<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(MARK ONE)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1999
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For transition period from ___________ to ____________
Commission File Number 02-99110
VITRISEAL, INC.
(Name of Small Business issuer in its charter)
NEVADA 91-1499978
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
12226 SOUTH 1000 EAST, SUITE 10
DRAPER, UTAH 84020
(Address of Principal Executive Office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (801) 553-8785
-----------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange
title of each class on which registered:
------------------- --------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK -- $.001 PAR VALUE
(Title of class)
Check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ___
Check if there is no disclosure of delinquent filers pursuant to
Item 405 of Regulation S-B contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-KSB. [ ]
The registrant had no revenues for the fiscal year ended December 31,
1999.
The aggregate market value of the Common Stock held by non-affiliates
of the registrant on December 31, 1999 was approximately $88,000,000 based
upon the average of the bid and asked prices of the Common Stock, as reported
by the National Quotation Bureau Incorporated.
<PAGE>
The number of shares of the Common Stock of the registrant outstanding
as of December 31, 1999 was 20,839,191.
DOCUMENTS INCORPORATED BY REFERENCE
Our Proxy Statement filed February 25th, 2000, is incorporated by
reference into Part III hereof.
Transitional Small Business Disclosure Format (check one):
Yes _____ No __X__
<PAGE>
PART I
All statements, other than statements of historical fact, included
in this Form 10-KSB, including the statements under "Management's Discussion
and Analysis," are, or may be deemed to be, "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended
(the "Securities Act"), and Section 21E of the Securities Exchange Act of
1934 (the "Exchange Act"). Such forward-looking statements involve
assumptions, known and unknown risks, uncertainties and other factors which
may cause our actual results, performance or achievements to be materially
different from any future results, performance, or achievements expressed or
implied by such statements contained in this Form 10-KSB. Such potential
risks and uncertainties include, without limitation, competitive technology
advancements and other pressures from competitors, economic conditions
generally and in our research and development efforts, availability of
capital, cost of labor (foreign and domestic), cost of raw materials,
occupancy costs, and other risk factors detailed herein and in our filings
with the Securities and Exchange Commission. We assume no obligation to
update the forward-looking statements or to update the reasons actual results
could differ from those projected in such statements. Readers are cautioned
not to place undue reliance on these forward-looking statements.
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
Our operations currently focus on the VitriSeal process, a patented
process based on inorganic silicate chemistry that makes bright, clear,
corrosion-protective coatings on metal surfaces at a lower cost than other
clear coatings. VitriSeal, a waterborne coating, has little to no organic
vapor emissions and creates minimal waste during the normal process
operation. We believe that existing products in the market are inferior in
terms of performance, cost, and environmental impacts, giving VitriSeal a
significant competitive advantage.
Our long-term goal is to exploit the VitriSeal technology through
licensing, joint venture agreements, and sales to strategically selected
manufacturers. We believe there is a large, growing market for our
proprietary silicate product.
The focus of current efforts for the VitriSeal process is to
establish a pilot production facility wherein automotive wheels and other
aluminum products would be coated. Toward this end, we have entered into an
agreement with an automotive after-market wheel manufacturer which is a
leading producer of bright, polished aluminum wheels. The agreement calls for
cooperative development of the application of the VitriSeal process to
coating wheels and for licensing the technology to the manufacturer once it
is proven. We are working with the manufacturer and an independent
engineering consulting firm on the mechanics of the production line. We
believe that this engineering work will lead to a commercially viable
application process featuring uniform quality of the product and competitive
economics. After proving the pilot line operations, we plan to make the
process available to other wheel manufacturers and to explore the viability
of coating other aluminum products.
Because of the improvements and refinements in the VitriSeal process
resulting from our on-going laboratory research, we are preparing to file
additional patent applications that would include both process and
state-of-matter claims that would incorporate what has been learned during
the research process.
REORGANIZATION
On March 18, 1999, we acquired Dancor, Inc., a development stage
company incorporated in Delaware on April 16, 1992, in a "reverse
acquisition" accomplished through a tax-free, stock-for-stock reorganization.
At the time of the acquisition we were a dormant entity with no assets, and
had no significant operations during 1997 or 1998, and no revenues since 1989.
The reverse acquisition was the result of an Agreement and Plan of
Reorganization (the "Plan") structured to result in the acquisition by
VitriSeal of all of the issued and outstanding shares of restricted common
stock of Dancor. Under the terms of the Plan, the former stockholders of
Dancor received three shares of VitriSeal common stock for each one share of
Dancor common stock owned and will ultimately acquire approximately 95% of
the issued and outstanding common stock of VitriSeal.
Management accounted for the reorganization as a capital stock
transaction (as opposed to a "business combination," as that term is defined
by GAAP). Accordingly, the reorganization is reported in the financial
3
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statements as a recapitalization, with Dancor considered the acquirer for
accounting purposes (a "reverse acquisition"). Through its former
stockholders, Dancor is deemed the acquirer for accounting purposes because
of (a) its majority ownership of VitriSeal, (b) its representation on
VitriSeal's board of directors, and (c) executive management positions held
by former officers of Dancor.
There are certain restrictions on the sale or other transfer of our
common stock issued under the Plan. Such stock, generally referred to as
"Rule 144 stock," was not registered under the Securities Act of 1933, as
amended ("the Act"), in reliance upon an exemption from its requirements.
Each exchanging shareholder agreed to (1) acquire such stock for his/her own
account and (2) hold the stock for investment purposes only. In addition, the
stock certificates are required to contain a legend (a) documenting these
restrictions and (b) requiring a legal opinion that any proposed sale is
exempt from registration under the Act. The majority of the Rule 144 stock
will be capable of being sold in the public market after March 18, 2000.
VitriSeal's common stock trades on the Nasdaq OTC Bulletin Board
under the symbol "VTSL".
COATING INDUSTRY
Coatings are used in virtually every manufacturing industry to
protect, preserve, and enhance a wide variety of products. Commonly coated
products are found in the transportation, container, metals, wood and
non-wood furniture, equipment, appliance, paper, and machinery industries.
Because the coatings industry is so vast, it is generally a profitable and
financially stable industry.
The U.S. original equipment manufacturer ("OEM") coatings market
consists of thousands of manufacturers in the United States who buy and use
hundreds of different types of coatings. Some product sectors, such as
military coatings or powder coatings, contain few coatings suppliers who
heavily dominate a market niche. Other product sectors, such as appliance,
wood, and metal coatings, have many suppliers, most of which have small
shares of the market. Du Pont, PPG Industries, Morton International, Valspar,
Akzo Nobel, and BASF are all companies that can be considered giants of the
U.S. OEM coatings market. The coating manufacturers compete aggressively on
quality, technological excellence, price, and changing industry trends.
Recent major market trends in the industry include the search for
environmentally friendly coatings, for less expensive organic chemical raw
materials and for more durable coatings.
COATING MARKET OPPORTUNITIES
Market opportunities in the coatings industry are vast and encompass
a wide variety of areas. Recently passed environmental regulations,
escalating costs of organic chemical raw materials, heightened expectations
for performance, and increased demand for all types of coatings have forced
the industry to search for new technologies to answer the toughest question
it faces - whether or not the industry can find a coating that simultaneously
provides high performance, low cost, and environmental friendliness. These
external conditions acting on the industry are causing an internal industry
revolution that is creating tremendous market opportunities.
COATING MARKET ANALYSIS
The major market segments which make up the coatings industry are
very broad and encompass many manufacturing processes that make only limited
use of clear coats. Clear coatings, however, are generally the final
appearance coating and command the highest price in the coatings market.
Because each coating has unique uses, generalizations about market segments
can not be used as solid quantitative bases for understanding the market
potential for clear coats within the segments, and do not suggest a simple
direction for introduction of a breakthrough clear coat technology.
COATING RESEARCH AND DEVELOPMENT
In January 1997, we retained the services of Hamlin M. Jennings,
Ph.D., a professor at Northwestern University, as an independent contractor
on a month-to-month basis as a technical specialist to perform development
work to enable VitriSeal to be sufficiently elastomeric or flexible for
commercialization, and research the properties of VitriSeal and prior art to
develop a scientific explanation of the VitriSeal process. We believe Dr.
Jennings' research will provide us with additional research findings enabling
us to more effectively market the VitriSeal technology.
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INSURANCE
We have obtained a general liability insurance policy and believe
that the insurance in place will be adequate for our anticipated immediate
and near future needs.
EMPLOYEES
At present, we have a full-time staff of one full-time employee and
one part-time employee. None of the employees is represented by a labor union
and we consider our relations with our employees to be excellent. We
anticipate hiring additional employees in conjunction with the planned
acquisitions.
ITEM 2. DESCRIPTION OF PROPERTY
We entered into a one year lease in March 1999 for a business office
located at 1101 Dove Street, Suite 235, Newport Beach, California, containing
approximately 720 square feet with a monthly rental of $1,188. We believe we
have a good relationship with the Landlord and can remain in the facility for
the term of the lease.
We currently have a lease expiring in March 2000 for a research
facility located at 1801 Maple Avenue, Evanston, Illinois, containing
approximately 700 square feet with a monthly rental of $1,700. The research
facility was opened to provide Dr. Jennings with necessary research space
close to his home and full time work. We are negotiating for replacement
laboratory space at this time and anticipate relocating the laboratory in the
next few months.
ITEM 3. LEGAL PROCEEDINGS
We are unaware of any actual, threatened, or planned legal actions
against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the stockholders for vote during the
fourth quarter of 1999.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK
The following table sets forth, for the period from February 1999
through February 16, 2000, the high and low bid quotations each quarter for
the Common Stock during the most recent fiscal year as reported on the OTC
Bulletin Board. Our stock was not actively traded during the two years before
March 1999. The prices represent quotations between dealers, without
adjustment for retail markup, mark down or commission, and do not necessarily
represent actual transactions.
COMMON STOCK PRICE ACTUAL AND ADJUSTED
<TABLE>
<CAPTION>
High Low
---- ---
<C> <C> <C>
2000
----
1st Quarter 6.0000 1.8750
1999
----
1st Quarter 3.7500 1.8750
2nd Quarter 2.8750 1.7500
3rd Quarter 1.9375 0.8750
4th Quarter 2.3750 0.7500
</TABLE>
We have not paid any cash dividends on our Common Stock since our
incorporation and anticipate that, for the foreseeable future, earnings, if
any, will continue to be retained for use in our business. As of February 16,
2000, we had approximately 502 shareholders of record.
5
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RECENT SALES OF UNREGISTERED SECURITIES
Subsequent to the year end, we undertook a private offering, the
"January 2000 Common Stock Offering," of up to 2,500,000 restricted shares of
our common stock at the price of $3.00 per share. The offering was made
pursuant to a claimed exemption under Rule 506 of Regulation D of the
Securities Act of 1933 based upon our offering of the securities to only
"accredited investors," all of whom were provided a Private Placement
Memorandum which included financial information. No general solicitation of
investors was undertaken and all investors were required to verify investment
intent. The January 2000 Common Stock Offering was fully subscribed on
February 2, 2000.
Additionally , subsequent to the year end, we undertook a private
offering, the "February 2000 Common Stock Offering," of up to 2,500,000
restricted shares of our common stock at the price of $4.00 per share. The
offering was made pursuant to a claimed exemption under Rule 506 of
Regulation D of the Securities Act of 1933 based upon our offering of the
securities to only "accredited investors," all of whom were provided a
Private Placement Memorandum which included financial information. No general
solicitation of investors was undertaken and all investors were required to
verify investment intent. The February 2000 Common Stock Offering has not yet
been completed.
Both of the offerings in 2000 were undertaken in anticipation of the
acquisitions we expect to be completing within the next several months.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion and analysis should be read in conjunction
with the Financial Statements and Notes thereto appearing elsewhere in this
report.
PLAN OF OPERATION
In addition to continuing our research and development efforts
related to the VitriSeal process as discussed above in the "BUSINESS"
section, we intend to expand and diversity operations through acquisitions.
ACQUISITIONS OF THERMOFLOW AND LIQUITEK
GENERAL
On December 30, 1999, we entered into a letter of intent ("LOI") for
the acquisition of two companies: Thermoflow Corporation, a Nevada corporation
with offices in Las Vegas, Nevada ("Thermoflow"), and Liquitek Corporation, a
Nevada corporation with offices in Knoxville, Tennessee ("Liquitek"). We
intend to acquire all of the shares of stock of both Thermoflow and Liquitek.
We plan to issue 10,060,000 shares of VitriSeal for all of the shares of
Thermoflow and 6,000,000 shares for all of the shares of Liquitek so that both
companies will be wholly-owned subsidiaries of VitriSeal.
Thermoflow owns and operates a proprietary antifreeze recycling
facility in Las Vegas, Nevada with a three million gallon per year capacity.
Thermoflow receives waste antifreeze and produces fully reformulated
antifreeze indistinguishable from antifreeze made from virgin materials. The
process is able to recover 100% of the waste materials for reuse. Thermoflow
was recently awarded a U.S. General Services Administration contract to
receive waste antifreeze and provide recycled, reformulated antifreeze to all
U.S. federal government agencies. The Thermoflow technology is capable of
economically treating/recycling many other contaminated liquids, including
wastewater. Thermoflow has licensed the technology to Liquitek under an
exclusive license agreement.
Liquitek refined the Thermoflow technology and has licensed and
leased an oily wastewater treatment system the largest recycler in Hawaii.
Liquitek, in conjunction with Thermoflow, developed a proprietary system for
recycling car wash wastewater and installed its first system in Hiroshima,
Japan. Liquitek has also secured a 20,000 square foot facility in Oak Ridge,
Tennessee, under an 18-year lease agreement. The Tennessee facility will be
used to build a three to six million gallon antifreeze recycling operation,
similar to Thermoflow's Las Vegas operation, by year-end 2000. Liquitek's
business plan includes designing and manufacturing advanced wastewater
6
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treatment systems, as well as systems for profitably recycling other
contaminated liquids, such as antifreeze, for domestic and international
customers.
Pursuant to the terms of the letter of intent, in January 2000 we
advanced Thermoflow $300,000 and Liquitek $200,000. We are obligated to raise
an additional $1,300,000 of working capital for Thermoflow and $450,000 for
Liquitek as a condition to completing the acquisitions. The proceeds of the
January 2000 Common Stock Offering will enable us to complete the funding
obligations required by the letter of intent and complete the acquisitions.
Through the acquisition of Thermoflow and Liquitek, we intend to own
and operate regional facilities for recycling antifreeze and treating oily
wastewater, to license and lease systems to domestic oily wastewater
treatment providers, and to design and build both types of facilities for
international markets. Our primary focus for Thermoflow and Liquitek will be
to develop and commercialize high-performance liquid recycling technologies.
THERMOFLOW/LIQUITEK PRODUCT
Thermoflow and Liquitek, through its license agreement with
Thermoflow, own the rights for a proprietary process for recycling
contaminated liquids and wastewater. Key benefits of the Thermoflow/Liquitek
process include:
- low life cycle treatment cost,
- low recycling cost,
- excellent chemistry quality of treated liquids (i.e., the
level of contaminant reductions achievable),
- excellent operational scalability, and
- flexibility of the process to be modified to accept a wide
range of liquids.
We anticipate that the Thermoflow/Liquitek process will yield
patents for water purification technology.
CLOSING THE ACQUISITIONS
The Thermoflow and Liquitek shareholders have the option to participate in a
registration statement to be filed under the Securities Act of 1933 within
four months of the closing of the acquisitions on Form S-3 (the "Registration
Statement"). Any of the shares that are included in the Registration
Statement shall be subject to lock-up agreements between the participating
shareholders and VitriSeal providing that the participating shareholders will
be permitted to sell no more than 25% of their shares received in the
exchange ("Exchange Shares") in the six months following the effective date
(the "Effective Date") of the Registration Statement, no more than 25% of
their Exchanged Shares during the period beginning six months after the
Effective Date until 12 months after the Effective Date, and no more than 25%
of their Exchanged Shares during the period beginning 18 months after the
Effective Date until 24 months after the Effective Date. No further
restrictions shall apply to the Exchanged Shares held by participating
shareholders participating in the Registration Statement 24 months after the
Effective Date. However, the shares held by Louis Sferrrazza, the Chief
Executive Officer of both Thermoflow and Liquitek ("Sferrazza") will be
subject to additional restrictions as a condition of his employment. In
connection with the anticipated employment of Sferrazza by VitriSeal,
one-third of his shares will be released from an escrow on each anniversary
of closing the acquisitions, conditioned upon his continued employment with
VitriSeal on each applicable anniversary. However, if Sferrazza's employment
with VitriSeal is terminated by VitriSeal for any reason other than cause, as
defined in an employment agreement to be negotiated between VitriSeal and
Sferrazza, all of his shares shall be immediately released from the escrow.
Another condition to closing the acquisitions required VitriSeal to
advance $300,000 to Thermoflow and $200,000 to Liquitek in the form of
unsecured loans payable by Thermoflow and Liquitek, respectively, with
interest at the rate of 10% per annum with principal and interest due
December 31, 2001. These advances were made in January 2000. The proceeds
from these advances have been used to pay monies owed to Thermoflow
shareholders, to settle accounts payable, and for working capital.
As an additional condition to the acquisitions, VitriSeal
must advance the lesser of $1,300,000 or the amount necessary to pay the
remaining debts of Thermoflow that exist as of the closing to Thermoflow on
or before March 1, 2000 in consideration for a promissory note payable by
Thermoflow, with interest at the rate of 10% per annum and with principal and
interest due March 1, 2002. VitriSeal must also advance $200,000 to Liquitek
on or before March 1, 2000 and $250,000 on or before June 1, 2000 in
consideration for promissory notes payable by
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Liquitek, with interest at the rate of 10% per annum and with principal and
interest due March 1, 2002 and June 1, 2002, respectively.
LIQUIDITY AND CAPITAL RESOURCES
We anticipate that proceeds received from the January and February
2000 Common Stock Offerings discussed in Item 5 will provide sufficient
working capital for us to continue with VitriSeal research and development,
complete the acquisitions of Thermoflow and Liquitek, and continue operations
through 2000.
ITEM 7. FINANCIAL STATEMENTS
The financial statements listed in the accompanying Index to
Financial Statements are attached hereto and filed as a part of this Report
under Item 13.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT
In conjunction with the merger and reorganization of Dancor, Inc.,
we changed auditors in April 1999. Our former accountants Jones, Jensen & Co.
were dismissed effective May 3, 1999, and Squar, Milner, Reehl & Williamson,
LLP, was appointed as our principal accountants. There were no disagreements
with the former accountant, and there are no disagreements with the current
Accountant on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure.
During the two most recent fiscal years, there have been no
disagreements with the former or current accountants on any matters of
accounting principles or practices, financial statement disclosure or
auditing scope or procedure or any reportable event. On May 3, 1999, we filed
an 8-K, which is incorporated herein by reference concerning the change of
accountants.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT
Incorporated by reference from our Proxy Statement filed February 25,
2000.
ITEM 10. EXECUTIVE COMPENSATION
Incorporated by reference from our Proxy Statement filed February 25,
2000.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from our Proxy Statement filed February 25,
2000.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from our Proxy Statement filed February 25,
2000.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report on Form
10-KSB:
1. Financial Statements for the years ended December 31, 1999 and 1998:
Independent Auditors' Report
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity
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Statements of Cash Flows
Notes to Financial Statements
2. Exhibits
The following exhibits are being filed with this Annual Report on
Form 10-KSB and/or are incorporated by reference therein in accordance with
the designated footnote references:
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
Form 8-K Filed May 3, 1999, as amended, regarding change of
accountants.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, we
caused this report to be signed on our behalf by the undersigned, thereunto
duly authorized, in the City of Draper, State of Utah, on the 24th day of
February 2000.
By:/s/Culley W. Davis
--------------------------------------------
Culley W. Davis, Chief Executive Officer
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
/s/Culley W. Davis Chief Executive Officer, February 24, 2000
- ------------------------------- Chairman of the Board, Director
Culley W. Davis
/s/Daniel L. Corbin President, Director February 24, 2000
- -------------------------------
Daniel L. Corbin
/s/Dennis A. Repp Director February 24, 2000
- -------------------------------
Dennis A. Repp
/s/John W. Nagel Director February 24, 2000
- -------------------------------
John W. Nagel
/s/Bruce H. Haglund Secretary, Director February 24, 2000
- -------------------------------
Bruce H. Haglund
</TABLE>
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VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report..............................................1
Balance Sheets ...........................................................2
Statements of Operations .................................................3
Statements of Stockholders' Equity........................................4
Statements of Cash Flows .................................................6
Notes to Financial Statements.............................................8
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
VitriSeal, Inc.
We have audited the accompanying balance sheets of VitriSeal, Inc., a
development stage company ("the Company"), as of December 31, 1999 and 1998
and the related statements of operations, stockholders' equity, and cash
flows for the years ended December 31, 1999 and 1998, and for the period
April 16, 1992 (inception) through December 31, 1999. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VitriSeal, Inc. at December
31, 1999 and 1998, and the results of its operations and its cash flows for
the years ended December 31, 1999 and 1998, and for the period April 16, 1992
(inception) through December 31, 1999, in conformity with accounting
principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has experienced a loss
of approximately $5.4 million for the period April 16, 1992 (inception)
through December 31, 1999. As discussed in Note 8 to the financial
statements, a significant amount of additional capital will be necessary to
advance the development of the Company's sole product to the point at which
it may become commercially viable. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's
plans regarding these matters are also described in Note 8. The accompanying
financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
SQUAR, MILNER, REEHL & WILLIAMSON, LLP
February 11, 2000
Newport Beach, California
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
1999 1998
---------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 366,566 $ 28,900
Prepaid expenses 26,023 -
---------------------------
392,589 28,900
Furniture, fixtures and equipment, net 64,249 45,598
Patents, net of accumulated amortization of $9,164
and $4,214 at December 31, 1999 and 1998,
respectively 151,392 171,633
Deferred tax asset, net of valuation allowance - -
Other assets 946 946
---------------------------
$ 609,176 $ 247,077
===========================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 55,207 $ 32,744
Commitments and contingencies
STOCKHOLDERS' EQUITY
Common stock, par value $0.001 per share, 100,000,000
shares authorized; 31,361,639 shares issued and
20,839,191 shares outstanding at December 31,
1999; 9,932,864 shares issued and 6,425,381
shares outstanding at December 31, 1998 20,839 6,425
Additional paid-in capital 5,799,936 4,000,284
Stock options outstanding 225,000 -
Accumulated deficit during the development stage (5,491,806) (3,792,376)
---------------------------
553,969 214,333
---------------------------
$ 609,176 $ 247,077
===========================
- -------------------------------------------------------------------------------------------
Page 2 The accompanying notes are an integral part of these financial statements.
</TABLE>
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VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND
FOR THE PERIOD APRIL 16, 1992 (INCEPTION) THROUGH DECEMBER 31, 1999
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
APRIL 16, 1992
(INCEPTION)
THROUGH
DECEMBER 31,
1999 1998 1999
-------------- -------------- --------------
<S> <C> <C> <C>
REVENUES
Licensing fees $ - $ - $ 25,000
EXPENSES
Research and development 650,194 530,731 2,143,479
Operating expenses 963,313 648,365 3,232,330
Interest (income) expense, net (19,143) 29,402 35,931
-------------- -------------- --------------
1,594,364 1,208,498 5,411,740
LOSS BEFORE INCOME TAX BENEFIT (1,594,364) (1,208,498) (5,386,740)
INCOME TAX BENEFIT
Current - - -
Deferred 515,000 460,000 1,800,000
-------------- -------------- --------------
515,000 460,000 1,800,000
Less valuation allowance (515,000) (460,000) (1,800,000)
-------------- -------------- --------------
- - -
-------------- -------------- --------------
NET LOSS $ (1,594,364) $ (1,208,498) $ (5,386,740)
============== ============== ==============
Basic and diluted loss per share $ (0.08) $ (0.07) $ (0.27)
============== ============== ==============
- ---------------------------------------------------------------------------------------------------
Page 3 The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND
FOR THE PERIOD APRIL 16, 1992 (INCEPTION) THROUGH DECEMBER 31, 1999
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
Accumulated
Deficit
Common Stock Additional Stock During
--------------------- Paid-in Options Development
Shares Amount Capital Outstanding Stage Total
---------- -------- --------- ----------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE - APRIL 16, 1992 (INCEPTION) - $ - $ - $ - $ - $ -
Common stock issued to related parties at par value 5,833,985 5,834 (5,834) - - -
Common stock issued at $0.63 per share to settle advances
from related parties 1,480,035 1,480 930,942 - - 932,422
Common stock issued at $0.63 per share for cash 800,000 800 503,200 - - 504,000
Common stock issued at $1.00 per share for cash 100,000 100 99,900 - - 100,000
Repurchase and retirement of common stock at $0.09 per
share (3,111,458) (3,111) (279,889) - - (283,000)
Repurchase and retirement of common stock from related
parties at $0.58 per share (386,025) (386) (224,614) - - (225,000)
Common stock issued to related parties at par value 1,132,963 1,133 (1,133) - - -
Common stock issued at $2.00 per share for cash 3,500 3 6,997 - - 7,000
Common stock issued at $3.00 per share for cash 157,000 157 470,843 - - 471,000
Repurchase and retirement of common stock at $3.00 per
share (10,000) (10) (29,990) - - (30,000)
Common stock issued at $8.33 per share to settle advances
from related parties 42,150 42 351,208 - - 351,250
Common stock issued at $10.00 per share for cash 1,000 1 9,999 - - 10,000
(continued)
- ---------------------------------------------------------------------------------------------------------------------------------
Page 4 The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND
FOR THE PERIOD APRIL 16, 1992 (INCEPTION) THROUGH DECEMBER 31, 1999
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
Accumulated
Deficit
Common Stock Additional Stock During
--------------------- Paid-in Options Development
Shares Amount Capital Outstanding Stage Total
---------- --------- ---------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Net loss for the period April 16, 1992 (inception)
through December 31, 1997 - - - - (2,583,878) (2,583,878)
---------- --------- ---------- ---------- ------------ -----------
BALANCE - DECEMBER 31, 1997 6,043,150 6,043 1,831,629 - (2,583,878) (746,206)
Common stock issued at $10.00 per share for cash 18,000 18 179,982 - - 180,000
Common stock issued at $6.85 per share to settle
advances from related parties 214,231 214 1,466,823 - - 1,467,037
Common stock issued on conversion of note payable
(note 10) 150,000 150 521,850 - - 522,000
Net loss - - - - (1,208,498) (1,208,498)
---------- --------- ----------- ---------- ------------ -----------
BALANCE - DECEMBER 31, 1998 6,425,381 6,425 4,000,284 - (3,792,376) 214,333
Common stock issued at $6.00 per share to settle
advances from related parties 28,167 28 168,972 - - 169,000
Common stock issued at $10.00 per share for cash 154,000 154 1,539,846 - - 1,540,000
Effect of merger with AXR Development Corporation,
Inc. 14,231,643 14,232 90,834 - (105,066) -
Stock options outstanding - - - 225,000 - 225,000
Net loss - - - - (1,594,364) (1,594,364)
---------- --------- ----------- ---------- ------------ -----------
BALANCE - DECEMBER 31, 1999 20,839,191 $ 20,839 $ 5,799,936 $ 225,000 $ (5,491,806) $ 553,969
========== ========= =========== ========== ============ ===========
- ---------------------------------------------------------------------------------------------------------------------------------
Page 5 The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND
FOR THE PERIOD APRIL 16, 1992 (INCEPTION) THROUGH DECEMBER 31, 1999
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
APRIL 16, 1992
(INCEPTION)
DECEMBER 31,
1999 1998 1999
-------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,594,364) $ (1,208,498) $ (5,386,740)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 15,483 10,644 46,190
Abandonment of patents pending 50,627 - 50,627
Stock options outstanding 225,000 - 225,000
Expenses paid by related party 169,000 - 169,000
Changes in current assets and
liabilities
Prepaid expenses (26,023) - (26,969)
Accounts payable and
accrued expenses 22,463 32,744 55,207
-------------- ------------- -------------
NET CASH USED IN OPERATING ACTIVITIES (1,137,814) (1,165,110) (4,867,685)
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of equipment (29,184) (18,265) (101,275)
Patent costs (35,336) (43,933) (211,183)
-------------- ------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (64,520) (62,198) (312,458)
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings on note payable - - 450,000
Advances from related party - 1,022,362 2,750,709
Proceeds from issuance of common stock 1,540,000 180,000 2,812,000
Repurchases of common stock - - (538,000)
Other capital contribution - - 72,000
-------------- ------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,540,000 1,202,362 5,546,709
-------------- ------------- --------------
(continued)
- ------------------------------------------------------------------------------------------------------------
Page 6 The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND
FOR THE PERIOD APRIL 16, 1992 (INCEPTION) THROUGH DECEMBER 31, 1999
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
APRIL 16, 1992
(INCEPTION)
THROUGH
DECEMBER 31,
1999 1998 1999
----------- ------------ ------------
<S> <C> <C> <C>
NET INCREASE (DECREASE) IN CASH 337,666 (24,946) 366,566
CASH - beginning of period 28,900 53,846 -
----------- ------------ ------------
CASH - end of period $ 366,566 $ 28,900 $ 366,566
=========== ============ ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH
FINANCING ACTIVITIES
Conversion of note payable to common stock $ - $ 450,000 $ 450,000
=========== ============ ============
Conversion of interest payable to common stock $ - $ 72,000 $ 72,000
=========== ============ ============
Conversion of advances from related party
to common stock $ 169,000 $ 1,467,037 $ 2,919,709
=========== ============ ============
Merger with AXR Development Corporation, Inc. $ 105,066 $ - $ -
=========== ============ ============
- -----------------------------------------------------------------------------------------------------
Page 7 The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
1. NATURE OF BUSINESS AND REORGANIZATION
NATURE OF BUSINESS
VitriSeal, Inc. (the "Company") was incorporated in Delaware on April 16,
1992 (inception). On April 24, 1992 (the effective date), the Company
executed a reorganization agreement whereby 3,043,350 shares of its common
stock were issued on the effective date in exchange for 100% of the
outstanding common stock of The Dancor Corporation, a Washington corporation,
in a substantially all-stock transaction. The Company did not record the only
significant asset acquired in this purchase (a patent pending, with an
undeveloped technology) at its estimated fair value on the effective date.
However, this amount is not material to the accompanying financial
statements. The Dancor Corporation was dissolved in November 1994.
The Company owns the right to a process called "VitriSeal," which is based on
inorganic silicate chemistry that produces a waterborne corrosion-protective
coating for metal surfaces. The Company is in the research and development
stage with respect to its application to particular industries. The Company
is classified as a development stage enterprise under accounting principles
generally accepted in the United States ("GAAP"), and has not commenced its
planned principal operations to generate revenues.
The Company's common stock trades on the OTC Bulletin Board of the National
Association of Securities Dealers under the symbol "VTSL."
REORGANIZATION
On December 23, 1998, AXR Development Corporation, Inc, a Nevada corporation
("AXR"), and the Company entered into an Agreement and Plan of Reorganization
(the "Plan") structured to result in AXR's acquisition of at least 80% of the
outstanding shares of the Company's restricted common stock (the
"Reorganization"). The Reorganization was intended to qualify as a tax-free
transaction under Section 368 (a)(1)(B) of the 1986 Internal Revenue Code, as
amended. Under the Plan's terms, the Company's former stockholders (1)
received three shares of AXR common stock for each one share of the Company
and (2) will ultimately acquire approximately 95% of the outstanding common
stock of AXR, if all of the Company's stockholders execute the Plan.
On March 18, 1999, the Company completed the Reorganization by entering into
a reverse merger through a tax-free reorganization with AXR, a publicly
traded "shell" company, whereby approximately 85% of the Company's
outstanding common stock was initially acquired by AXR.
Management has accounted for the Reorganization as a capital stock transaction
(as opposed to a "business combination," as that term is otherwise defined by
GAAP). Accordingly, the Reorganization has been reported as a recapitalization
of the Company,
- -------------------------------------------------------------------------------
Page 8
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
1. NATURE OF BUSINESS AND REORGANIZATION (continued)
REORGANIZATION (continued)
which is considered the acquirer for accounting purposes (a reverse
acquisition). Through its former stockholders, the Company is deemed the
acquirer for accounting purposes because of (a) its majority ownership of
AXR, (b) its representation on AXR's board of directors, and (c) executive
management positions held by former officers of Dancor, Inc., the predecessor
entity.
There are certain restrictions on the sale or other transfer of the Company's
common stock issued under the Plan. Such stock, generally referred to as
"Rule 144 stock," was not registered under the Securities Act of 1933, as
amended (the "Act"), in reliance upon an exemption from its registration
requirements. Each exchanging stockholder agreed to (1) acquire such stock
for his/her own account, and (2) hold the stock for investment purposes only.
In addition, the stock certificates are required to contain a legend
documenting these restrictions, and a legal opinion that any proposed sale is
exempt from registration under the Act.
AXR was incorporated in 1985 and was a dormant entity on March 18, 1999. AXR
had no assets or liabilities as of March 18, 1999, and had not recognized any
revenues since 1989. AXR changed its name to VitriSeal, Inc. in February,
1999.
As of January 31, 2000, the former stockholders of the Company owned
approximately 94% of the 20.8 million post-Reorganization shares of AXR's
outstanding common stock. Such shares are restricted securities under Federal
law, and will begin to become available for sale (under certain conditions,
and subject to statutory limitations) after March 18, 2000.
If the Reorganization had occurred on January 1, 1999, the pro forma effect
on basic and diluted loss per share for 1999 would not have been significant.
Since the Reorganization is not considered a business combination, additional
pro forma financial information otherwise required by the rules and
regulations of the Securities and Exchange Commission has not been presented.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of significant accounting policies of the Company presented below
is designed to assist the reader in understanding the Company's financial
statements. Such financial statements and these notes are the representations
of the Company's management, which is responsible for their integrity and
objectivity. These accounting policies conform to GAAP in all material
respects, and have been consistently applied in preparing the accompanying
financial statements.
- -------------------------------------------------------------------------------
Page 9
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to expense when incurred. Such
costs include scientific research and laboratory testing intended to advance
the VitriSeal process to the point of commercial production.
PATENTS
The Company capitalizes the cost of domestic and foreign patents and patents
pending, and amortizes such costs over the shorter of the remaining legal
life or their estimated economic life. Amortization expense for the years
ended December 31, 1999 and 1998 approximated $5,000 and $2,000,
respectively. The unamortized cost of patent applications is written off when
management determines there is no future benefit. In 1999, the Company
wrote-off patent pending costs totaling $50,627. No such write-offs were
recorded in 1998.
FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are stated at cost less accumulated
depreciation or amortization. Leasehold improvements are amortized over the
shorter of the remaining lease term or their estimated economic life.
Furniture and other equipment are depreciated using the straight-line method
over their estimated useful lives, ranging from five to seven years.
Repairs, maintenance, and similar costs that do not significantly improve or
extend the useful lives of the assets are expensed as incurred. When an asset
is sold or retired, the cost and accumulated depreciation or amortization are
removed from the accounts and any gain or loss is included in current
operations.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews the carrying values of its long-lived and identifiable
intangible assets for possible impairment whenever events or changes in
circumstances indicate that the carrying amount of the assets may not be
recoverable. No impairment losses were recorded during the period April 16,
1992 (inception) through December 31, 1999.
INCOME TAXES
Using the liability method required by Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes," the estimated tax
effects of temporary differences between financial and income tax reporting
are recorded in the period in which the events occur. Such differences
between the financial and tax bases of assets and liabilities result in
future tax deductions or taxable income (see Note 6).
- -------------------------------------------------------------------------------
Page 10
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
USE OF ESTIMATES
Management uses estimates and assumptions in preparing financial statements
in accordance with GAAP. Such estimates and assumptions affect the reported
amounts of certain assets and liabilities, disclosures relating to any
contingent assets and liabilities, and the reported amounts of certain
expenses. Actual results could vary from the estimates used to prepare the
accompanying financial statements.
STOCK-BASED COMPENSATION
The Company has implemented the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" (see Note 11), and measures
compensation expense for its stock-based compensation awards to employees and
directors using the intrinsic value method of accounting prescribed by
Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees." As described in Note 11, the Company accounts for stock
options issued to outside consultants using SFAS No. 123.
LOSS PER SHARE
In accordance with SFAS No. 128, "Earnings per Share," basic loss per share
is computed by dividing the loss attributable to common stockholders by the
weighted average number of common shares outstanding during the period.
Diluted loss per share reflects the amount that would have resulted if
certain dilutive potential common stock had been issued. Because the Company
has experienced losses from inception, the stock options described in Note 11
are antidilutive. Therefore, if such options had been granted prior to
January 1, 1999, they would not have impacted the disclosures in the table
that follows below.
The weighted average number of common shares outstanding for the indicated
periods is as follows:
Year ended December 31, 1999 20,627,000
Year ended December 31, 1998 18,249,000
Period April 16, 1992 (inception) through
December 31, 1999 19,750,000
The weighted average number of common shares outstanding for the year ended
December 31, 1999 includes approximately 99,000 shares of Dancor, Inc. stock
owned by persons who have not yet executed an agreement to convert their
shares to the Company's stock. The outstanding shares reported in the
accompanying December 31,
- -------------------------------------------------------------------------------
Page 11
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
LOSS PER SHARE (continued)
1999 balance sheet also include these shares, which represent less than 1% of
the shares outstanding.
OWNERSHIP OF NON-CONVERTING STOCKHOLDERS
At December 31, 1999, the ownership attributable to the non-converting
Dancor, Inc. stockholders who have not yet executed an agreement to convert
their shares to the Company's stock is considered immaterial by management of
the Company. As such, this amount has not been separately reported in the
accompanying December 31, 1999 balance sheet.
ELEMENTS OF OTHER COMPREHENSIVE INCOME
For the period April 16, 1992 (inception) through December 31, 1999, the
Company did not have any elements of other comprehensive income as defined by
SFAS No. 130, "Reporting Comprehensive Income." Therefore, statements of
comprehensive income have not been presented.
COVENANTS NOT TO COMPETE
As set forth in Note 7, the Company is the beneficiary of certain covenants
not to compete. For reasons discussed in Note 8, management has determined
that it is appropriate to allocate only a nominal value (which is not
significant to the accompanying financial statements) to such intangible
assets.
3. RELATED PARTY TRANSACTIONS AND RELATIONSHIPS
The names and relationships of related parties referred to in these notes are
set forth below (Company stock ownership percentages, which are as of
December 31, 1999, include beneficial ownership):
- - Culley W. Davis: Chairman of the Board of Directors; 12% stockholder,
including ownership through Pinnacle Enterprises, Inc. ("PEI") and Family
Legacy Ltd., which are controlled by Culley W. Davis or a member of his
immediate family.
- - Bruce H. Haglund, Esq.: an officer and director of the Company; the
brother-in-law of the Company's Chief Financial Officer; and a 1%
stockholder of the Company. Bruce Haglund is a partner in the law firm of
Gibson, Haglund & Paulsen ("GHP"), the Company's legal counsel. For the
period from inception to December 31, 1999, the Company paid or incurred
legal fees to GHP of approximately $217,000,
- -------------------------------------------------------------------------------
Page 12
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
3. RELATED PARTY TRANSACTIONS AND RELATIONSHIPS (continued)
including $119,000 and $33,500 for the years ended December 31, 1999 and
1998, respectively. The Salt Lake City, Utah office of GHP rents office
space from PEI.
- - Daniel L. Corbin: President; director; 7% stockholder; and brother-in-law
of Culley W. Davis.
- - Dennis A. Repp: Director and 2% stockholder.
- - John Nagel: Chief Financial Officer
On May 12, 1999, the Company granted stock options to several individuals,
including all of the persons listed above (see Note 11).
Because the Company, PEI and other entities have commonality of ownership and
are under common management control, reported operating results and/or
financial position of the Company could significantly differ from what would
have been obtained if such entities were autonomous (see Note 9).
Other related party transactions are discussed elsewhere in these notes to
the financial statements.
4. CONCENTRATION OF CREDIT RISK
Financial instruments that may subject the Company to credit risk principally
consist of uninsured cash-in-bank balances. On any given date, the Company's
bank balance may exceed the FDIC-insured amount. At December 31, 1999, the
Company's bank balance reported by its principal financial institution
exceeded the insured amount by approximately $315,000.
5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following at December 31:
<TABLE>
<CAPTION>
1999 1998
-------------- --------------
<S> <C> <C>
Computer and software $ 3,738 $ 3,738
Furniture and fixtures 18,163 18,163
Testing equipment 76,897 47,713
Lease improvements 2,477 2,477
-------------- --------------
101,275 72,091
Accumulated depreciation and amortization (37,026) (26,493)
-------------- --------------
$ 64,249 $ 45,598
============== ==============
</TABLE>
- -------------------------------------------------------------------------------
Page 13
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
6. INCOME TAXES
The Company files its income tax returns using the cash basis of accounting.
For the period April 16, 1992 (inception) through December 31, 1999, the
Company is considered a start-up entity for federal and state income tax
purposes. As a result, research/development and start-up expenses are
capitalized for tax purposes while such costs are expensed as incurred for
financial reporting purposes. This is the only significant temporary
difference at December 31, 1999 and 1998, and for the period April 16, 1992
(inception) through December 31, 1999.
The reported income tax benefit (expense) differs from the amount that would
result from applying the federal statutory rate to the pre-tax loss because
of the state income tax effect at a rate of approximately 5%. The components
of the deferred income tax benefit (expense) are set forth below:
<TABLE>
<CAPTION>
APRIL 16, 1992
(INCEPTION)
YEAR ENDED YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1998 1999
------------- ------------ -------------
<S> <C> <C> <C>
Federal $ 555,000 $ 360,000 $ 1,555,000
State (40,000) 100,000 245,000
------------- ------------ -------------
$ 515,000 $ 460,000 $ 1,800,000
============= ============ =============
</TABLE>
The Company has an estimated federal tax net operating loss ("NOL")
carryforward at December 31, 1999 of approximately $234,000 expiring as
follows:
<TABLE>
<S> <C>
2011 $ 168,000
2012 66,000
============
$ 234,000
============
</TABLE>
The Company's accounting NOL carryforward approximates $5.4 million at
December 31, 1999. The related deferred tax asset arising in 1999 and 1998
approximated $515,000 and $460,000, respectively. Because the Company is a
development stage enterprise and there is no reasonable assurance that such
asset will be realized in future years, the Company has recorded a 100%
valuation allowance against these deferred tax assets at December 31, 1999
and 1998.
A summary of the activity in the valuation allowance for the deferred tax
asset for the years ended December 31, 1999 and 1998 is presented below:
- -------------------------------------------------------------------------------
Page 14
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
6. INCOME TAXES (continued)
<TABLE>
<S> <C>
Balance at January 1, 1998 $ 825,000
Adjustment for 1998 deferred tax asset 460,000
------------
Balance at December 31, 1998 1,285,000
Adjustment for 1999 deferred tax asset 515,000
------------
Balance at December 31, 1999 $ 1,800,000
============
</TABLE>
7. COMMITMENTS AND CONTINGENCIES
LEASES
The Company is obligated on two operating leases at December 31, 1999. The
first lease is for an office facility in Newport Beach, California, which
calls for monthly rent of approximately $1,200. Daniel Corbin is a co-lessee
on this lease, which expires April 14, 2000. Future minimum rent payable
under this lease approximates $4,000. The second lease, which has been
amended to expire March 31, 2000, is for research activity laboratory space
at Northwestern University in Evanston, Illinois; such lease requires monthly
rent of approximately $1,700.
For the years ended December 31, 1999 and 1998, rent expense approximated
$53,000 and $25,000, respectively. For the period April 16, 1992 (inception)
through December 31, 1999, total rent expense approximated $132,000.
RESEARCH AND CONSULTING CONTRACTS
In January, 1997, the Company entered into a month-to-month consulting
contract (the "Jennings Contract") to engage Hamlin Jennings, Ph. D.
("Jennings") as an independent contractor to provide technical consulting
services on a best-efforts basis relating to (1) product
research/development, technology, and commercialization and (2) patent
completion and processing. At December 31, 1999, payments being made under
the Jennings Contract were generally $35,000 per month. The performance of
services under the Jennings Contract is neither transferable nor assignable
without the Company's prior written consent. The Company paid approximately
$451,000 and $390,000 to Jennings during the years ended December 31, 1999
and 1998, respectively, and approximately $1,160,000 for the period April 16,
1992 (inception) through December 31, 1999.
The Jennings Contract also requires the Company to allocate a portion of its
revenues from all sources to a deferred compensation plan. The terms of such
deferred compensation plan are set forth below under "Royalty Agreements."
- -------------------------------------------------------------------------------
Page 15
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
7. COMMITMENTS AND CONTINGENCIES (continued)
RESEARCH AND CONSULTING CONTRACTS (continued)
Jennings has provided a non-compete covenant prohibiting him from engaging in
any activities that are competitive with or adverse to the Company's business
during the term of the Jennings Contract.
In September, 1998, the Company entered into a consulting contract (the
"Hanneman Contract") with Rodney Hanneman to provide management, marketing,
and technical services in return for a $10,000 annually renewable retainer
and hourly consulting fees. For the years ended December 31, 1999 and 1998,
the Company paid approximately $29,000 and $17,000, respectively, under the
Hanneman Contract.
The Hanneman Contract also provides that Rodney Hanneman will receive (a)
incentive and performance payments of 1% of the Company's gross revenue from
1999 through 2005 payable quarterly; or (b) 1% of the selling price of the
Company, or 1% of the value of any initial public offering, if either
transaction occurs before December 31, 2005.
ROYALTY AGREEMENTS
In February, 1997, the Company entered into separate royalty agreements with
Dennis Repp ("Repp") and Daniel Corbin ("Corbin") whereby Repp and Corbin
shall each receive a 2% royalty on all revenues or other proceeds earned by
the Company resulting from the VitriSeal process, including licensing fees,
product and technology sales, royalty income, and asset sales. The royalty
agreements provide that such payments will continue until the termination of
the recipient's services to the Company in connection with the development
and commercialization of the VitriSeal process.
Upon the termination of such services, Repp and Corbin and their
heirs/successors shall receive post-termination royalties equal to 2% of
defined revenues earned by the Company from (1) existing customers at the
termination date and (2) prospects who were contacted prior to such date and
later became customers of the Company. Such payments will continue until the
customers described in the preceding sentence no longer generate any revenue.
Repp and Corbin have each provided a covenant not to compete prohibiting them
from engaging in any activities that are competitive with or adverse to the
Company's business during the term of the royalty agreements. Violation of
this covenant will discharge the Company from any future obligation to make
royalty payments.
In February 1997, the Company also entered into an agreement with Jennings
identical to those with Repp and Corbin as set forth above. On July 15, 1998,
the Jennings royalty agreement was amended to provide for a 3% royalty; all
other provisions of such agreement remain in effect.
- -------------------------------------------------------------------------------
Page 16
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
7. COMMITMENTS AND CONTINGENCIES (continued)
ROYALTY AGREEMENTS (continued)
On November 23, 1998, the Company entered into a royalty agreement with
Culley W. Davis ("Davis") whereby Davis shall receive a 2% royalty on all
revenues or other proceeds earned by the Company resulting from the VitriSeal
process, including licensing fees, product and technology sales, royalty
income, and asset sales. On June 24, 1999, the Davis royalty agreement was
mutually canceled as additional consideration for the 164,548 shares of
common stock issued in settlement of advances payable to PEI in 1998 and 1999
(see Note 9).
In January 1999, the Company granted a worldwide, non-exclusive licensing
agreement to a wheel manufacturer to use the VitriSeal process to apply a
protective coating to wheels used in the automotive and truck industries.
Effective June 4, 1999, the agreement, as amended, has three phases. In phase
I, the manufacturer shall pay $2.50 per coated wheel sold with a maximum
royalty of $200,000. In phase II (which commences after the sale of a maximum
of 80,000 units), the manufacturer is obligated to pay royalties of $5.00 per
coated wheel sold for one year following the completion of Phase I. In phase
III, the manufacturer shall pay, for each coated wheel, the lower of (a)
$10.00 less the manufacturer's total production cost or (b) the lowest
royalty rate then being paid by all other licensees, less $1.00. Royalties
are due quarterly, with interest at 1% per month on any unpaid amounts. The
agreement terminates on December 31, 2004. As of February 11, 2000, the
manufacturer has not commenced any production activity.
8. GOING CONCERN/LIQUIDITY CONSIDERATIONS
As discussed in Note 1, the Company is a development stage enterprise
developing a metal coating process known as "VitriSeal." There have been no
product sales or significant royalty revenues to date, and management
projects that the Company will require significant additional capital to
advance the development of its sole product to the point where it may become
commercially viable. The Company intends to finance the continuing research
and development of its product with equity capital (see Note 14).
Accordingly, there is substantial doubt about the Company's ability to
continue as a going concern. The accompanying financial statements do not
include any adjustments that might result from the outcome of this
uncertainty. If operations are discontinued, unamortized patent costs may not
be fully recoverable.
9. ADVANCES FROM RELATED PARTIES AND COMMON STOCK TRANSACTIONS
From April 16, 1992 (inception) through December 31, 1999, PEI and other
related
- -------------------------------------------------------------------------------
Page 17
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
9. ADVANCES FROM RELATED PARTIES AND COMMON STOCK TRANSACTIONS (continued)
parties periodically made cash advances to the Company and/or directly funded
the Company's research and development and operating expense requirements.
The Company repaid these advances with the issuance of common stock as
follows:
<TABLE>
<CAPTION>
NUMBER OF
SHARES AMOUNT
--------- -----------
<S> <C> <C>
1994 252,715 $ 159,210
1995 1,227,320 773,212
1997 42,150 351,250
1998 214,231 1,467,037
1999 28,167 169,000
</TABLE>
During 1998, the Company issued 136,381 additional shares of common stock to
PEI (see "Royalty Agreements" in Note 7). Concurrent with this transaction,
the Company recorded an $818,287 reduction of advances payable to related
party with a corresponding increase of additional paid-in capital. Because
the parties agreed that the original terms of such advances included a
conversion privilege, no gain or loss was recognized on the transactions.
During the year ended December 31, 1999, an additional 28,167 shares of
common stock representing $169,000 were issued to PEI under the same terms
and conditions.
During 1999 and 1998, the Company incurred approximately $55,000 and
$400,000, respectively, for reimbursement of certain operating and overhead
expenses to PEI. For the period April 16, 1992 (inception) through December
31, 1999, such expenses approximated $1,080,000.
10. CONVERTIBLE NOTE PAYABLE TO RELATED PARTY
On September 7, 1996, the Company borrowed $450,000 from R. A. Properties,
Ltd. ("RAP"), which is owned/controlled by Dennis Repp, and executed a
$450,000 note payable with all principal and interest (at 7%) due on
September 8, 1998. Such note was convertible any time at RAP's option into
Company common stock at $3.00 per share. On December 10, 1998, when principal
plus accrued interest approximated $522,000, the note was converted into
150,000 shares of common stock. The $522,000 (less the par value of common
stock) was credited to additional paid-in capital upon conversion of the note
payable.
- -------------------------------------------------------------------------------
Page 18
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
11. STOCK OPTIONS
On May 12, 1999, the Company granted non-statutory options to purchase
1,225,000 post-Reorganization shares of its common stock to certain
employees, directors and outside consultants at an exercise price of $1.75
per share. Such options, which expire on June 30, 2009, became exercisable on
the grant date. As of February 11, 2000, the Company had not adopted a formal
stock option plan. The related parties listed below are the recipients of the
stock options described in this paragraph:
<TABLE>
<CAPTION>
NUMBER OF
SHARES
------------
<S> <C>
Culley W. Davis 300,000
Daniel Corbin 300,000
Dennis Repp 300,000
Hamlin Jennings 100,000
Bruce Haglund 50,000
John Nagel 25,000
Rodney Hanneman 100,000
Greg Weld 25,000
Paul Kokx 25,000
------------
1,225,000
============
</TABLE>
STOCK OPTIONS ISSUED TO EMPLOYEES AND DIRECTORS
The Company has adopted the disclosure-only provisions of SFAS No. 123 and,
as permitted by such pronouncement, measures compensation cost as the excess
of the quoted market price of the Company's stock at the grant date over the
amount the employee must pay for the stock. In accordance with APB Opinion
25, the Company did not recognize any compensation expense for the 975,000
options granted to employees and directors.
SFAS No. 123 requires disclosure of the pro forma net income/loss and the
related per-share effect as if the fair-value method had been applied in
measuring compensation cost for all stock-based awards. Such information is
set forth below for the year ended December 31, 1999:
Net loss:
As reported $ 1,594,000
Pro forma $ 2,470,000
Loss per share:
As reported $ 0.08
Pro forma $ 0.12
- -------------------------------------------------------------------------------
Page 19
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
11. STOCK OPTIONS (continued)
STOCK OPTIONS ISSUED TO EMPLOYEES AND DIRECTORS (continued)
The weighted average fair value of options granted in 1999 was approximately
$1.1 million. Such value was estimated on the grant date using the
Black-Scholes stock option-pricing model based on the option exercise price,
the grant date market price of the stock, and the following assumptions:
Risk-free interest rate 5.2 %
Expected option life 2.5 years
Estimated annualized volatility 80 %
Expected dividend yield Zero
STOCK OPTIONS ISSUED TO OUTSIDE CONSULTANTS
During 1999, 250,000 options granted to outside consultants of the Company
have been accounted for using the fair-value method of SFAS 123. The
estimated compensation expense recognized in 1999 was $225,000 (see Note 13).
The fair value of such options was estimated on the grant date using the
Black-Scholes stock option-pricing model, as described above.
SUMMARY
The following table summarizes information about stock option activity during
the year ended December 31, 1999:
<TABLE>
<S> <C>
Number of options outstanding on January 1, 1999 -
Number of options granted in 1999 1,225,000
Number of options outstanding at December 31, 1999 1,225,000
Number of options exercisable at December 31, 1999 1,225,000
Weighted average exercise price per share outstanding $ 1.75
Total compensation cost recognized in 1999 for stock-based
compensation awards $ 225,000
Grant date fair value of options granted in 1999 $ 1,100,000
Weighted average grant date fair value of options granted in 1999 $ 1,100,000
Weighted average remaining contractual life of options outstanding
and exercisable 9.5 years
During 1999, no options were exercised, forfeited or expired.
</TABLE>
- -------------------------------------------------------------------------------
Page 20
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
12. EXPENSE PAID BY A PRINCIPAL STOCKHOLDER
In March, 1995, PEI transferred as additional compensation 120,000 of its
Company shares to James A. Latty, Ph. D., owner of JAL Engineering and an
officer and stockholder of the Company in 1995 and 1996. JAL Engineering was
a former research consultant to the Company. At that time, the Board of
Directors estimated the value of the stock at $1.00 per share. In November,
1996, PEI repurchased such stock for cash. The Company has accounted for
these transactions by recording approximately $120,000 of research and
development expense.
13. FOURTH-QUARTER ADJUSTMENT
In the fourth quarter of 1999, the Company recorded an adjustment of
approximately $212,000 to increase the compensation expense (and revise the
attribution period) associated with stock options issued to outside
consultants (see Note 11). As a result, the previously reported net loss of
$456,000 (unaudited) for the quarter ended June 30, 1999 has been restated to
approximately $668,000 or $(0.03) per share (unaudited).
14. SUBSEQUENT EVENTS
PROPOSED ACQUISITION
On December 30, 1999, the Company entered into a letter of intent (the "LOI")
with Thermoflow Corporation ("Thermoflow") and Liquitek Corporation
("Liquitek") to acquire substantially all of the outstanding shares of
Thermoflow and Liquitek in exchange for 16,060,000 shares of the Company's
common stock. The parties intend to execute definitive tax-free
reorganization agreements to accomplish these transactions. One of the
conditions for closing this proposed acquisition is that the Company receives
agreements to participate in such reorganization from the stockholders
representing 90% of Liquitek's outstanding shares and at least 80% of
Thermoflow's outstanding shares. As of February 11, 2000, this transaction
had not closed.
On January 11, 2000, in connection with the proposed acquisition, the Company
authorized non-statutory options to purchase a total of 775,000 shares of its
common stock to the following related parties: Culley Davis (275,000 shares);
Bruce Haglund (250,000 shares); and Allen Kirschbaum (250,000 shares), who is
a director of Thermoflow. The granting of such options is contingent upon the
closing of the proposed acquisition. The options, which have an exercise
price of $2.00 per share and expire on March 31, 2010, vest when and if the
proposed acquisition closes. The grant date closing market price of the
Company's common stock approximated $2.30.
- -------------------------------------------------------------------------------
Page 21
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
14. SUBSEQUENT EVENTS (continued)
PRIVATE OFFERINGS OF COMMON STOCK
Under the LOI, the Company is obligated to make certain interest-bearing
loans to Thermoflow and Liquitek in an aggregate amount of approximately $2.3
million. The Company intends to finance such loans through the sale of a
maximum of $17.5 million of restricted common stock in private placement
offerings (less legal fees, finder's fees, and other issuance costs).
As of February 11, 2000, the Company has received gross proceeds of
approximately $5.7 million from such offerings, advanced a total of $500,000
to Thermoflow and Liquitek, and paid approximately $545,000 of finder's fees
related to the offerings, including approximately $265,000 paid to related
parties.
The Company borrowed the $500,000 advanced to Thermoflow and Liquitek from
Culley Davis and PEI. On January 11, 2000, the Board of Directors authorized
the Company to issue 285,715 shares of its common stock to Culley Davis as
consideration for such borrowing and forgiveness of the obligation to repay
the debt.
EMPLOYMENT AGREEMENT
Effective February 1, 2000, the Company entered into an employment agreement
(the "Agreement") with Paul Kokx ("Kokx") to hire Kokx as executive
vice-president at a minimum annual salary of $175,000 plus certain benefits.
The Agreement prohibits Kokx from competing with the Company in any country
where the Company has protected business interests for the period beginning
February 1, 2000 and ending two years after the termination of his
employment. Unless the Agreement is terminated early, the employment of Kokx
will continue until January 31, 2004.
The Company has granted Kokx a non-statutory option to purchase 500,000
shares of its common stock at $2.00 per share. The grant date closing market
price of the Company's stock approximated $5.00 per share. Such option
expires on January 31, 2010 and, except as described in the following
paragraph, vests as follows:
<TABLE>
<CAPTION>
Number of
Shares
----------------
<S> <C>
December 31, 2000 50,000
December 31, 2001 100,000
December 31, 2002 150,000
December 31, 2003 200,000
</TABLE>
- -------------------------------------------------------------------------------
Page 22
<PAGE>
VITRISEAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
14. SUBSEQUENT EVENTS (continued)
EMPLOYMENT AGREEMENT (continued)
Accelerated vesting is available based on executed wheel-coating process
license agreements and royalty revenue received by the Company under such
agreements. Any unvested options immediately vest and become exercisable upon
a change in control of the Company.
- -------------------------------------------------------------------------------
Page 23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AND STATEMENT OF OPERATIONS FOR VITRISEAL, INC., A DEVELOPMENT STAGE
COMPANY AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 366,566
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 392,589
<PP&E> 101,277<F1>
<DEPRECIATION> 37,028
<TOTAL-ASSETS> 609,176
<CURRENT-LIABILITIES> 55,207
<BONDS> 0
0
0
<COMMON> 20,839
<OTHER-SE> 553,130
<TOTAL-LIABILITY-AND-EQUITY> 609,176
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,613,507<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (19,143)
<INCOME-PRETAX> (1,594,364)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,594,364)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,594,364)
<EPS-BASIC> (.08)
<EPS-DILUTED> (.08)
<FN>
<F1>GROSS INVESTMENT IN PP&E, i.e., BEFORE DEPRECIATION DEDUCTION
<F2>OPERATING EXPENSE 963,313; R&D 650,194
</FN>
</TABLE>
