma net loss and
recognizing compensation expense for consultants and the former Board of
Advisors as stated below are not necessarily representative of the effects on
reported net loss for future years due to, among other things, (1) the vesting
period of the stock options and the (2) fair value of additional stock options
in future years. Had compensation cost for the Company's 1996 Option Plan grants
to employees and directors been determined based upon the fair value at the
grant date for awards under the 1996 Option Plan consistent with the methodology
prescribed under SFAS No. 123, the Company's net loss in 1997 and 1996 would
have been approximately $(4,703,000) or $(.91) per basic and diluted share and
$(2,119,000) or $(.64) per basic and diluted share, respectively. The fair value
of the options granted to employees/directors during 1997 are estimated as $.97
per share ($.44 per share in 1996), on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions: dividend
yield 0% in 1996 and 1997, volatility of 58% in 1997 and 40% in 1996, risk-free
interest rate of 6.0% in 1997 and 5.8% in 1996 and expected life of 2.3 years in
1997 and 1.8 years in 1996.
During 1997 and 1996, the Company expensed approximately $120,000 and $243,800,
respectively, related to the granting of 1,091,250 stock options to various
consultants and the former Board of Advisors. The fair value of these options
granted was $.34 on the date of grant using the Black-Scholes Option Pricing
model with the following weighted average assumptions: dividend yield 0%,
volatility 40%, risk free interest rate of 5.6% and expected life of 1 year.
During 1997, the Company expensed approximately $73,000 related to the granting
of 50,000 stock options and warrants to various consultants in 1997. The fair
value of these options was $1.86 on the date of grant using the
Black-Scholes-option-pricing model with the following weighted assumptions:
dividend yield 0%, volatility 40%, risk free interest rate of 5.7% and expected
life of 1.3 years.
Further, during 1996, the Company expensed $75,400 related to the granting of
47,125 stock options to officers and an employee at $1.60 less than the quoted
market value ($7.60) of the Company's Common Stock.
During 1996, the Company granted consultants 250,000 options (included in
1,091,250 discussed above) to purchase Common Stock at $2.00 per share, which
are outstanding at
F-20
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
15. Stock Options and Warrants (continued)
December 31, 1996 and 1997 and became exercisable in 1997. At December 31, 1997
and 1996, this option had a remaining contractual life of seven and nineteen
months, respectively. Additionally, in 1997 the Company granted a consultant
20,000 options to purchase Common Stock at an exercise price of $9.00 per share
of which 20,000 are outstanding and 7,500 are exercisable at December 31, 1997.
At December 31, 1997, this option had a remaining contractual life of 27 months.
Finally, at December 31, 1997, the Company had 10,000 warrants outstanding which
were granted in 1997 to various consultants which are exercisable at $10.00 per
share and expire on January 27, 1999. At December 31, 1997, this warrant had a
remaining contractual life of thirteen months. The Company has reserved 250,000
and 280,000 shares of Common Stock related to these options and warrants at
December 31, 1996 and December 31, 1997, respectively.
At December 31, 1996 and 1997, the Company had 325,000 warrants outstanding
issued in connection with a private placement which are exercisable at $2 per
share and expire on December 31, 1999 for which it has reserved 325,000 shares
of Common Stock underlying such warrants.
See Note 10 for other warrant grants.
16. Income Taxes
At December 31, 1997, the Company has a net operating loss carryforward of
approximately $5,730,000 for income tax purposes which expires in 2011 and 2012,
respectively. Due to the Company's net losses, no provision was made for income
taxes from April 1, 1996 to December 31, 1996 or for 1997.
The significant components of the net deferred tax asset as of December 31, 1997
and 1996 are as follows:
Deferred tax assets: 1996 1997
---- ----
Net operating losses $557,000 $2,156,000
Excess tax basis of
manufacturing rights acquired
from related party 70,000 65,000
Compensatory options and warrants 120,000 241,000
Intangible assets 122,000
Other 16,000 52,000
--------- ----------
763,000 2,636,000
Valuation allowance (763,000) (2,636,000)
--------- ----------
Net deferred tax asset $ - $ -
========= ==========
F-21
<PAGE>
Puradyn Filter Technologies, Incorporated
Notes to Financial Statements (continued)
16. Income Taxes (continued)
The difference between the statutory tax rate of 34% and the Company's effective
tax rate of 0% is due to the increase in valuation allowance of $763,000 and
$1,873,000 in 1996 and 1997, respectively.
As a result of certain ownership changes, the Company may be subject to an
annual limitation on the utilization of its net operating loss carryforward
pursuant to Section 382 of the Internal Revenue Code.
During the first quarter of 1996, the differences between financial statement
loss and taxable loss related primarily to the timing of the deductibility of
certain related party accrued expenses.
17. Related Party Transaction
In January 1997, as amended, the Company loaned Richard C. Ford, its then
President and principal shareholder, $200,000 bearing interest at 10% per annum
and due in June 1997 secured by 40,000 shares of the Company's Common Stock
owned by Mr. Ford. On June 19, 1997, Mr. Ford repaid the entire principal and
accrued interest on this loan in the amount of $209,078.
On July 17, 1997, the Company entered into a six month consulting agreement with
Richard C. Ford, former President of the Company, whereby Mr. Ford would perform
various sales consulting and other services for the Company in exchange for a
fee of $8,000 per month, provision for health benefits, reimbursable business
expenses and a commission of 10% on the gross margin of any sales consummated by
Mr. Ford during this period. Such agreement was extended to March 4, 1998.
During 1997, Mr. Ford was paid approximately $45,000 pursuant to this consulting
agreement.
F-22
<PAGE>
PART III
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS.
---------------------------------------------
Not applicable.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
------------------------------------------------------------
The following table sets forth the names, positions with the Company
and ages of the directors, executive officers and significant employees and
directors of the Company. Directors will be elected at the Company's annual
meeting of stockholders and serve for one year or until their successors are
elected and duly qualified. Officers are elected by the Board and their terms of
office are, except to the extent governed by employment contract, at the
discretion of the Board.
Directors and Executive Officers
- --------------------------------
Name Age Position
Richard C. Ford 54 Director
Alan J. Sandler 60 President, Chief Operating Officer, Secretary,
Chief Financial Officer, and Director
RICHARD C. FORD had been President, Chief Executive Officer, Treasurer and a
Director of the Company since its inception in 1988. In April 1997, Mr. Ford
resigned as President of the Company and in June 1997, Mr. Ford resigned as
Chief Executive Officer, Treasurer and Chief Financial Officer of the Company.
Mr. Ford was also a Director of TF Purifiner Ltd through July 17, 1997 at which
time he resigned. He served as Secretary of the Company from its inception until
August 1996.
ALAN J. SANDLER joined the Company in June, 1998. He serves as President, Chief
Operating Officer, Secretary, Chief Financial Officer, and Director. Most
recently Mr. Sandler served as President, Chief Executive Officer and Consultant
to Hood Depot, Inc., a national restaurant supply manufacturer/distributor. From
1979-1995 he was President and Chief Executive Officer of Sandler & Sons Dental
Supply Company, a regional dental supply and equipment distributor. Previous to
this position he was a Vice President of Gardner Advertising Company, an
advertising agency where he worked with clients such as Anheuser Busch, Inc.,
Ralston Purina Company, Monsanto, Sun Oil, Pet, Inc., and Southwestern Bell
Telephone Company.
ITEM 10. EXECUTIVE COMPENSATION
----------------------
Cash Compensation
- -----------------
The following table shows, for the three year period ended December 31,
1997, the cash and other compensation paid by the Company to its former
Presidents and Chief Executive Officer and to each of the executive officers of
the Company who had annual compensation in excess of $100,000.
33
<PAGE>
<TABLE>
<CAPTION>
Summary Compensation Table
Name and Other All
Principal Annual Options/ LTIP Other
Position Year Salary Bonus Compensation(l) (#) Payouts Compensation(2)
- -------- ---- ------ ----- --------------- -------- ------- ---------------
<S> <C> <C> <C> <C> <C>
Keith T.J. Hart (3)
President, CEO, CFO, 1997 $91,346 -0- $4,752 100,000 - -
Treasurer and Secretary
Richard C. Ford (4) 1997 $85,800 -0- $700 - - $3,899
President, CEO, 1996 $120,000 -0- $1,200 275,000 - $11,000
Treasurer, CFO 1995 $104,000 -0- $1,370 - - $12,000
</TABLE>
(1) This amount represents payments made by the Company for health insurance
premiums.
(2) This amount represents payments made to Mr. Ford for performing various
product field testing in 1995 and 1996 and a car allowance in 1997.
(3) Mr. Hart served as President and Chief Operating officer since April 1,
1997 and served as Chief Executive Officer, Treasurer, Secretary and
Chief Financial Officer since June 19, 1997. In March 1997, Mr. Hart
served as a consultant for the Company for which he received
approximately $10,400.
(4) Mr. Ford served as Secretary of the Company until August 1996. Mr. Ford
served as President of the Company until April 1, 1997 and served as
Chief Executive Officer, Treasurer and Chief Financial Officer until
June 19,1997. Mr. Ford left the employment of the Company on July 17,
1997 and entered into a consulting agreement with the Company. (See
Item 12 - Certain Relationships and Related Transactions).
Employment Agreements
- ---------------------
Effective June 1, 1998, the Company hired Alan Sandler as president of the
Company under an employment contract. Mr. Sandler will receive initial
compensation at the rate of $80,000 per year which will be reviewed within a
three to six month period. The terms of the employment contract are yet to be
completed. The Company has granted Mr. Sandler options to purchase 260,000
shares of the Company's stock and applicable terms are being arranged.
The Company currently does not have any other employment agreements with
executive officers or significant employees.
Option Grants in Last Fiscal Year
- ---------------------------------
The following table sets forth information with respect to the grant of
options to purchase shares of Common Stock during the fiscal year ended December
31, 1997 to each person named in the Summary Compensation Table.
<TABLE>
<CAPTION>
Number of % of total
Securities Options
Underlying Granted to Exercise or
Options Employees in Base Price Expiration
Name Granted (#) Fiscal year ($ / Shares) Date
- ---- ----------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Keith T.J. Hart 100,000 19.5% $8.50/100,000 April 2007
</TABLE>
34
<PAGE>
Incentive and Nonqualified Stock Option Plan
- --------------------------------------------
The Board of Directors and a majority of the Company's stockholders
adopted the Company's 1996 Stock Option Plan (the "Plan") on July 31, 1996 and
the approval was ratified at the Company's Annual Meeting held on August 28,
1996. The number of shares authorized under the Plan was increased by the Board
of Directors from 1,625,000 to 2,200,000 in July 1997, which increase in subject
to stockholder approval.
The Plan will work to increase proprietary interest in the Company of
the employees', Board of Advisors, consultants, and non-employee Directors and
to align more closely their interests with the interests of the Company's
stockholders. The Plan will also maintain the Company's ability to attract and
retain the services of experienced and highly qualified employees and
non-employee directors.
Under the Plan, the Company had reserved an aggregate of 2,200,000
shares of Common Stock for issuance pursuant to options granted under the Plan
("Plan Options"). The Board of Directors or a Committee of the Board of
Directors (the "Committee") of the Company will administer the Plan including,
without limitation, the selection of the persons who will be granted Plan
Options under the Plan, the type of Plan Options to be granted, the number of
shares subject to each Plan Option and the Plan Option price.
Plan Options granted under the Plan may either be options qualifying as
incentive stock options ("Incentive options") under Section 422 of the Internal
Revenue Code of 1986, as amended, or options that do not so qualify
("Non-Qualified Options") . In addition, the Plan also allows for the inclusion
of a reload option provision ("Reload Option"), which permits an eligible person
to pay the exercise price of the Plan Option with shares of Common Stock owned
by the eligible person and receive a new Plan Option to purchase shares of
Common Stock equal in number to the tendered shares. Any Incentive Option
granted under the Plan must provide for an exercise price of not less than 100%
of the fair market value of the underlying shares on the date of such grant, but
the exercise price of any Incentive Option granted to an eligible employee
owning more than 10% of the Company' s Common Stock must be at least 110% of
such fair market value as determined on the date of the grant. The term of each
Plan Option and the manner in which it may be exercised is determined by the
Board of the Directors or the Committee, provided that no Plan Option may be
exercisable more than 10 years after the date of its grant and, in the case of
an Incentive Option granted to an eligible employee owning more than 10% of the
Company's Common Stock, no more than five years after the date of the grant.
The exercise price of Non-Qualified Options shall be determined by the
Board of Directors or the Committee and cannot be less than the par value of the
Company's Common Stock.
The per share purchase price of shares subject to Plan Options granted
under the Plan may be adjusted in the event of certain changes in the Company's
capitalization, but any such adjustment shall not change the total purchase
price payable upon the exercise in full of Plan Options granted under the Plan.
35
<PAGE>
Officers, directors, key employees and consultants of the Company and
its subsidiaries (if applicable in the future) will be eligible to receive
Non-Qualified Options under the Plan. Only officers, directors and employees of
the Company who are employed by the Company or by any subsidiary thereof are
eligible to receive Incentive Options.
All Plan Options are generally nonassignable and nontransferable, except
by will or by the laws of descent and distribution, and during the lifetime of
the optionee, may be exercised only by such optionee. If an optionee's
employment is terminated for any reason, other than his death or disability or
termination for cause, or if an optionee is not an employee of the Company but
is a member of the Company's Board of Directors and his service as a Director is
terminated for any reason, other than death or disability, the Plan Option
granted to him generally shall lapse to the extent unexercised on the earlier of
the expiration date or 30 days following the date of termination. If the
optionee dies during the term of his employment, the Plan Option granted to him
generally shall lapse to the extent unexercised on the earlier of the expiration
date of the Plan Option or the date one year following the date of the
optionee's death. If the optionee is permanently and totally disabled within the
meaning of Section 22 (c) (3) of the Internal Revenue Code of 1986, the Plan
Option granted to him generally lapses to the extent unexercised on the earlier
of the expiration date of the option or one year following the date of such
disability.
The Board of Directors or the Committee may amend, suspend or terminate
the Plan at any time, except that no amendment shall be made which (i) increases
the total number of shares subject to the Plan or changes the minimum purchase
price therefor (except in either case in the event of adjustments due to changes
in the Company's capitalization) , (ii) affects outstanding Plan Options or any
exercise right thereunder, (iii) extends the term of any Plan Option beyond ten
years, or (iv) extends the termination date of the Plan. Unless the Plan shall
theretofore have been suspended or terminated by the Board of Directors, the
Plan shall terminate on July 31, 2006. Any such termination of the Plan shall
not affect the validity of any Plan Options previously granted thereunder.
As of December 31, 1997, incentive stock options to purchase 601,163
shares of Common Stock were outstanding and non-qualified options to purchase
1,068,657 shares of Common Stock were outstanding under the Plan.
Options Granted to Officers and Directors. On August 2, 1996, the
Company granted Richard C. Ford incentive Plan Options to purchase an aggregate
of 50,000 shares of Common Stock at $2.20 per share through August 2, 2001, of
which 25,000 vested on August 2, 1996, 12,500 vested on August 2, 1997, and
12,500 vest on August 2, 1998. On August 2, 1996, the Company granted Richard C.
Ford nonqualified options to purchase an aggregate of 200,000 shares of Common
Stock at $2.00 per Share through August 2, 2006, of which 100,000 vested on
August 2, 1996, 50,000 vested on August 2, 1997, and 50,000 vest on August 2,
1998. On December 3, 1996, the Company granted Richard C. Ford nonqualified
options to purchase an aggregate of 25,000 shares of Common Stock at $6.00 per
share through December 3, 2006, all of which vested on December 3, 1996.
On December 1, 1997, the Company granted Bradley A. Hittle, a former
director who was appointed on July 17, 1997 and resigned on March 25, 1998,
non-qualified Plan Options to purchase an aggregate of 15,000 shares of Common
Stock at $2.75 per share
36
<PAGE>
through December 1, 2007 of which 7,500 vest on December 1, 1998 and 7,500 vest
on December 1, 1999. These options were cancelled upon Mr. Hittle's resignation.
On April 1, 1997, the Company granted Keith T.J. Hart, a former
director, incentive Plan Options to purchase an aggregate of 47,056 shares of
Common Stock at $8.50 per share through April 1, 2007, of which 11,764 vested on
April 1, 1997, 11,764 vest on April 1, 1998, 11,764 vest on April 1, 1999 and
11,764 vest on April 1, 2000. On April 1, 1997, the Company granted Mr. Hart
non-qualified Plan Options to purchase an aggregate of 52,944 shares of Common
Stock at $8.50 per share through April 1, 2007 of which 13,236 vested on April
1, 1997, 13,236 vest on April 1, 1998, and 13,236 vest on April 1, 1999 and
13,236 vest on April 1, 2000, respectively. These options were cancelled upon
Mr. Hart's resignation.
On August 2, 1996, the Company granted Byron Lefebvre, a former Director
who resigned on June 19, 1997, incentive Plan Options to purchase an aggregate
of 75,000 shares of Common Stock at $2.00 per share through August 2, 2006, of
which 37,500 vested on August 2, 1996, 18,750 vested on August 2, 2997 and
18,750 vest on August 2, 1988.
On August 2, 1996, the Company granted Richard J. Ford, a former
Director and Secretary who resigned on June 19, 1997 and a former Vice President
who resigned on July 17, 1997, incentive Plan Options to purchase an aggregate
of 18,750 shares of Common Stock at $2.20 per share through August 2, 2001, of
which 9,375 vested on August 2, 1996, 4,668 vested on August 2, 1997, and 4,687
vest on August 2, 1998. On December 3, 1996, the Company granted Richard J. Ford
nonqualified options to purchase an aggregate of 3,375 shares of Common Stock at
$6.00 per share through December 3, 2006, all of which vested on December 3,
1996. On January 16, 1997, the Company granted Richard J. Ford nonqualified
options to purchase an aggregate of 62,500 shares of Common Stock at $8.75 per
share through January 16, 2007 of which 31,250 vested on January 16, 1997,
15,625 vested on January 16, 1998 and 15,625 vest on January 16, 1999.
On July 8, 1998 the Company granted its employees a 40% bonus of their
current salary in the form of non -qualified stock options which vest in equal
portions of 25% per year over the next four years beginning July 7, 1999, at
.375 cents per share. The aggregate shares amount to approximately 149,900.
On July 8, 1998 the Company granted Alan J. Sandler 260,000 stock
options to be vested in equal 25% proportions, the first of which 65,000 vested
July 8, 1998. The balance of 195,000 shares will vest at the rate of 65,000
shares over the next three annual anniversary dates beginning July 7, 1999.
Richard C. Ford was granted 300,000 stock options in addition to
deferred compensation until the Company has the funds to pay him for past and
future services beginning March of 1998. Of these options 50% will vest July 8,
1998 and 50% July 7, 1999.
Option Exercises and Holdings
- -----------------------------
The following table sets forth information with respect to the exercise
of options to purchase shares of Common Stock during the fiscal year ended
December 31, 1997 to
37
<PAGE>
each person named in the Summary Compensation Table and the unexercised options
held as of the end of the 1997 fiscal year.
<TABLE>
<CAPTION>
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FY-END OPTION/SAR VALUES
Securities Underlying Value of Unexercised
Number of Unexercised in-the-Money
Shares Acquired Options/SARS Options/SARs
On Exercise Value at FY-End (#) at FY-End ($)
Realized Exercsiable/ Exercisable/ Exercissable/
(#) ($) Unexercisable Unexercisable (1)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Richard C. Ford - - 212,500/62,500 $ 50,625/ $16,875
Former President, Chief Executive
Officer, Treasurer, and CFO
Keith T.J. Hart - - 25,000/75,000 $0 / $0
Former President, Chief Executive Officer,
Treasurer, Secretary and CFO
</TABLE>
(1) In accordance with the Securities and Exchange Commission's rules, values
are calculated by subtracting the exercise price from the fair market value of
the underlying common stock. For purposes of this table, fair market value is
deemed to be $2.31, the closing price reported on December 31, 1997.
LONG-TERM INCENTIVE PLANS AWARDS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Number Performance Estimated Future Payouts Under
of Shares, or Other Non-Stock Price-Based Plans
Units or Period Until ---------------------------
Other Rights Maturation Threshold Target Maximum
Name (#) or Payout ($ or #) ($ or #) ($ or #)
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Richard C. Ford - - - - -
Former President, Chief
Executive Officer,
Treasurer, and CFO
Keith T.J. Hart - - - - -
Former President, Chief Executive
Officer, Treasurer, Secretary
and CFO
</TABLE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The following table sets forth certain information regarding the
Company' s Common Stock beneficially owned on August 15, 1998 for (i) each
stockholder known
38
<PAGE>
by the Company to be the beneficial owner of five (5%) percent or more of the
Company's outstanding Common Stock, (ii) each of the Company's executive
officers and directors, and (iii) all executive officers and directors as a
group. In general, a person is deemed to be a "beneficial owner" of a security
if that person has or shares the power to vote or direct the voting of such
security, or the power to dispose or to direct the disposition of such security.
A person is also deemed to be a beneficial owner of any securities of which the
person has the right to acquire beneficial ownership within sixty (60) days. At
August 15, 1998, there were 5,206,379 shares of Common Stock outstanding. The
address of each of the persons set forth below is 3020 High Ridge Road, Suite
100, Boynton Beach, Florida 33426, except as otherwise noted.
<TABLE>
<CAPTION>
No. of Shares Percent of
Name and Address or of Common Stock Beneficial
Identity of Group Beneficially Owned Ownership
- ----------------- ------------------ ----------
<S> <C> <C>
Richard C. Ford (1) 1,308,521 23.8%
Alan J. Sandler (2) 65,000 *
Armen Partners, L.P. (3) 850,000 15.0%
Richard J. Ford (4) 336,578 6.4%
Traci M. Ford (5) 285,750 5.5%
Jennifer D. Ford/Roe (6) 269,250 5.2%
Greystone Partners, L.P. (7) 285,000 5.4%
Quantum Industrial Partners LDC ("QIP") (8) 2,479,091 37.4%
All Executive Officers
and Directors as a group (3 persons) 1,358,521 24.5%
*Less than 2%
</TABLE>
(1) Mr. Ford serves as a Director. Includes 36,875 shares owned by Catherine
Ford, Mr. Ford's wife, of which Mr. Ford disclaims beneficial ownership.
Also includes options to purchase (i) 37,500 shares of Common Stock at
$2.20 per Share through August 2, 2001; 150,000 shares of Common Stock
at $2.00 per Share through August 2, 2006; and 25,000 shares of Common
Stock at $6.00 per share through December 3, 2006, (iii) options issued
to Mrs. Catherine Ford to purchase 46,875 shares of Common Stock at
$8.75 through January 16, 2007, 18,750 shares of Common Stock at $6.00
per share through December 3, 2006, and 4,688 shares at $2.20 through
August 2, 2001 for which Mr. Ford disclaims beneficial ownership. Also
includes 7,000 shares held in custody by Mr. Ford for his grandchild and
14,000 shares held in custody by Mrs. Ford for her children for which
Mr. Ford disclaims beneficial ownership.
(2) Mr. Sandler as an officer and director includes 65,000 subject options
but does not include 195,000 subject options which have not been
vested up to this date.
(3) Address is c/o Armen Partners LP, 630 Fifth Avenue, Suite 918, New York,
New York 10111. Includes 325,000 and 50,000 shares of Common Stock owned
by Armen Partners, L.P. and Armen Partners Offshore Fund Ltd. of which
Garo Armen is the general partner. Includes warrants to purchase 162,500,
25,000 and 12,500 shares of Common Stock at $2.00 per share through
December 31, 1999 owned by Armen Partners, L.P., Armen Partners Offshore
Fund Ltd., and Garo Armen, respectively. Includes options to purchase
250,000 shares of Common Stock at $2.00 per share through August 2, 1998
owned by Armen Capital Management Corp. Also includes 25,000 shares of
Common Stock owned by Garo Armen.
39
<PAGE>
(4) Address is 859 Glouchester St. Boca Raton, FL. 33487. Includes options
to purchase 14,063 shares of Common Stock at $2.20 per Share through
August 2, 2006, 3,375 shares of Common Stock at $6.00 per share through
December 3, 2006 and 46,875 shares of Common Stock at $8.75 per share
through January 16, 2007.
(5) Address is 61 Lexington Avenue, New York, New York 10010.
(6) Address is 1627 SE Greenacres Circle, Port St. Lucie, Florida 34952.
(7) Address is 1160 Third Avenue, New York, New York 10021. Includes 150,000
shares of Common Stock and Warrants to purchase 75,000 shares of Common
Stock at $2.00 per share through December 31, 1999 owned by Greystone
Partners, LP. Also includes 50,000 shares of Common Stock and options to
purchase 10,000 shares of Common Stock at $9.00 per share through March
31, 2000 owned by Mr. Harvey Stober, the General Partner of Greystone
Partners, L.P.
(8) Address is c/o Curacao Corporation Company, N.V., Kaya Flamboyan,
Willenstad Curacao, Netherlands, Antilles. Includes warrants to purchase
500,000 shares of Common Stock at $2.75 per share through December 31,
2000. Includes 909,091 shares of Common Stock which can be obtained upon
conversion of $2.5 million of 12% Senior Subordinated Convertible Notes
at a conversion price of $2.75 per share through January 1, 2003.
Beneficial Ownership Reporting Compliance
- -----------------------------------------
Section 16 (a) of the Exchange Act requires the Company's directors and
executive officers, and persons who own more than ten percent (10%) of a
registered class of the Company's equity securities, to file with the Commission
initial reports of ownership and reports of changes in ownership of Common Stock
and other equity securities of the Company. Officers, directors and greater than
ten percent (10%) stockholders are required by Commission regulation to furnish
the Company with copies of all Section 16 (a) forms they file.
To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, during the year ended December 31, 1997, all Section 16
(a) filing requirements applicable to its officers, directors and greater than
ten percent (10%) beneficial owners were completed and filed on a timely basis,
except that reports for Mr. Ron Hiram, a director elected on July 17, 1997 who
resigned on December 4, 1998, and Mr. Robert Soros, who replaced Mr. Hiram as a
director on December 4, 1998 and resigned on February 5, 1998, were not filed on
a timely basis.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
----------------------------------------------
Loans and Issuances of Securities to Taylor/Ford. During 1994, the Company and
its then principal shareholder, Richard C. Ford, instituted legal action against
the estate of a former 50% owner of the Company ("the Estate"). This litigation
sought a declaratory judgment approving the dilution of the Estate's interest in
the Company from 50% to approximately 10% as a result of the issuance of
additional Common Stock in 1994 to the principal shareholder and his children.
Subsequently, the beneficiaries of the Estate filed counterclaims against the
Company and its principal shareholder and his children seeking
40
<PAGE>
declaratory relief, cancellation of additional stock issuances by the Company,
an injunction against further issuances, appointment of a receiver and damages
against Ford individually. In June 1995, the Estate demanded repayment of the
non interest bearing shareholder loans due to the Estate for which there were no
stated due dates. In September 1996, the Company entered into an Agreement in
Partial Settlement of Puradyn Issues ("Agreement") which released the Company,
with prejudice, from all litigation pending or contemplated by the Taylor
Family, the beneficiaries of the Estate, and individually, against the Company
related to any actions taken by the Company before the date of the Agreement. In
return, the Company agreed to repay the Estate's loans of $502,026 as follows:
$167,342 due 90 days after any equity financings which raise in excess of
$5,000,000 of gross proceeds; $167,342 on the first and second anniversaries of
such equity financings. If the equity financings are less than $5,000,000 the
amount of the periodic debt repayment will be reduced and the term extended
proportionately. The Estate has agreed not to commence any action for loan
repayment as long as the Company is in compliance with the Agreement and raises
gross proceeds of at least $2,000,000 within one year of the Agreement. The
Company has made all required payments to the Estate and has raised in excess of
$2,000,000 as required by the Agreement.
In 1996, Mr. Ford loaned the Company $23,458 at 10% per annum. During
1996, the Company incurred approximately $500 of interest expense related to
these and other loans. See "Note 4 to the Notes to Financial Statements".
During 1996, Mr. Richard C. Ford was repaid an aggregate amount of
$58,671 on all outstanding loans. On August 1, 1996, Mr. Ford received 251,013
shares of Common Stock in exchange for his non interesting bearing shareholder
loans in the amount of $502,026.
In January 1997, as amended, the Company loaned Richard C. Ford $200,000
bearing interest at 10% per annum and due in June 1997 secured by 40,000 shares
of the Company's Common Stock owned by Mr. Ford. On June 19, 1997, Mr. Ford
repaid the entire principal and accrued interest on his loan in the amount of
$209,078.
During 1995, Mr. Richard C. Ford agreed to become personally obligated
on behalf of the Company for the repayment of certain loans made to the Company
of which all such loans had been repaid as of December 31, 1996.
Richard C. Ford Consulting Agreement. On July 17, 1997, the Company
entered into a six month consulting agreement with Richard C. Ford whereby Mr.
Ford would perform various sales consulting and other services for the Company
in exchange for a fee of $8,000 per month, health insurance premiums of
approximately $1,000, reimbursable business expenses and a commission of 10% of
the gross margin of any sales consummated by Mr. Ford during this period. Such
agreement was extended to March 4, 1998. During 1997, Mr. Ford was paid
approximately $45,000 pursuant to this consulting agreement.
On July 8, 1998 Richard C. Ford was awarded 300,000 options for past and
future services to the Company covering March 1998 through July 7, 1999. One-
half of these options vested July 8, 1998 and the other half will vest July 7,
1999.
41
<PAGE>
D.B. Filters, Inc. On May 20, 1996, the Company acquired all of the
common stock of D.B. Filters, Inc. ("DB Filters") for $1,275 in cash and 90,773
shares of its Common Stock with an estimated fair value of approximately
$137,000. The fair market value of the shares of Common Stock was based upon
$1.51 per Share, which was the price per Share being offered by the Company to
investors pursuant to a private offering, which was being undertaken by the
Company at the same time as the acquisition of D.B. Filters. DB Filters was
owned by two employees of the Company, one of which was Byron Lefebvre, a former
Director of the Company. D.B Filter's only assets were the future royalty rights
related to the Company's new Element patent and certain restricted, as defined,
North American Element manufacturing rights. DB Filters had no other material
assets or liabilities at December 3, 1994 and 1995 and no material operations in
1994 and 1995.
Quantum Industrial Partners LLC. On June 19, 1997, the Company and
members of the Ford Family and Taylor Family entered into a Securities Purchase
Agreement with Quantum Industrial Partners LDC ("QIP") ("the Agreement").
Pursuant to the Agreement, the Company issued QIP a $2,000,000 non-interest
bearing promissory note due December 19, 1997 and received gross proceeds of
$2,000,000. This note was subject to mandatory prepayment prior to its due date
upon the Company's consummation of a public offering of either debt or equity
securities. As long as this note was outstanding, the Company cannot, without
the consent of QIP, declare or pay any dividends, purchase, redeem or acquire
any of its Common Stock or retire its existing indebtedness other than required
periodic payments. Effective December 19, 1997, the QIP note began accruing
interest at 12% per annum ($8,000 of accrued interest at December 31, 1997).
Additionally, the Company issued a Common Stock Purchase Warrant to QIP
for the purchase of 500,000 shares of the Company's Common Stock, exercisable at
$2.75 per share and expiring on December 31, 2000. The warrant is subject to
anti-dilution provisions under certain circumstances. The Company has also
agreed to register securities of QIP under certain circumstances.
On January 26, 1998, the Company and QIP entered into a Note Exchange
Agreement whereby the above $2,000,000 promissory note, due December 19, 1997,
was exchanged for a $2,000,000 12% Senior Subordinated Convertible Note (Note)
due 2003. Interest shall be payable quarterly commencing April 1, 1998, provided
however that at the option of the Company, unpaid interest may be added to the
principal balance of the Note in lieu of a cash payment. The Note is senior to
all indebtedness of the Company, except bank or financial institution debt. The
Note will be redeemable at the option of QIP on or after the earlier of January
1, 2001 and the date on which the Company raises cash proceeds aggregate $10
million involving the sale of debt, equity or assets. As long as this Note is
outstanding, the Company cannot, without the consent of QIP, declare or pay any
dividends, purchase, redeem or acquire any of its Common Stock, retire its
existing indebtedness other than existing required periodic payments or enter
into transactions with any affiliate.
Prior to January 1, 2003, the Note shall be convertible, at the option
of QIP, into Common Stock in the Company at a conversion price of $2.75 per
share. The Note is subject to anti-dilution provisions under certain
circumstances. The Company has also agreed to register the securities underlying
the Note under certain circumstances.
42
<PAGE>
Additionally, on January 26, 1998, the Company and QIP entered into a
Note Purchase Agreement whereby the Company issued QIP a 12% Senior Subordinated
Convertible Note in the aggregate principal amount of $500,000. The loan
proceeds can be used for general operating expenses of the Company and to repay
$103,501 due to a former shareholder. The terms and conditions of this $500,000
Note are identical to the $2,000,000 Note described above.
On June 19, 1997, QIP purchased 285,000 and 785,000 shares of the
Company's Common Stock directly from the children of the Taylor Family and from
Mr. Richard Ford and his children for an aggregate purchase price of $785,750
and $2,158,750, respectively.
Consulting Services. On August 2, 1996, the Company granted Armen
Capital Management Corp., whose President is Garo Armen, non-qualified stock
options to purchase an aggregate of 250,000 shares of Common Stock at $2.00 per
share through August 2, 1998, which vested on January 1, 1997, for various
consulting services.
On May 20, 1997, the Company granted Harvey Stober non-qualified stock
options to purchase an aggregate of 20,000 shares of Common Stock at $9.00 per
share through March 31, 2000, of which 2,500 shares vested on May 20, 1997, and
the remaining options shall vest on a quarterly basis in increments of 2,500
shares commencing on September 30, 1997 for various consulting services.
The Company believes that the transactions referred to above were on
terms no less favorable to the Company than terms which could have been obtained
from unrelated third parties.
43
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
A) Index to Exhibits
Exhibits Description of Documents
- -------- ------------------------
3.1 Amended and Restated Certificate of Incorporation of T/F
Purifiner, Inc. dated December 30, 1996 (2).
3.1(a) Certificate of Amendment to Certificate of Incorporation dated
February 3, 1998 (4)
3.2 Bylaws of T/F Purifiner, Inc. (1).
3.3 Memorandum and Articles of Association of TF Purifiner
Ltd. (1).
4.1 Amendment No. 1 to Registration Rights Agreement (4).
10.1 Stock Option Plan (1).
10.2 Agreement between T/F Systems, Inc. and T/F Purifiner, Inc.
dated March 1, 1991 (with exhibits) (1).
10.3 Asset Purchase Agreement between T/F Systems, Inc. and T/F
Purifiner, Inc. dated December 31, 1995 (1).
10.4 Stock Exchange Agreement between D.B. Filters, Inc., Byron
Lefebvre and Robert Meyer, and T/F Purifiner, Inc. (with
exhibits) (1).
10.5 Joint Venture Agreement between T/F Purifiner, Inc. T/F
Systems, Inc., Centrax Limited, The Barr Family and A.N.
Davies (1).
10.6 Lease Agreement between Papeyco Trading International, Inc.
and T/F Purifiner, Inc. dated August 23, 1993 (1).
10.7 Master Distributor Agreement dated April 6, 1995 between KLC
Corporation and the Company (1).
10.8 Exclusive Distributor Agreement/Colombia Effective Date
March 1, 1996, between Al Pacific Cali and the Company (1).
10.9 Exclusive Agreement for Distributorship in Singapore dated
February 6, 1996 between Kian Seng Hardware Trading Pte. Ltd.
and the Company (1).
10.10 Exclusive Agreement for Distributorship in Malaysia dated
February 5, 1995 between Kian Seng Hardware Trading Pte. Ltd.
and the Company (1).
44
<PAGE>
10.11 Exclusive Agreement for Distributorship in Thailand dated
November 17, 1995 between N.Haven Group International Co. Ltd.
and the Company (1).
10.12 Exclusive Agreement for Distributorship in Indonesia dated
February 5, 1996 between PT Hista Bayhu and the Company (1).
10.13 Master Distributor Agreement dated January 11, 1995 between
Trimex Korea and the Company (1).
10.14 Promissory Note dated December 21, 1995 between the Company,
Richard C. Ford, individually, T/F Systems, Inc. as maker and
Bassett Boat Company of Florida in the principal amount of
$200,000 (1).
10.15 Securities Purchase Agreement and Exhibits thereto (3)
10.16 Note Exchange Agreement dated as of January 26, 1998 (4).
10.17 12% Senior Subordinated Convertible Note in the principal
amount of $2,000,000 (4).
10.18 Note Purchase Agreement dated January 26, 1998 (4)
10.19 12% Senior Subordinated Convertible Note in the principal
amount of $500,000 (4).
24.1 Consent of Independent Auditors (5)
27 Financial Data Schedule (5)
99.1 Final Judgment in T/F Systems, Inc. v. Southeast Capital
Financing, Inc., Case No. CL 90-12772AE in the Circuit Court
of the 15th Judicial Circuit in and for Palm Beach County,
Florida (1).
- ----------------
(1) Incorporated by reference from the Exhibits to the Company's Form 10-SB
Registration Statement, as amended, as filed with the Securities and
Exchange Commission.
(2) Incorporated by reference from the Exhibit to the Company's Form 8-K,
January 9, 1997, as filed with the Securities and Exchange Commission.
(3) Incorporated by reference from the Exhibit to the Company's Form 8-K,
June 19, 1997, as filed with the Securities and Exchange Commission.
(4) Incorporated by reference from the Exhibit to the Company's Form 8-KA,
February 11, 1998, as filed with the Securities and Exchange
Commission.
(5) Filed herewith.
B) Report on Form 8-K.
None
45
<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.
Puradyn Filter Technologies, Incorporated
(Registrant)
Date: September 10, 1998 By: /s/Alan J. Sandler
-------------------
Alan J.Sandler
President
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
date indicated.
Date: September 10, 1998
By: /s/ Alan J. Sandler By: /s/Richard C. Ford
-------------------- -------------------
Alan J. Sandler Richard C. Ford
President, Director and Principal Director
Financial and Accounting Officer
46
Exhibit 24.1
CONSENT OF INDEPENDENT AUDITORS
Puradyn Filter Technologies, Incorporated
Boynton Beach, Florida
We consent to the incorporation by reference in the Registration
Statement on Form S-8 of our report dated February 20, 1998 (with respect to
Note 8, September 8, 1998) on the financial statements of Puradyn Filter
Technologies, Incorporated (formerly known as T/F Purifiner, Inc.) (the
"Company") as of December 31, 1997 and for each of the years in the two-year
period then ended, included in the Company's 1997 Annual Report on Form 10-KSB.
Richard A. Eisner & Company, LLP
New York, New York
September 10, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 252,874
<SECURITIES> 0
<RECEIVABLES> 137,142
<ALLOWANCES> (50,000)
<INVENTORY> 529,440
<CURRENT-ASSETS> 981,933
<PP&E> 570,633
<DEPRECIATION> (207,735)
<TOTAL-ASSETS> 1,361,970
<CURRENT-LIABILITIES> 624,288
<BONDS> 0
0
0
<COMMON> 5,206
<OTHER-SE> (1,608,754)
<TOTAL-LIABILITY-AND-EQUITY> 1,361,970
<SALES> 1,352,663
<TOTAL-REVENUES> 1,352,663
<CGS> 1,019,317
<TOTAL-COSTS> 4,360,267
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 397,204
<INCOME-PRETAX> (4,424,125)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,424,125)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,424,125)
<EPS-PRIMARY> (.86)
<EPS-DILUTED> (.86)
</TABLE>
