NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of Business and Summary of Significant Accounting
Policies
Organization
Essential Innovations Technology Corp. (the “Company”) was
incorporated under the laws of the state of Nevada on April 4, 2001. The
Company’s subsidiary, Essential Innovations Corporation (“EIC”), is
engaged in the manufacturing, installation, and distribution of the “EI Elemental
Heat Energy System” family of geo exchange heat products and technology in North
America, though its sales to date are primarily in western Canada. On March 6,
2006, the Company acquired all of the issued and outstanding shares of Pacific Geo
Exchange Inc. (“PGE”) and its wholly owned subsidiary, Earth Source Energy
Inc. (“ESE”), which is engaged in the design and installation of geo
exchange systems in western Canada. Effective February 1, 2005, the Company had
sales of its developed products and management determined that the Company had emerged
from the development stage.
Future Operations
The
Company’s consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States applicable to a going
concern which contemplates the realization of assets and liquidation of liabilities in
the normal course of business. The Company has not yet generated positive cash flows
from operations. It is the Company’s intention to raise additional equity to
finance the further development of a market for its products until positive cash flows
can be generated from its operations. However, there can be no assurance that such
additional funds will be available to the Company when required or on terms acceptable
to the Company. Such limitations could have a material adverse effect on the
Company’s business, financial condition, or operations, and these consolidated
financial statements do not include any adjustment that could result. Failure to obtain
sufficient additional funding would necessitate the Company to reduce or limit its
operating activities or even discontinue operations.
Basis of Consolidation
The
accompanying unaudited interim consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with SEC instructions. Accordingly, they do not include all the
information and footnotes required by generally accepted accounting principles for
complete financial statements. The results of operations reflect interim adjustments,
all of which are of a normal recurring nature and which, in the opinion of management,
are necessary for a fair presentation of the results for such interim period. The
results reported in these interim consolidated financial statements should not be
regarded as necessarily indicative of results that may be expected for the entire year.
Certain information and note disclosure normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to the Securities and Exchange Commission’s rules
and regulations. These unaudited interim consolidated financial statements should be
read in conjunction with the audited consolidated financial statements included in the
Company’s Annual Report on Form 10-KSB for the year ended October 31,
2007.
7
These consolidated financial statements include the accounts of
Essential Innovations Technology Corp. and its wholly owned subsidiaries, EIC, PGE, and
ESE, as well as its majority-owned subsidiary, Essential Innovations Asia Limited
(“EIA”). All significant inter-company balances and transactions have been
eliminated.
Cash
Cash
consists of checking accounts held at financial institutions in Canada and Hong Kong.
At times, cash balances may exceed insured limits.
Accounts Receivable
Accounts receivable result primarily from installation contracts and the
sale of geothermal products and are recorded at their principal amounts. Receivables
are considered past due after 30 days. When necessary, the Company provides an
allowance for doubtful accounts that is based on a review of outstanding receivables,
historical collection information, and current economic conditions. There is an
allowance for doubtful accounts of $80,944 at January 31, 2008. Receivables are
generally unsecured. At January 31, 2008, two customers accounted for 30% of the
net accounts receivable balance.
As
of January 31, 2008, accounts receivable totaling $161,229 were in dispute by the
Company’s customers, and the Company has filed certain legal claims in an attempt
to recover those amounts. These factors have been considered in the Company’s
estimate of allowance for doubtful accounts.
Inventory
Inventory consists primarily of raw materials used in the manufacture of
geo exchange products, which are stated at the lower of cost (first-in, first-out
method) or market.
Revenue Recognition
Revenues from the sales of geo exchange products are recognized as the
sales are made, the price is fixed and determinable, collectibility is probable, and no
significant Company obligations with regard to the products remain.
Revenue from construction contracts are recognized on the
percentage-of-completion method, measured by the percentage of costs incurred to date
to estimated total costs for each contract. Because of the inherent uncertainties in
estimating costs, it is at least reasonably possible that the estimates used may change
in the near term. If estimated costs to complete long-term contracts indicate a loss,
provision is made in the current period for the total anticipated loss. The lives of
contracts entered into are typically twelve months or less, but performance may require
two construction seasons.
The
asset, “Costs and estimated earnings in excess of billings on uncompleted
contracts,” represents revenues recognized in advance of amounts billed.
Conversely, the liability, “Billings in excess of costs and estimated earnings on
uncompleted contracts,” represents amounts billed in advance of revenues
recognized.
8
Net Loss per Share
Basic net loss per share is calculated by dividing the net loss
attributable to common shareholders by the weighted average number of common shares
outstanding in the period. Diluted loss per share takes into consideration common
shares outstanding (computed under basic loss per share) and potentially dilutive
securities. For the three-month periods ended January 31, 2008 and 2007,
outstanding stock options and warrants are antidilutive because of net losses, and as
such, their effect has not been included in the calculation of diluted net loss per
share.
Common shares issuable are considered outstanding as of
the original approval date for purposes of earnings per share computations.
Comprehensive Income (Loss)
Statement of Financial Accounting Standards (“SFAS”) No. 130
establishes standards for reporting comprehensive income (loss) and its components in
financial statements. Other comprehensive income (loss), as defined, includes all
changes in equity (net assets) during a period from non-owner sources. To date, the
Company has not had any significant transactions that are required to be reported in
other comprehensive income (loss), except for foreign currency translation
adjustments.
Foreign Operations and Currency Translation
The
Company translates foreign assets and liabilities of its subsidiaries, other than those
denominated in U.S. dollars, at the rate of exchange at the balance sheet date.
Revenues and expenses are translated at the average rate of exchange throughout the
period. Gains or losses from these translations are reported as a separate component of
other comprehensive income (loss), until all or a part of the investment in the
subsidiaries is sold or liquidated. The translation adjustments do not recognize the
effect of income tax because the Company expects to reinvest the amounts indefinitely
in operations.
Transaction gains and losses that arise from exchange rate fluctuations
on transactions denominated in a currency other than the local functional currency are
included in general and administrative expenses.
Use of Estimates
The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities
and disclosures of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during the
fiscal year. The Company makes estimates for, among other items, percentage of
completion method of accounting for revenue from construction contracts, determination
of inventory at the lower of cost or market, useful lives for depreciation and
amortization, determination of future cash flows associated with impairment testing for
goodwill and long-lived assets, determination of the fair value of stock options and
warrants, determination of warranty accruals, and allowances for doubtful accounts. The
Company bases its estimates on historical experience, current conditions, and on other
assumptions that it believes to be reasonable under the circumstances. Actual results
could differ from those estimates and assumptions.
9
Note
2. Uncompleted Contracts
Costs, estimated earnings, and billings on uncompleted contracts as of
January 31, 2008, are summarized as follows:
Costs incurred on uncompleted contracts
|
$
|
96,100
|
Estimated earnings
|
|
105,079
|
|
|
201,179
|
Billings to date
|
|
(201,424)
|
|
$
|
(245)
|
Included in the accompanying balance sheet under the following
captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts
|
$
|
69
|
Billings in excess of costs and estimated earnings on
uncompleted contracts
|
|
(314)
|
|
$
|
(245)
|
Note
3. Property and Equipment, net
Property and equipment consist of the following as of January 31,
2008:
Office furniture and equipment
|
$
|
76,681
|
Leasehold improvements
|
|
52,857
|
Computer equipment
|
|
65,371
|
Computer software
|
|
37,372
|
|
|
232,281
|
Less accumulated depreciation
|
|
(156,051)
|
Property and equipment, net
|
$
|
$ 76,230
|
Note
4. Intangible Assets
Intangible assets consist of the following as of January 31,
2008:
Geo-site rights (finite-lived)
|
$
|
458,595
|
Intellectual property (indefinite-lived)
|
|
41,379
|
|
|
499,974
|
Less accumulated amortization
|
|
(42,041)
|
Intangible assets, net
|
$
|
457,933
|
Geo-Site Rights
During 2005, the Company acquired the exclusive rights to provide a
geo-field operating lease and to supply its heating and cooling units to a new
residential subdivision in Westbank, British Columbia, for 225,000 shares of the
Company’s common stock with a fair value of $225,000 and options, with a fair
value of $47,468, exercisable until 2010, redeemable for 150,000 shares of the
Company’s common stock, 75,000 at $0.75 per share and 75,000 at $1.00 per share.
The Company guaranteed that the 225,000 shares of the Company’s common stock
would have an aggregate fair market value of at least $225,000 one year after issuance,
and if the aggregate fair market value is less than $225,000, the Company would issue
additional shares of common stock to make the aggregate value $225,000.
10
The
225,000 shares issued in 2005 had an aggregate value of $112,500 and during 2006, the
Company issued an additional 225,000 shares of the Company’s common stock to make
up the deficit. The total cost of $434,987 will be amortized on a pro rata per-unit
basis as residential lots are sold. During the year ended October 31, 2007, $42,041 of
amortization was recognized. No additional amortization was recognized during the
period ended January 31, 2008, as no additional lots were sold during that
time.
Intellectual Property
The
Company acquired certain proprietary information that provides the basis for the
effective implementation and operation of the geo-utility business concept in return
for 75,000 fully paid and nonassessable shares of common stock with a fair value of
$30,000 and options to purchase 150,000 shares of common stock, 37,500 at $0.75 per
share and 37,500 at $1.00 per share exercisable until July 31, 2009, and 37,500 at
$1.25 per share and 37,500 at $1.50 per share exercisable until July 31, 2010.
These have been recorded at the fair value of $57,496. In addition, the vendor is
entitled to a royalty of 2.5% from gross revenue of geo-utility projects in which the
Company is directly involved and 0.5% of gross fees from geo-utility projects when the
Company provides project management. This intangible asset has an indefinite life. The
Company has not earned any gross revenue from geo-utility projects and, accordingly, no
royalty expense is included in the accompanying consolidated statements of operations.
Management evaluates the asset for impairment on at least an annual basis and recorded
an impairment loss of $41,378 during 2006. No further impairment occurred in 2007 or in
the first three months of 2008.
Note 5. Related-Party Transactions and Balances
Loans Payable, Related Parties
During 2003, a director and officer of the Company made an unsecured
loan to the Company in the amount of $30,600, due on demand, interest only payable
monthly at 8%, with the principal to be repaid in full on or before April 1, 2004.
In connection with this loan, options were granted which entitled the holder to
purchase 50,000 shares of common stock of the Company until 2012: 25,000 at $0.25 per
share and 25,000 at $0.50 per share. The fair value of the options of $37,978 was
recorded as interest expense during 2003. During 2004, the loan was extended and the
Company agreed to pay an additional $6,511 in refinancing costs. The balance remaining
at January 31, 2008, is $11,195.
During 2006, two related parties made unsecured loans to the Company
totaling $61,191, due September 30, 2006, with interest at 15%. The Company also
granted options to purchase 195,000 shares of common stock of the Company until 2011 at
$0.30 per share. The fair value of the warrants of $69,787 was recorded as interest
expense during 2006. The full amount of $61,191 remains due to these related parties at
January 31, 2008, as well as accrued interest in the amount of $12,764.
During 2007, a former officer of the acquired ESE subsidiary paid off
the balance of $15,051 of a finance loan on behalf of the Company. The Company has
accrued that amount for reimbursement of the former officer.
Due to Shareholders
Amounts due to shareholders in the amount of $251,700 at
January 31, 2008, are unsecured, without specific terms of repayment and are
non-interest-bearing.
11
Note
6. Term Loan
During 2006, the Company arranged term financing of $2 million to
complete the acquisition of PGE and ESE. This loan is secured against all assets of the
Company and bears interest, payable monthly, at the rate of prime plus 3%, with a
minimum interest rate of 8%. During the first half of 2007, the principal repayments
were renegotiated and the new principal payments are $30,000 per month from May 2007 to
November 2007; $37,500 per month from December 2007 to May 2008; and $62,500 per month
from June 2008 until the loan is paid in full. In addition to the monthly payments, the
Company is required to pay 30% of annual positive cash flow as additional principal
payments. At January 31, 2008, the Company was delinquent in interest payments and
other fees of $85,148 and principal payments of $285,000. As a result of such default,
all amounts due under the term loan have been reclassified to current on the
accompanying consolidated balance sheet.
The
Company has recorded a discount against the loan based on the relative fair value of
related warrants to purchase 2,919,496 shares of common stock related to the $2 million
term loan in the amount of $960,000. As the lender has agreed not to hold more than
4.99% of the Company’s stock at any one time, only that portion of the debt
discount equivalent to the exercising of warrants that would equate to 4.99% of the
Company’s outstanding stock as of the date of funding was expensed as interest in
the amount of $391,000 in the accompanying statements of operations during 2006. The
balance of the debt discount is being amortized over 36 months, and related discount
amortization of $47,415 and $47,415 for the periods ended January 31, 2008 and 2007,
respectively, is included in the accompanying statements of operations.
The
following represents payments due under the term loan as renegotiated as if the default
had not occured:
|
Principal due
|
|
Less discount
|
|
Net
|
Delinquent amounts due
|
$
|
285,000
|
|
$
|
--
|
|
$
|
285,000
|
February 2008 – January 2009
|
|
650,000
|
|
|
189,660
|
|
|
460,340
|
February 2009 – January 2010
|
|
750,000
|
|
|
15,825
|
|
|
734,175
|
February 2010
|
|
57,110
|
|
|
--
|
|
|
57,110
|
Total term loan
|
$
|
1,742,110
|
|
$
|
205,485
|
|
|
1,536,625
|
Plus amounts due under finance loans
|
|
|
|
|
|
|
|
4,959
|
Total current portion of long-term debt
|
|
|
|
|
|
|
$
|
1,541,584
|
Note 7. Share Capital
Preferred Stock
The
Company’s authorized capital includes 10,000,000 shares of preferred stock of
$0.001 par value. The designation of rights including voting powers, preferences, and
restrictions shall be determined by the Board of Directors before the issuance of any
shares.
No
shares of preferred stock are issued and outstanding as of January 31,
2008.
Common Stock
During the three months ended January 31, 2008, the Company issued
1,000,000 shares of common stock of the Company and warrants to purchase 1,000,000
shares of common stock of the Company at $0.10 per share for total proceeds of $50,000.
The proceeds allocated to warrants based on their relative fair value were
$22,100.
12
Stock Purchase Warrants
At
January 31, 2008, the Company had reserved shares of common stock for the
following outstanding warrants to purchase 17,682,724 shares of the
Company’s common stock:
Number of warrants
|
Exercise Price
|
Expiry
|
|
1,329,882
|
|
$ 0.001
|
2050
|
|
300,000
|
|
0.01
|
2011
|
|
8,610,000
|
|
0.10
|
2012
|
|
967,400
|
|
0.25
|
2011
|
|
4,831,732
|
|
0.30
|
2011
|
|
115,000
|
|
0.35
|
2010/2011
|
|
791,250
|
|
0.40
|
2010/2011
|
|
270,000
|
|
0.50
|
2010/2011
|
|
317,460
|
|
0.63
|
2011
|
|
75,000
|
|
0.75
|
2010
|
|
75,000
|
|
1.00
|
2010
|
|
17,682,724
|
|
|
|
Note 8. Minority Interest – Sale of Subsidiary Common
Stock
On
January 15, 2008, the Company sold a minority interest of 12.5% in its wholly owned
subsidiary EIA, for cash proceeds of $98,226, resulting in a gain of $98,226. At the
date of sale, liabilities of EIA exceeded its assets, therefore the amount of gain
recorded has been limited to the proceeds and no value was allocated to the minority
interest.
Note 9. Stock-Based Compensation
Although the Company does not have a formal stock option plan, it issues
stock options to directors, employees, advisors, and consultants. Stock options
generally have a four- to five-year contractual term, vest immediately, and have no
forfeiture provisions. No new options were granted during the three months ended
January 31, 2008.
The
following table summarizes stock options outstanding at January 31,
2008:
Exercise Price
|
|
Number Outstanding
at January 31, 2008
|
|
Average Remaining
Contractual Life
(Years)
|
|
Number
Exercisable at
January 31, 2008
|
$0.25
|
|
389,750
|
|
2.3
|
|
389,750
|
0.26
|
|
75,000
|
|
3.8
|
|
75,000
|
0.30
|
|
2,279,887
|
|
3.3
|
|
2,279,887
|
0.37
|
|
90,000
|
|
3.3
|
|
90,000
|
0.40
|
|
125,000
|
|
3.2
|
|
125,000
|
0.50
|
|
1,237,250
|
|
2.9
|
|
1,237,250
|
0.53
|
|
1,250,000
|
|
3.3
|
|
1,250,000
|
0.63
|
|
250,000
|
|
3.2
|
|
250,000
|
0.75
|
|
1,835,500
|
|
3.8
|
|
1,835,500
|
1.00
|
|
3,101,250
|
|
2.6
|
|
3,101,250
|
1.25
|
|
87,500
|
|
2.6
|
|
87,500
|
1.50
|
|
282,500
|
|
1.9
|
|
282,500
|
2.00
|
|
16,250
|
|
2.8
|
|
16,250
|
|
|
11,019,887
|
|
|
|
11,019,887
|
Aggregate Intrinsic Value
|
|
$ --
|
|
|
|
$ --
|
13
The
aggregate intrinsic value in the table above represents the total pretax intrinsic
value for all “in-the-money” options. At January 31, 2008, all outstanding
options had exercise prices greater than the Company’s closing stock price on
that day, so the aggregate intrinsic value of all outstanding and exercisable options
was $0 as of that day. The aggregate intrinsic value changes based on the fair market
value of the Company’s stock.
Note 10. Segment Information
The
Company views its operations in two lines of business – (1) manufacturing and (2)
geo exchange design and installation. Summarized financial information by segment for
the three months ended January 31, 2008 and 2007, as taken from the internal
management reports, is as follows:
|
Three Months
Ended
January
31, 2008
|
|
|
Three Months
Ended
January
31, 2007
|
|
|
Revenue
|
|
|
|
|
|
Manufacturing
|
$
|
93,962
|
|
$
|
153,474
|
Geo exchange design and installation
|
|
126,759
|
|
|
564,148
|
|
$
|
220,721
|
|
$
|
717,622
|
Loss
|
|
|
|
|
|
Manufacturing
|
$
|
(149,670)
|
|
$
|
(183,808)
|
Geo exchange design and installation
|
|
(9,918)
|
|
|
(205,992)
|
Corporate
|
|
(67,523)
|
|
|
(347,732)
|
|
$
|
(227,111)
|
|
$
|
(737,532)
|
Assets
|
|
|
|
|
|
Manufacturing
|
$
|
783,781
|
|
$
|
716,764
|
Geo exchange design and installation
|
|
328,253
|
|
|
3,048,683
|
Corporate
|
|
65,942
|
|
|
80,295
|
|
$
|
1,177,976
|
|
$
|
3,845,742
|
Note 11. Subsequent Events
Subsequent to January 31, 2008, the Company:
|
•
|
Agreed to an amendment to its service agreement to
provide a geo-field operating lease and to supply its heating and
cooling units to a new residential subdivision in Westbank, British
Columbia. The agreement was amended from a geo exchange mandated model
to a geo exchange optional model, which means that buyers in the
subdivision are now entitled to choose whether they want to utilize the
geo exchange option provided by the Company.
|
|
•
|
Entered into private placement agreements to issue a
total of 1,947,198 shares of the Company’s common stock for cash
of approximately $80,000.
|