QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
From time to time our investments may be exposed to market risk related to changes in
interest rates. Our current investment policy is to maintain an investment portfolio
consisting only of diversified institutional money market mutual funds investing in A-1
(S&P), Prime-1 (Moody’s) or F1 (Fitch) short-term corporate debt obligations;
U.S. Treasury Securities, or United States Government obligations issued by or backed by a
federal agency of the United States Government. We do not enter into investments for
trading or speculative purposes, and our cash is deposited in and invested through highly
rated financial institutions in the United States. While our available for sale securities
are subject to interest rate risk and would fall in value if market interest rates
increased, we estimate that the fair value of our investment portfolio would not decline by
a material amount in the event of an increase in market interest rates. We therefore would
not expect our operating results or cash flows to be affected to any significant degree by
the effect of a change in market interest rates on our investments.
RISKS RELATED TO OUR CAPITAL
RESOURCES
At July 31, 2007 we had current assets of $1,694,200, current liabilities of $502,400 and
no outstanding long-term debt. We do not yet have significant cash inflows from product
sales to offset our ongoing planned investments in corporate infrastructure, research and
development projects, regulatory submissions, business development activities, and sales
and marketing, among other investments.
On October 19, 2007, subsequent to
the end of the fiscal year, we closed on the sale of 1,677,596 unregistered securities
units to accredited investors, at $5.03 per unit. Each unit consisted of one share of PURE
Bioscience common stock and one quarter of a five-year warrant to purchase PURE Bioscience
common stock at $7.17 per share. A total of 419,394 such five-year warrants were issued to
the investors. Additionally, a five-year warrant to purchase 167,776 shares of common stock
at $8.60 per share was issued to Taglich Brothers, Inc. as the placement agent. The gross
proceeds of the sale were $8,438,328 and the net proceeds to us, after fees and expense,
were $7,720,743. If the shares of common stock are not registered within 210 of the filing
date, we would be required to repay 2% of the gross proceeds for each thirty day period
until the shares are registered, up to a maximum repayment of 18% of the gross proceeds. No
registration penalties are payable with respect to the shares underlying the
warrants.
In future periods we may need to seek
additional capital through the issuance of debt, equity, convertible securities or through
other means, any one of which could reduce the value to us, perhaps substantially, of our
technology and its commercial potential. The issuance of debt or equity, or convertible
securities, could lead to the dilution of our existing shareholders. There is no guarantee
that we would be able to obtain capital on terms acceptable to us, or at all. Insufficient
funds could require us to delay, scale back or eliminate some or all of our research and
product development programs, license to third parties the right to commercialize products
or technologies that we would otherwise commercialize ourselves, or to reduce or cease
operations.
RISKS RELATED TO OUR
OPERATIONS
We had a loss of $4,654,900 after taxes in the fiscal year ending July 31, 2007, and a loss
of $3,682,900 after taxes in the fiscal year ending July 31, 2006. We may continue to have
losses in the future. If the penetration into the marketplace of SDC is later than
anticipated, revenue growth is slower than anticipated or operating expenses exceed
expectations, it may take an unforeseen period of time to achieve or sustain profitability
and we may never achieve or sustain profitability. During the year ended July 31, 2007 we
invested in the expansion and improvement of our manufacturing facility, and to a lesser
extent our office space, and our future revenues may not provide an adequate return, if
any, on such investments. We may never achieve or sustain cash inflows that exceed our cash
outflows. Slower than anticipated revenue growth would or could force us to scale back
research, testing, product development and marketing of new products, and/or force us to
reduce the size and scope of our operations, or cease operations altogether.
11
We are a bioscience company focused
on the marketing and continued development of our electrolytically generated stabilized
ionic silver technology, including our flagship silver dihydrogen citrate antimicrobial,
and to a much lesser extent our Triglycylboride pesticide technology. While the rewards in
these fields are potentially great, the risks, the regulatory hurdles and the costs of
doing business are also high. Our silver dihydrogen citrate is a platform technology rather
than a single use applied technology. As such, products developed from the platform fall
under the jurisdiction of multiple U.S. and international regulatory agencies. We currently
have U.S. Environmental Protection Agency (“EPA”) registration for our
2400-parts per million (ppm) technical grade SDC concentrate (trade name Axenohl), as well
as for our Axen and Axen30 hard surface disinfectant products for commercial, industrial
and consumer applications including restaurants, homes and medical facilities. We intend to
fund and manage additional U.S. EPA-regulated product development internally, in
conjunction with our regulatory consultants and potentially by partnering with other third
parties. We are also partnering, or intend to partner, with third parties who are seeking,
or intend to seek, approvals to market SDC-based products in markets outside the United
States. However, the introduction of additional regulated antimicrobial products in the
U.S. or in markets outside the U.S. could take several months or years.
In addition to its use on inanimate
surfaces, we believe that our technology also shows promise as a broad-spectrum
antimicrobial for use in human and veterinary healthcare products. We are pursuing certain
approvals through the U.S. Food and Drug Administration (FDA) by partnering with
Therapeutics, Incorporated, which has assumed responsibility for the testing and regulatory
process for selected potential FDA regulated silver dihydrogen citrate-based products. We
expect that the development of SDC-based products could lead to multiple IND, NDA and/or
510-K filings for silver dihydrogen citrated-based healthcare products with the FDA. In
December 2006 Therapeutics submitted an Investigational New Drug (IND) application with the
FDA for an SDC-based hand sanitizer, to enable initiation of the first clinical trial of a
product containing SDC as an active pharmaceutical ingredient. After reviewing the
submission the FDA determined that the product testing in man may begin as proposed.
However, the FDA and comparable agencies in many foreign countries impose substantial
limitations on the introduction of new products through costly and time-consuming
laboratory and clinical testing and other procedures. The process of obtaining FDA and
other required regulatory approvals is lengthy, expensive and uncertain. There is no
guarantee that either Therapeutics, Inc., any other potential partner, or ourselves will be
able to obtain the resources necessary to further develop our technology or obtain
regulatory approvals, or that the products will be successful in meeting the strict
criteria imposed by the FDA. It may be several years before we, or a third party to whom we
grant rights to use our silver ion technologies, are able to introduce any FDA regulated
antimicrobial pharmaceutical products containing our technology. Such products may never
achieve regulatory approval and may never be commercialized.
We are marketing our new
antimicrobial silver ion technology to industrial and consumer markets. We also have begun
marketing our environmentally safe pesticides. These products have not yet been accepted
into the marketplace. Risks involved in introducing these new products include liability
for product effectiveness and safety, and competition from existing or emerging sources.
Additionally, government regulation in the United States and in other countries is a
significant factor in the development, manufacturing and marketing of many of our products
and in our ongoing research and development activities. Complying with applicable
government regulations and obtaining necessary clearances or approvals can be time
consuming and expensive, and there can be no assurance that regulatory review will not
involve delays or other actions adversely affecting the marketing and sale of our products.
We also cannot predict the extent or impact of future legislation or regulation. Some of
our new bioscience applications for the healthcare markets and food preparation markets
will require approval by government agencies prior to marketing or sale in the United
States. We have not yet applied for Food and Drug Administration or Department of
Agriculture approval to market any such products. If any future applications are not
approved, we will not be able to market or sell such products, which would limit the
revenues which may be realized. Even after approval, if any, we will remain subject to
changing governmental policies regulating antimicrobial products. We also intend to take
these technologies to the international marketplace, and doing business internationally
carries a great deal of risk, with regard to foreign government regulation, banking and
other factors.
Our silver ion, pesticide and other
products will be competing in markets dominated by extremely large, well financed and
internationally recognized chemical and pharmaceutical companies. Our ability to compete
will depend upon developing brand recognition and distribution methods. Many of our
competitors already have well established brands and distribution, as well as many times
our financial resources. Focused competition by such chemical and pharmaceutical giants
could substantially limit our potential market share and ability to profit from these
products.
We expect that sales of SDC will
constitute a substantial portion of our revenues in future periods. Any material decrease
in the overall level of sales or expected sales of, or the prices for SDC, whether as a
result of competition, change in consumer demand, or any other factor, would have a
materially adverse effect on our business, financial condition and results of
operations.
LEGAL AND REGULATORY RISKS RELATED
TO OUR BUSINESS
We rely and may in the future rely on a combination of patent, trademark, trade secret and
copyright law and contractual restrictions to protect the proprietary aspects of our
technology and business. These legal protections afford only limited protection for our
intellectual property and trade secrets. Despite efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our proprietary technology or otherwise
obtain and use information that we regard as proprietary.
We have filed for U.S. and foreign
patent applications and trademark registrations for our patents and trademarks. It is
possible that competitors or others will create and use products in violation of our
patents and/or adopt service names similar to our service names. Such patent infringement
could have a material, adverse effect on our business. Adopting similar names and
trademarks by competitors could lead to customer confusion. Any claims or customer
confusion related to our trademarks could negatively affect our business.
Litigation may be necessary to
enforce our intellectual property rights and protect our trade secrets. If third parties
prepare and file applications in the United States or other countries that claim trademarks
used or registered by us, we may oppose those applications and may be required to
participate in proceedings before the regulatory agencies who determine priority of rights
to such trademarks. Any litigation or adverse priority proceeding could result in
substantial costs and diversions of resources, and could seriously harm our business and
operating results.
12
To the extent that we operate
internationally, the laws of many countries may not protect our proprietary rights to as
great an extent as do the laws of the United States. Many countries have a
“first-to-file” trademark registration system. As a result, we may be prevented
from registering or using our trademarks in certain countries if third parties have
previously filed applications to register or have registered the same or similar
trademarks. Our means of protecting our proprietary rights may not be adequate, and our
competitors could independently develop similar technology.
As a business which manufactures and
markets products for use by consumers, we may become liable for any damage caused by our
products when used in the manner intended. Any such claim of liability, whether meritorious
or not, could be time-consuming and/or result in costly litigation. Although we maintain
general liability insurance, our insurance may not cover potential claims of the types
described above and may not be adequate to indemnify for all liabilities that may be
imposed. Any imposition of liability that is not covered by insurance or is in excess of
insurance coverage could harm our business and operating results, and you may lose some or
all of any investment you have made, or may make, in our common stock.
Our common stock is registered under
the Securities Exchange Act of 1934, as amended (the “Exchange Act”). It is
therefore subject to the information, proxy solicitation, insider trading and other
restrictions and requirements of the SEC under the Exchange Act. On July 30, 2002, the
Sarbanes-Oxley Act of 2002 was signed into law. The Sarbanes-Oxley Act relates to us and
adds to our obligations for regulatory reporting, accounting, corporate governance,
internal controls and business practices. The SEC continues to issue new and proposed rules
implementing various provisions of the Sarbanes-Oxley Act, and meeting these rules will
substantially increase the cost to us of being a public company, including substantial
costs during the year ending July 31, 2008. This additional cost will reduce our future
profits or increase our future losses, and a greater proportion of management time and
effort will be needed to meet our regulatory obligations than before.
Since becoming a public company in
August 1996, we have filed our annual and period reports as a small business issuer using
forms 10K-SB and 10Q-SB. Under the provisions of Regulation S-B, as the aggregate market
value of our common stock held by non-affiliates at July 31, 2006 and July 31, 2007 was
more than $25,000,000, we will no longer be within the small business reporting category
under the Exchange Act for the year ending July 31, 2008 and subsequent years. The
increased reporting requirements and heightened corporate governance obligations that we
will face now that we are no longer a small business filer will further increase the cost
to us, perhaps substantially, of being a public company. Additionally, during the year
ending July 31, 2008 or in future fiscal years, based on the aggregate market value of our
common stock we could be required to file our periodic and annual reports on an accelerated
basis, which would necessitate us incurring additional costs to remain compliant with our
obligations under the Exchange Act or Sarbanes-Oxley Act.
OTHER RISKS RELATED TO INVESTING
IN OUR SECURITIES
As of October 25, 2007, Michael L. Krall, our President and Chief Executive Officer,
beneficially owned, including exercisable options, approximately 8% of our common stock. As
of the same date, our Directors and Officers as a group beneficially owned, including
exercisable options and warrants, approximately 25% of our common stock. As a result, our
management, and Mr. Krall in particular, are in a position to significantly influence the
direction and policies of the Company, the election of the Board of Directors of the
Company and the outcome of any other matters requiring stockholder approval.
Since our initial public offering in
August 1996, the price and trading volume of our common stock have been highly volatile.
The price has ranged from below $1 per share to over $7 per share, and the monthly trading
volume has varied from under 200,000 shares to over 5.1 million shares. During the twelve
months prior to October 2007, the closing price of our common stock on any given day has
ranged from $1.75 to $7.45, and the monthly trading volume has varied from approximately
1.2 million shares to approximately 5.1 million shares. This volatility could adversely
affect an investor’s ability to sell shares of our common stock and/or the available
price for such shares, and could result in lower prices being available to an investor if
the investor wishes to sell their shares at any given time.
Our common stock may be characterized
as a “penny stock” under SEC regulations. As such, broker-dealers dealing in
the common stock may be subject to the disclosure rules for transactions involving penny
stocks, which generally require that, prior to a purchase, the broker-dealer determine if
purchasing the common stock is suitable for the applicable purchaser. The broker-dealer
must also obtain the written consent of the applicable purchasers to purchase the common
stock and disclose the best bid and offer prices available for the common stock and the
price at which the broker-dealer last purchased or sold the common stock. These additional
burdens imposed upon broker-dealers may discourage them from effecting transactions in our
common stock, which could make it difficult for an investor to sell their shares at any
given time.
We have approximately 10,348,918
shares of common stock reserved for issuance, which includes shares under equity
compensation plans, vested and unvested options, and warrants. These shares
have a weighted-average exercise price of approximately $1.59. An additional
approximately 12,687,181 authorized shares of common stock remain available for
future issuance under equity compensation plans or otherwise. The exercise of options
and warrants, and the sale of shares underlying such options or warrants, could have
an adverse effect on the market for our common stock, including the price that an
investor could obtain for their shares. Investors may experience dilution in the
net tangible book value of their investment upon the exercise of outstanding options
and warrants granted under our stock option plans, and other options and warrants.
We have never paid any cash dividends
on our common stock and do not anticipate paying cash dividends on our common stock in the
foreseeable future. The future payment of dividends on our common stock will depend on our
earnings, financial condition and other business and economic factors, which the Board of
Directors of the Company may consider relevant.
13
Certain provisions of our charter and
by-laws may delay or frustrate the removal of incumbent Directors and may prevent or delay
a merger, tender offer or proxy contest involving the Company that is not approved by the
Board of Directors of the Company, even if such events may be beneficial to the interests
of stockholders. For example, our Board of Directors, without stockholder approval, has the
authority and power to issue all authorized and unissued shares of common stock and
preferred stock which have not otherwise been reserved for issuance on such terms as the
Board of Directors determines. The Board of Directors could also issue 5,000,000 shares of
preferred stock and such preferred stock could have voting or conversion rights which could
adversely affect the voting power of the holders of common stock. In addition, California
law may contain provisions that have the effect of making it more difficult for others to
gain control of the Company.
CRITICAL ACCOUNTING
POLICIES
Accounting for Long-Lived Assets / Intangible Assets
We assess the impairment of long-lived assets, consisting of property, plant, equipment and
finite-lived intangible assets, whenever events or circumstances indicate that the carrying
value may not be recoverable. Examples of such events or circumstances include:
An
asset’s ability to continue to generate income from operations and positive cash flow
in future periods
Loss
of legal ownership or title to an asset
Significant
changes in our strategic business objectives and utilization of the asset(s)
The
impact of significant negative industry or economic trends
Recoverability of assets to be held
and used in operations is measured by a comparison of the carrying amount of an asset to
the future net cash flows expected to be generated by the assets. The factors used to
evaluate the future net cash flows, while reasonable, requires a high degree of judgment
and the results could vary if the actual results are materially different than the
forecasts. In addition, we base useful lives and amortization or depreciation expense on
our subjective estimate of the period that the assets will generate revenue or otherwise be
used by us. If such assets are considered to be impaired, the impairment to be recognized
is measured by the amount by which the carrying amount of the assets exceeds the fair value
of the assets. Assets to be disposed of are reported at the lower of the carrying amount or
fair value less selling costs.
We also periodically review the lives
assigned to our intangible assets to ensure that our initial estimates do not exceed any
revised estimated periods from which we expect to realize cash flows from the technologies.
If a change were to occur in any of the above-mentioned factors or estimates, the
likelihood of a material change in our reported results would increase.
Accounting for Stock-Based Compensation
We adopted the fair value provisions of SFAS 123(R) on August 1, 2006. Stock-based
compensation expense for all stock-based compensation awards granted after August 1, 2006
is based on the grant date fair value estimated in accordance with the provisions of SFAS
1(R). Specifically, we estimate the weighted-average fair value of options granted using
the Black-Scholes option pricing model based on evaluation assumptions regarding expected
volatility, dividend yield, risk-free interest rates, the expected term of the option and
the expected forfeiture rate. Each of these assumptions, while reasonable, requires a
certain degree of judgment and the fair value estimates could vary if the actual results
are materially different than those initially applied. Prior to the adoption of SFAS
123(R), we did not record compensation cost in the consolidated financial statements for
stock options issued to employees or Directors.
RECENT ACCOUNTING
PRONOUNCEMENTS
In preparing our financial statements, we continuously review and adopt new accounting
pronouncements and standards as they apply to us.
In June 2006, the Financial
Accounting Standards Board, or FASB, issued FASB Interpretation No. 48 (“FIN
48”), Accounting for Uncertainty in Income Taxes—an interpretation of FASB
Statement No. 109, which prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or expected to
be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006 (our fiscal year ending July
31, 2008). We are still evaluating the impact of FIN 48 on our consolidated financial
statements for future periods.
In September 2006, the FASB issued
Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value
Measurements, which provides a single definition of fair value, a framework for measuring
fair value, and expanded disclosures concerning fair value. Previously, different
definitions of fair value were contained in various accounting pronouncements creating
inconsistencies in measurement and disclosures. SFAS No. 157 applies under those previously
issued pronouncements that prescribe fair value as the relevant measure of value, except
Statement No. 123R and related interpretations and pronouncements that require or permit
measurement similar to fair value but are not intended to measure fair value. This
pronouncement is effective for fiscal years beginning after November 15, 2007 (our fiscal
year ending July 31, 2009). We do not expect the adoption of SFAS No. 157 to have a
material impact on our consolidated financial statements or results of
operations.
Also in September 2006, the SEC
released Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides
guidance on how the effects of the carryover or reversal of prior year misstatements should
be considered in quantifying a current year misstatement. In some situations, companies
will be required to record errors that occurred in prior years even though those errors
were immaterial for each year in which they arose. Companies may choose to either restate
all previously presented financial statements or record the cumulative effect of such
errors as an adjustment to retained earnings at the beginning of the period in which SAB
108 is applied. SAB 108 is effective for fiscal years ending after November 15, 2006 (our
fiscal year ending July 31, 2007), however the adoption of SAB 108 had no impact on our
consolidated financial statements or results of operations.
14
In February 2007, the FASB issued
SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities—Including an Amendment of FASB Statement No. 115. This standard permits
an entity to choose to measure many financial instruments and certain other items at fair
value. Most of the provisions in SFAS No. 159 are elective, however the amendment to SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all
entities with available-for-sale and trading securities. The fair value option established
by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at
specified election dates. Under SFAS No. 159 we would report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each subsequent
reporting date. The fair value option: (a) may be applied instrument by instrument, with a
few exceptions, such as investments otherwise accounted for by the equity method; (b) is
irrevocable (unless a new election date occurs); and (c) is applied only to entire
instruments and not to portions of instruments. SFAS No. 159 is effective as of the
beginning of the first fiscal year that begins after November 15, 2007 (our fiscal year
ending July 31, 2009); however we do not currently expect the adoption of SFAS No. 159 to
have a material impact on our consolidated financial statements.
15
ITEM 7. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
Notes to Consolidated
Financial Statements
Note 1. Organization
and Summary of Significant Accounting Policies
This summary of significant
accounting policies of PURE Bioscience (formerly Innovative Medical Services) is presented
to assist in understanding the Company’s financial statements. The financial
statements and notes are representations of the Company’s management, who are
responsible for their integrity and objectivity. These accounting policies conform to
Generally Accepted Accounting Principles in the United States of America and have been
consistently applied in the preparation of the financial statements.
Organization
and Business Activity
PURE Bioscience was incorporated as
Innovative Medical Services in San Diego, California on August 24, 1992 as a provider of
pharmaceutical water purification products. In September 2003, the Company’s
shareholders approved a change in the name of the corporation, to PURE
Bioscience.
In October 1998, the Company formed a
subsidiary, EXCOA Nevada to purchase the assets of Export Company of America, Inc. (EXCOA),
a privately held Fort Lauderdale, Florida-based distributor of disposable medical, dental
and veterinary supplies. The major asset of this company was its 45% interest in Ampromed
Comercio Importacao E Exportacao Ltda (AMPROMED), a Rio de Janeiro-based import company
that sells medical, dental and veterinary supplies and water filtration products to
practitioners, retail outlets and government agencies. We acquired the remaining 55%
interest in AMPROMED from a private individual and transferred it to EXCOA
Nevada.
In November 2000, PURE Bioscience
acquired 100% of the stock of ETIH2O, Inc., a privately held technology corporation that
developed silver dihydrogen citrate and its associated brands, Axenohl and Axen.
Subsequent to the acquisition of
ETIH2O, our business activity was divided into two basic business segments, the Bioscience
Division and the Water Treatment Division. In May 2005, we sold the assets of our Water
Treatment Division to Maryland-based Innovative Medical Services, LLC, and since this time
our business has consisted of a single Bioscience Division, engaged in the development,
production, sale and licensing of silver ion bioscience technologies and boric acid based
pesticides.
Basis
of Presentation and Principles of Consolidation
The accompanying financial statements
include the consolidated accounts of PURE Bioscience and its subsidiaries. All
inter-company balances and transactions have been eliminated.
Use
of Estimates
The preparation of the financial
statements in conformity with Generally Accepted Accounting Principles requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications
Certain comparative figures for prior
periods have been reclassified to conform to the current year presentation. Specifically,
we have reclassified $1,743,600 from Common Stock to Additional Paid-In Capital on the
consolidated balance sheets at July 31, 2006 and in the consolidated statements of
stockholders’ equity. This amount relates to the fair value of common stock options
issued for services in the periods prior to August 1, 2006. Additionally, we have
consolidated amounts of $(2,400) and $(129,990) recorded on separate lines within the
statements of operations for the year ended July 31, 2006 related to tax provisions for
continued operations, into one “Income tax provision” of $(132,190). See Note 9
for a further description of this tax provision.
Revenue
Recognition
During the periods presented herein
our revenue was derived from the sale of SDC concentrate, the sale of finished packaged
products containing SDC, the sale of SDC blending systems, and the sale of products in our
Innovex® line of pest control products. We recognize revenue from sales of these
products under the provisions of Staff Accounting Bulletin (“SAB”) No. 104,
Revenue Recognition, which is generally when we ship the products free on board from either
our facility or from third party packagers, we have transferred title to the goods, and we
have eliminated our risk of loss.
Accounts
Receivable
We generally sell on terms of cash or
net 30 days. Invoices not paid within stated terms are considered delinquent. We analyze
our accounts receivable periodically and recognize an allowance for doubtful accounts based
on estimated collectibility, however at July 31, 2007 we deemed all customer accounts to be
collectable and therefore recorded no such allowance.
Intangible
Assets / Long-Lived Assets
Our intangible assets primarily
consist of the worldwide patent portfolio of our silver ion technologies, and to a lesser
extent our Triglycylboride technology. Outside legal costs and filing fees related to
obtaining patents are capitalized as incurred. The total amounts capitalized for pending
patents was $204,200 and $111,100 in the fiscal years ended July 31, 2007 and 2006,
respectively. Patents are stated net of accumulated amortization of $988,742 and $824,217
at July 31, 2007 and July 31, 2006 respectively.
The cumulative cost of acquiring
patents is amortized on a straight-line basis over the estimated remaining useful lives of
the patents, generally between 17 and 20 years from the date of issuance. At July 31, 2007
the weighted average remaining amortization period for all patents was approximately 12.5
years. Amortization expense for the years ended July 31, 2007 and July 31, 2006 was
$164,500 and $157,400 respectively, and the estimated amortization expense over each of the
next five years is as follows:
22
Year Ended July
31
|
Estimated
Amortization
|
2008
2009
2010
2011
2012
|
$
182,000
$ 193,000
$ 206,000
$ 220,000
$ 235,000
|
|
|
In accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, our long-lived assets and amortizable
intangible assets are tested for impairment whenever events or changes in circumstances
indicate that their carrying value may not be recoverable. We assess the recoverability
such assets by determining whether their carrying value can be recovered through
undiscounted future operating cash flows, including our estimates of revenue driven by
assumed market segment share and estimated costs. If impairment is indicated, we measure
the amount of such impairment by comparing the fair value to the carrying value, however
during the fiscal years ended July 31, 2006 and 2007 there have been no indicators of
impairment.
Accounting
for Stock-Based Compensation
In December 2004, the Financial
Accounting Standards Board (“FASB”) revised SFAS 123(R), Share-Based Payment,
which establishes accounting for share-based awards exchanged for employee and Director
services and requires us to expense the estimated fair value of these awards over the
applicable service period. On April 14,2005, the SEC adopted a new rule amending the
effective dates for SFAS No. 123(R). Under SFAS No. 123(R), share-based compensation cost
is measured at the grant date based on the estimated fair value of the award, and is
recognized as expense over the applicable service period.
We
do not have, and have not had during the years ended July 31, 2007 or 2006, any stock
option awards with market or performance conditions.
We
adopted the accounting provisions of SFAS No. I23(R) in our first fiscal quarter of the
year ended July 31, 2007 (our fiscal quarter ended October 31, 2006), using the modified
prospective application. Under the modified prospective application, prior fiscal periods
are not revised for comparative purposes. Prior to August 1, 2006, we followed Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, as amended, in
our accounting for share-based compensation. The valuation provisions of SFAS No. I23(R)
apply to new awards and to awards that were outstanding on the adoption date and were or
are subsequently modified or cancelled. As at July 31, 2006, all outstanding share-based
awards were fully vested, with the exception of the consultant options recorded in our
balance sheets as “prepaid consulting” (as further discussed in Note
8).
Stock
Options to Non-Employees
Charges for stock options granted to
non-employees have been determined in accordance with SFAS No. 123(R) and EITF No. 96-18,
“Accounting for Equity Instruments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services”, whereby we use the
estimated fair value of the consideration received or the estimated fair value of the stock
options issued, whichever is more reliably measured. The fair value for these stock options
is based on the Black-Scholes pricing model. For such stock options, during the year ended
July 31, 2007 we recorded $346,873 in selling expense, $91,290 in general and
administrative expense, and $39,032 in research and development expense; and during the
year ended July 31, 2006 we recorded $188,863 in selling expense, $307,888 in general and
administrative expense, and $107,962 in research and development expense. Included in these
amounts is the amortization of consultant options recorded in our consolidated balance
sheets as “prepaid consulting” and further discussed in Note 8.
Depreciation
Method
The cost of property, plant and
equipment is depreciated on a straight-line basis over the estimated useful lives of the
related assets. The useful lives of property, plant, and equipment for purposes of
computing depreciation are:
|
|
|
|
|
Computers and
equipment
Computer Software
Furniture and fixtures
Leasehold Improvements
|
|
7.0
years
5.0 years
10.0 years
4.5 years
|
|
|
|
|
In May 2007 we completed a
redevelopment of our leasehold operating facility in El Cajon, California. All costs
associated with the facility redevelopment have been classified as leasehold improvements
and are being depreciated over the remaining life of the lease. See Note 5 for details of
the current lease term of our facility.
Shipping
and Handling Costs
Shipping and handling costs payable
by us are charged to cost of sales.
Inventory
Inventories are stated at the lower
of cost or net realizable value using the average cost method.
23
Cash,
Cash Equivalents and Short-term Investments
We consider all liquid investments
with maturities of ninety days or less when purchased to be cash equivalents. Our
short-term investments have maturities of greater than ninety days from our date of
purchase. We classify securities as “available-for-sale” in accordance with
SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, and carry these
investments at fair market value with any unrealized gains and losses reported as a
component of stockholders’ equity on the consolidated balance sheets and in the
statements of stockholders’ equity. All of our short-term investments as at July 31,
2007 are carried at fair value, based upon market prices quoted on the last day of the
fiscal period, and are considered available for sale. We use the specific identification
method to determine the cost of debt securities sold, and include gross realized gains and
losses in investment income, however there were no realized gains and losses recorded for
the years ended July 31, 2007 or 2006. All interest and dividends received from short-term
investments are included in interest income.
As at July 31, 2007 and 2006, all
cash deposits and short-term investments were invested in either U.S. FDIC insured bank
accounts; institutional money market mutual funds investing in A-1 (S&P), Prime-1
(Moody’s) or F1 (Fitch) short-term corporate debt obligations; U.S. Treasury
Securities, or United States Government obligations issued by or backed by a federal agency
of the United States Government.
Comprehensive
loss
SFAS 130, Reporting Comprehensive
Income, requires us to display comprehensive loss (or income) and its components as part of
our consolidated financial statements. Comprehensive loss includes our net loss and certain
changes in equity that are excluded from our net loss, including unrealized holding gains
and losses on available-for-sale securities. SFAS 130 requires such changes in
stockholders’ equity to be included in accumulated other comprehensive loss, however
there were no elements of comprehensive loss other than net loss in the periods ended July
31, 2007 or 2006.
Fair
Value of Financial Instruments
The carrying amounts for receivables
and payables are the approximate fair value because of their short maturity, generally less
than three months. Whenever shares are issued for services, we use market prices of our
common stock to estimate the fair value of the shares issued. Whenever options or warrants
are issued for services, we use the Black Scholes Option Pricing Model to estimate the fair
value of the equity instrument, using historical market prices of our common stock and
prevailing risk-free interest rates.
Advertising
and Promotional Costs
The cost of advertising and promotion
is expensed as incurred.
Net
Loss Per Common Share
In accordance with FASB Statement No.
128, Earnings Per Share (“SFAS 128”), the Company computes basic loss per share
by dividing the applicable net loss by the weighted average number of common shares
outstanding during the respective period. Diluted per share amounts assume the conversion,
exercise or issuance of all potential common stock equivalents, including stock options and
warrants, unless the effect is to reduce a loss or increase the income per common share
from continuing operations. As we incurred losses in years ended July 31 2007 and 2006, we
did not include common stock equivalent shares in the computation of net loss per share as
the effect would have been anti-dilutive. Therefore, both the basic and diluted loss per
common share for the years ended July 31, 2007 and July 31, 2006 are based on the weighted
average number of shares of our common stock outstanding during the periods.
The following is a reconciliation of
the weighted average number of shares actually outstanding with the number of shares used
in the computations of loss per common share:
|
For the Years Ended
|
|
|
July 31, 2007
|
|
July 31, 2006
|
|
Shares
outstanding
|
|
|
|
24,961,805
|
|
|
23,983,002
|
|
|
|
|
Weighted average number of
common shares actually outstanding
|
|
|
|
24,432,905
|
|
|
20,056,721
|
|
Stock Options
|
|
|
|
10,293,750
|
|
|
11,634,000
|
|
Warrants
|
|
|
|
391,698
|
|
|
391,698
|
|
|
|
|
|
|
Total weighted
average shares
|
|
|
|
35,118,353
|
|
|
32,082,419
|
|
|
|
|
|
|
Loss from continuing
operations
|
|
|
$
|
(4,654,877
|
)
|
$
|
(3,812,916
|
)
|
Income from discontinued
operations
|
|
|
|
—
|
|
|
129,990
|
|
|
|
|
|
|
Net loss
|
|
|
$
|
(4,654,877
|
)
|
$
|
(3,682,926
|
)
|
|
|
|
|
|
Net loss per common share,
basic and diluted
|
|
|
Continuing
operations
|
|
|
$
|
(0.19
|
)
|
$
|
(0.19
|
)
|
Discontinued
operations
|
|
|
|
—
|
|
|
0.01
|
|
|
|
|
|
|
Net
loss
|
|
|
$
|
(0.19
|
)
|
$
|
(0.18
|
)
|
|
|
|
|
|
Income
Taxes
We record deferred taxes in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
“Accounting for Income Taxes.” The Statement requires recognition of deferred
tax assets and liabilities for temporary differences between the tax basis of assets and
liabilities and the amounts at which they are carried in the financial statements, based
upon the enacted tax rates in effect for the year in which the differences are expected to
reverse. A valuation allowance is established when necessary to reduce deferred tax assets
to the amount expected to be realized.
24
Recent
Accounting Pronouncements
In June 2006, the Financial
Accounting Standards Board, or FASB, issued FASB Interpretation No. 48 (“FIN
48”), Accounting for Uncertainty in Income Taxes—an interpretation of FASB
Statement No. 109, which prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or expected to
be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006 (our fiscal year ending July
31, 2008). We are still evaluating the impact of FIN 48 on our consolidated financial
statements for future periods.
In September 2006, the FASB issued
Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value
Measurements, which provides a single definition of fair value, a framework for measuring
fair value, and expanded disclosures concerning fair value. Previously, different
definitions of fair value were contained in various accounting pronouncements creating
inconsistencies in measurement and disclosures. SFAS No. 157 applies under those previously
issued pronouncements that prescribe fair value as the relevant measure of value, except
Statement No. 123R and related interpretations and pronouncements that require or permit
measurement similar to fair value but are not intended to measure fair value. This
pronouncement is effective for fiscal years beginning after November 15, 2007 (our fiscal
year ending July 31, 2009). We do not expect the adoption of SFAS No. 157 to have a
material impact on our consolidated financial statements or results of
operations.
Also in September 2006, the SEC
released Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides
guidance on how the effects of the carryover or reversal of prior year misstatements should
be considered in quantifying a current year misstatement. In some situations, companies
will be required to record errors that occurred in prior years even though those errors
were immaterial for each year in which they arose. Companies may choose to either restate
all previously presented financial statements or record the cumulative effect of such
errors as an adjustment to retained earnings at the beginning of the period in which SAB
108 is applied. SAB 108 is effective for fiscal years ending after November 15, 2006 (our
fiscal year ended July 31, 2007), however the adoption of SAB 108 had no impact on our
consolidated financial statements or results of operations.
In February 2007, the FASB issued
SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities—Including an Amendment of FASB Statement No. 115. This standard permits
an entity to choose to measure many financial instruments and certain other items at fair
value. Most of the provisions in SFAS No. 159 are elective, however the amendment to SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all
entities with available-for-sale and trading securities. The fair value option established
by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at
specified election dates. Under SFAS No. 159 we would report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each subsequent
reporting date. The fair value option: (a) may be applied instrument by instrument, with a
few exceptions, such as investments otherwise accounted for by the equity method; (b) is
irrevocable (unless a new election date occurs); and (c) is applied only to entire
instruments and not to portions of instruments. SFAS No. 159 is effective as of the
beginning of the first fiscal year that begins after November 15, 2007 (our fiscal year
ending July 31, 2009), however we do not currently expect the adoption of SFAS No. 159 to
have a material impact on our consolidated financial statements.
Note 2. Research and
Development
All in-house Research and Development
(“R&D”) costs, and outside legal costs and filing fees for maintaining
approved patents are charged to operations when incurred and are included in operating
expenses. During the year ended July 31, 2007, $25,300 of the costs charged to R&D
related to manufacturing and R&D facility overheads incurred during periods in which we
were designing and implementing new manufacturing and bottling processes and in which no
products were manufactured.
Note 3.
Inventory
Inventories are stated at the lower
of cost or net realizable value using the average cost method. Inventories at July 31, 2007
and 2006 consisted of:
|
2007
|
|
2006
|
|
|
|
|
Raw
Materials
|
|
|
$
|
78,816
|
|
$
|
59,843
|
|
Work in
Progress
|
|
|
|
—
|
|
|
—
|
|
Finished
Goods
|
|
|
|
164,083
|
|
|
112,096
|
|
|
|
|
|
|
|
|
|
$
|
242,899
|
|
$
|
171,939
|
|
|
|
|
|
|
Note 4. Property, Plant
and Equipment
Property, plant and equipment are
stated at cost less accumulated depreciation. All improvements and additions that extend
the life of existing asset are capitalized. The cost of maintenance and repairs that do not
extend or improve the asset are expensed as occurred. The following is a summary of
property, plant, and equipment – at cost less accumulated depreciation:
|
July 31, 2007
|
|
July 31, 2006
|
|
|
|
|
Computers and
equipment
|
|
|
$
|
1,137,431
|
|
$
|
997,861
|
|
Furniture and
fixtures
|
|
|
|
94,004
|
|
|
86,490
|
|
Leasehold
improvements
|
|
|
|
567,104
|
|
|
309,830
|
|
|
|
|
|
|
|
|
|
|
1,798,539
|
|
|
1,394,181
|
|
Less:
accumulated depreciation
|
|
|
|
829,802
|
|
|
1,040,909
|
|
|
|
|
|
|
Total
|
|
|
$
|
968,737
|
|
$
|
353,272
|
|
|
|
|
|
|
25
In May 2007 we completed a
redevelopment of our leasehold facility in El Cajon, California. Construction costs
totaling $567,100 were capitalized as leasehold improvements. Depreciation on the facility
redevelopment is based on the time remaining on the facility lease term at the time of
completion, which was 4.5 years at July 31, 2007, and during the year ended July 31, 2007
we recognized depreciation expense of $31,505 related to the facility redevelopment.
Additionally, during the year ended July 31, 2007 we wrote down the value of our
capitalized property, plant and equipment by $167,600, based on our evaluation of
impairment and the disposal of assets that were replaced during the facility redevelopment,
and recorded this amount as “Other” within “Other income and
(expense)” in the consolidated statements of operations for the year ended July 31,
2007.
Total depreciation expense for the
years ended July 31, 2007 and July 31, 2006 was $92,600 and $69,500,
respectively.
Note 5. Commitments and
Contingencies
In May 1996, we entered into an
operating lease agreement for our office and manufacturing location in El Cajon,
California, which expired under extension in October 2006, at which time we entered into a
new sixty month operating lease. The rental expense recorded in general and administrative
expenses for the years ended July 31, 2007 and July 31, 2006 was $173,300 and $137,000,
respectively, net of sublease income. As part of the agreement to sell the assets of the
Water Treatment Division to Innovative Medical Services, LLC, in May 2005 we entered into a
sublease agreement with IMS LLC under which IMS LLC occupied approximately 28% of the
square footage of the facility and paid us approximately $3,800 per month in rent. IMS LLC
vacated the space in September 2006 and we are now operating in the full 13,067 square feet
of the facility.
Future minimum rental payments under
the lease for each of the next five fiscal years, excluding variable and therefore
currently unknown costs for the maintenance of common areas, are as follows:
|
Year Ended July 31
|
Amount
|
|
|
2008
2009
2010
2011
2012
|
$
144,800
$ 150,600
$ 156,600
$ 162,900
$ 69,000
|
|
|
|
|
|
The Company has an employment
contract with its Chief Executive Officer/President which includes a provision for him to
be paid an amount equal to 3% of the Company’s net income before taxes, if
any.
Note 6. Equity and
Common Stock
We paid no cash dividends during the
fiscal years ended July 31, 2007 or 2006.
Whenever shares are issued for
services, we use market prices of our common stock to estimate the fair value of the shares
issued. Whenever options or warrants are issued for assets, services or interest, we use
the Black Scholes Option Pricing Model to estimate the fair value of the equity instrument,
using market prices of our common stock and prevailing risk-free interest rates.
In October 2006, we issued options on
100,000 shares in exchange for operations, manufacturing and facility development
consulting services, at an exercise price of $1.83, valued at $91,300 (based on the
Black-Scholes Option Pricing Model assuming no dividend yield, volatility of 70.88% and a
risk-free interest rate of 5.25%). Also during the three months ended October 31, 2006, we
received an aggregate of $51,500 from the exercise of non-employee options on 51,500 shares
of common stock at an average exercise price of $1.00. In November 2006, we issued 30,000
shares of common stock at a market price of $2.17 for research and development services
valued at $65,100.
During the first quarter of the year
ended July 31, 2007, Mr. Michael Sitton resigned from our Board of Directors. At that time,
the Board agreed to modify a stock option agreement for 100,000 shares of common stock that
had been granted to Mr. Sitton in November 2005, to extend the period in which the option
could be exercised as it would otherwise have terminated within a shorter time period based
on his resignation. We expensed $19,237 to general and administrative expense based on this
modification, in accordance with SFAS 123(R). The 100,000 stock options were not exercised
within the extended period and were therefore subsequently forfeited.
In January 2007, there were net
exercises of options which were due to expire and which were issued under the 2002
Non-Qualified Stock Option Plan (See Note 7 for a further description of this Plan).
Options on 450,000 shares under this plan were exercised, resulting in the issuance of
338,553 shares of common stock. We also, in the same month, received $53,000 from the
exercise by a Director of the Company of an option on 100,000 shares of common stock under
the same Plan. Also during the three months ended January 31, 2007 we received an aggregate
of $74,000 from the exercise of non-employee options on 86,500 shares of common stock at an
average exercise price of $0.86, and recorded $2,465 of employee stock option
expense.
During the three months ended April
30, 2007 we received an aggregate of $169,190 from the exercise of non-employee options on
200,000 shares of common stock at an average exercise price of $0.85, received $8,125 from
the exercise of options on 16,250 shares of common stock issued under employee stock option
plans, and recorded $2,465 of employee stock option expense.
In May 2007, we granted options on
275,000 shares of common stock to Directors and Officers of the Company at an exercise
price of $3.00, valued at $429,180 (based on the Black-Scholes Option Pricing Model
assuming no dividend yield, volatility of 84.88% and a risk-free interest rate of 5.25%).
Additionally, in the same month we granted 30,000 shares of stock to two Directors of the
Company, valued at $177,600 based on the market price of our common stock at the time of
grant. In June 2007, we appointed Murray H. Gross to our Board of Directors and on
appointment to the Board Mr. Gross was granted options on 100,000 shares of common stock at
an exercise price of $3.64, valued at $187,100 (based on the Black-Scholes Option Pricing
Model assuming no dividend yield, volatility of 86.35% and a risk-free interest rate of
5.25%). The stock options and stock granted to Directors and Officers during the three
months ended July 31, 2007 were issued under the 2007 Equity Incentive Plan.
26
During the three months ended July
31, 2007 we received an aggregate of $119,375 from the exercise of options on 186,000
shares of common stock issued under employee equity plans, and recorded $11,550 of employee
stock option expense.
Note 7. Stock-Based
Compensation
We have, or have had during the
fiscal years presented herein, the following equity incentive plans (the Plans) pursuant to
which options to acquire common stock have been granted:
1996 Directors And Officers Stock
Option Plan: In April 1996, the Company’s Board of Directors approved a Directors and
Officers Stock Option Plan. The Plan was not subject to Shareholder approval, and
terminated in April 2006.
1998 Directors And Officers Stock
Option Plan: In December 1998, the Company’s Shareholders approved the Amended PURE
Bioscience 1998 Officers and Directors Stock Option Plan.
2001 Directors And Officers Stock
Option Plan: In January 2001, the Company’s Shareholders approved the PURE Bioscience
2001 Officers and Directors Stock Option Plan.
2001 ETIH2O Stock Option Plan:
Adopted by the Board in January 2001, there are 1,000,000 shares authorized under this
Plan. Executive Officers and Directors are not eligible participants under this
plan.
2001 Consultants and Advisors Stock
Option Plan: Adopted by the Board in January 2001, there are 500,000 shares authorized
under this Plan. Executive Officers and Directors are not eligible participants under this
plan.
2002 Non-Qualified Stock Option Plan:
In March 2002, the Company’s Shareholders approved the PURE Bioscience 2002
Non-Qualified Stock Option Plan. Eligible Plan Participants include the Directors and
Officers of the Company, consultants, advisors and other individuals deemed by the
Compensation Committee to provide valuable services to the Company but who are not
otherwise eligible to participate in the Employee Incentive Stock Option Plan.
2002 Employee Incentive Stock Option
Plan: In March 2002, the Company’s Shareholders approved the PURE Bioscience 2002
Employee Incentive Stock Option Plan. Eligible Plan Participants include employees and
non-employee Directors for the Company.
2004 Consultants and Advisors Stock
Option Plan: Adopted by the Board in April 2004, there are 2,000,000 shares authorized
under this plan. Executive Officers and Directors are not eligible participants under this
plan.
2007 Equity Incentive Plan: Approved
by the Company’s shareholders in April 2007, the 2007 Equity Incentive Plan has a
share reserve of 5,000,000 shares of common stock, which were registered under a Form S-8
filed with the SEC in May 2007. The Plan provides for the grant of incentive and
nonstatutory stock options as well as stock appreciation rights, common stock awards,
restricted stock units, performance units and shares and other stock-based awards. During
the year ended July 31, 2007 common stock options and common stock awards were granted
under this Plan. Eligible Plan Participants include employees, Directors and consultants of
the Company, although incentive stock options generally may be granted only to
employees.
Non-employee Directors are eligible
to receive stock option or other incentive grants under the Company’s 1998 and 2001
Directors and Officers Stock Option Plans, the 2002 Non-Qualified and Employee/Incentive
Stock Option Plan, and the 2007 Equity Incentive Plan. Employee Directors are eligible to
receive stock option or other incentive grants under the Company’s 1998 and 2001
Directors and Officers Stock Option Plans, the 2002 Non-Qualified Stock Option Plan, and
the 2007 Equity Incentive Plan.
The Plans are administered by an
Administrative Committee. The exercise price for stock options, or the value of other
incentive grants granted under the Plans, are set by the Administrative Committee but may
not be for less than the fair market value of the shares on the date the award is granted.
Fair market value is defined under the Plans as being the average of the closing price for
a specified number of consecutive trading days ending on the day prior to the date the
option or other award is granted. The period in which options can be exercised is set by
the Administrative Committee but is not to exceed five years from the date of grant.
Options granted to new Executive Officers or Directors vest one year from date of
appointment or election. Options granted to continuing Officers or Directors are
immediately exercisable and vest upon exercise.
On August 1, 2006, we adopted the
provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123
(revised 2004), Share-Based Payment (“SFAS123(R)”), requiring us to recognize
expense related to the fair value of share-based compensation awards to employees and
Directors. We elected to use the modified-prospective-transition method as permitted by
SFAS 123R and therefore have not restated our financial results for prior fiscal years. As
at July 31, 2006, all outstanding share-based awards were fully vested, with the exception
of the consultant options recorded in our balance sheets as “prepaid
consulting” (as further discussed in Note 8). We recognize compensation expense for
stock option awards on a straight-line basis over the applicable service period of the
award, which is the vesting period. Share-based compensation expense for awards granted
subsequent to July 31, 2006 is based on the grant date fair value estimated in accordance
with the provisions of SFAS 123R, using the Black-Scholes option pricing model. The
following methodology and assumptions were used to calculate share based compensation for
the years ended July 31, 2007 and July 31, 2006:
|
|
For the years ended July
31
|
|
|
2007
|
2006
|
|
Expected price
volatility
Risk-free interest rate
Expected Rate of Forfeiture
Expected Dividend yield
Weighted Average Expected Term
|
70.88% - 86.35%
5.25%
0.0%
0.0%
2.3 years
|
72.35% - 82.23%
4.25% - 5.25%
0.0%
0.0%
2.5 years
|
|
|
|
|
27
Expected price volatility is the
measure by which our stock price is expected to fluctuate during the expect term of an
option. Expected volatility is derived from the historical daily change in the market price
of our common stock, as we believe that historical volatility is the best indicator of
future volatility. For stock options granted during the year ended July 31, 2007 we have
excluded the period prior to November 1, 2005 from our historical price volatility, as
during this period our market price reflected significant uncertainty associated with both
our arbitration proceedings against Falken Industries and our ability to close the sale of
the assets of the Water Treatment Division. We believe that the volatility of the market
price of our common stock during periods prior to November 1, 2005 is not reflective of
future expected volatility.
Following the guidance of Staff
Accounting Bulletin No. 107, we follow the “shortcut” method to determine the
expected term of plain vanilla options issued to employees and Directors. The expected term
is presumed to be the mid-point between the vesting date and the end of the contractual
term. Our estimation of expected term for non-employee options is the contractual term of
the option award.
For the purposes of estimating the
fair value of stock option awards, the risk-free interest rate used in the Black-Scholes
calculation is based on the prevailing U.S Treasury yield as determined by the U.S. Federal
Reserve. We have never paid any cash dividends on our common stock and do not anticipate
paying cash dividends on our common stock in the foreseeable future.
Stock-based compensation expense
recognized in the consolidated statements of operations is based on awards ultimately
expected to vest, reduced for estimated forfeitures. SFAS 123R requires forfeitures to be
estimated at the time of grant, and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. Historically, we have not had significant
forfeitures of unvested stock options granted to employees and Directors. A significant
number of our stock option grants are fully vested at issuance or have short vesting
provisions. Therefore, we have estimated the forfeiture rate of our outstanding stock
options as zero.
The following table sets forth the
share-based compensation expense recorded in our consolidated statements of operations for
the fiscal year ended July 31, 2007 resulting from share-based compensation awarded to our
employees, Directors and third party service providers, excluding the amortization of
prepaid consulting as detailed in Note 8:
|
Twelve months ended
July 31, 2007
|
|
|
|
Share-based compensation for
employees and Directors:
|
|
|
|
|
|
Selling
expense
|
|
|
$
|
23,400
|
|
General and
administrative expenses
|
|
|
|
790,600
|
|
Research and
development
|
|
|
|
15,600
|
|
|
|
|
Total
share-based compensation for employees and Directors
|
|
|
|
829,600
|
|
Share-based
compensation for third party service providers:
|
|
|
Selling
expense
|
|
|
$
|
—
|
|
General and
administrative expenses
|
|
|
|
91,300
|
|
Research and
development
|
|
|
|
65,100
|
|
|
|
|
Total
share-based compensation for third party service providers
|
|
|
|
156,400
|
|
|
|
|
Total
share-based compensation expense
|
|
|
$
|
986,000
|
|
|
|
|
For comparative purposes to our
consolidated statements of operations for the fiscal year ended July 31, 2007, the
following table illustrates the pro forma effect on net loss and net loss per common share
of applying the fair value recognition provisions of SFAS 123 to share-based compensation
during our prior fiscal year ending July 31, 2006.
|
Twelve months ended
July 31, 2006
|
|
|
|
Net
loss, as reported
|
|
|
$
|
(3,682,926
|
)
|
Employee
stock-based compensation expense under fair-value method
|
|
|
|
(436,608
|
)
|
Employee
stock-based compensation expense included in reported net loss
|
|
|
|
—
|
|
Pro forma net
loss
|
|
|
$
|
(4,119,534
|
)
|
|
|
|
Net loss per
share:
|
|
|
As
reported
|
|
|
$
|
(0.18
|
)
|
Pro
forma
|
|
|
$
|
(0.21
|
)
|
28
A summary of stock option activity is
as follows:
|
Number of
Shares
|
|
Weighted-Average
Exercise Price
|
|
Aggregate Intrinsic
Value ($000's)
|
|
|
|
|
|
Balance at July 31,
2005
|
|
|
|
6,485,960
|
|
$
|
0
|
.64
|
|
|
|
Granted
|
|
|
|
6,558,333
|
|
$
|
1
|
.56
|
|
|
|
Exercised
|
|
|
|
(1,002,488
|
)
|
$
|
0
|
.64
|
|
|
|
Forfeited
|
|
|
|
(407,805
|
)
|
$
|
1
|
.57
|
|
|
|
|
|
|
|
|
Balance at
January 31, 2006
|
|
|
|
11,634,000
|
|
$
|
1
|
.12
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
575,000
|
|
$
|
2
|
.86
|
|
|
|
Exercised
|
|
|
|
(978,803
|
)
|
$
|
0
|
.67
|
|
|
|
Forfeited
|
|
|
|
(936,447
|
)
|
$
|
1
|
.86
|
|
|
|
|
|
|
|
|
Balance at July
31, 2007
|
|
|
|
10,293,750
|
|
$
|
1
|
.18
|
|
$22,500
|
|
|
|
|
|
|
|
|
Outstanding
|
Exercisable
|
Range of Exercise
Prices
|
Number
Shares
Outstanding
|
Weighted Average
Remaining
Contractual Life
(in years)
|
Weighted
Average
Exercise
Price
|
Number
Exercisable
|
Weighted
Average
Exercise
Price ($)
|
$0.50 to $0.75
|
|
|
|
4,175,000
|
|
|
2
|
.07
|
$
|
0
|
.55
|
|
4,175,000
|
|
$
|
0
|
.55
|
$0.80 to
$1.20
|
|
|
|
1,773,000
|
|
|
2
|
.39
|
$
|
0
|
.90
|
|
1,773,000
|
|
$
|
0
|
.90
|
$1.50 to
$3.65
|
|
|
|
4,345,750
|
|
|
2
|
.96
|
$
|
1
|
.89
|
|
3,752,000
|
|
$
|
1
|
.80
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,293,750
|
|
|
2
|
.50
|
$
|
1
|
.18
|
|
9,700,000
|
|
$
|
1
|
.10
|
|
|
|
|
|
|
|
|
|
|
|
Cash received from options exercised
for the twelve months ended July 31, 2007 and 2006, was $475,190 and $366,210 respectively.
During the twelve month period ended July 31, 2007 there were net exercises of options on
450,000 shares which resulted in the issuance of 338,553 shares of common stock. During the
twelve month period ended July 31, 2006 there were net exercises of options on 580,960
shares which resulted in the issuance of 448,155 shares of common stock, and a net exercise
of 300,000 warrants which resulted in the issuance of 200,000 shares of common stock. The
intrinsic value of all options exercised during the twelve months ended July 31, 2007 and
2006, was $2,012,600 and $1,798,200 respectively. The weighted-average grant date fair
value of equity options granted during the twelve months ended July 31, 2007 and 2006, was
$1.45 and $1.36 respectively.
During the first quarter of the year
ended July 31, 2007, Mr. Michael Sitton resigned from our Board of Directors. At that time,
the Board agreed to modify a stock option agreement for 100,000 shares of common stock. We
expensed $19,237 to general and administrative expense based on this modification, in
accordance with SFAS 123(R). The 100,000 stock options were not exercised within the
extended period and were therefore subsequently forfeited. See Note 6 for a more detailed
discussion of this modification.
As of July 31, 2007, there was
$111,500 of unrecognized non-cash compensation cost related to unvested options, which will
be recognized over a weighted average period of 1.7 years. In addition, $13,010 is recorded
on the face of the consolidated balance sheets as “prepaid consulting”, which
will be fully amortized by December 2007, as further discussed in Note 8.
Note 8. Prepaid
Consulting
In January 2006, we entered into a
two-year consulting agreement with Mr. Michael Sitton for domestic and international
business development, the compensation being a fee of $12,500 per month and an option on
2,000,000 shares of unregistered common stock, which vest over three years. We also entered
into a two-year consulting agreement with Secretary Tommy Thompson, for domestic and
international business development, the compensation being a fee of $12,500 per month and
an option on 300,000 shares of unregistered common stock, which vest over three years. Mr.
Sitton subsequently transferred the rights to 700,000 options to Secretary Thompson. Mr.
Sitton was therefore the beneficial owner of 1,300,000, and Secretary Thompson is the
beneficial owner of 1,000,000 of these options.
Under the option agreements, unvested
options would not be issued if the associated consulting agreements were terminated prior
to their two year term. Mr. Sitton and Secretary Thompson were each elected to our Board of
Directors during the quarter ended January 31, 2006, however in the first quarter of the
year ended July 31, 2007 Mr. Sitton resigned from the Board of Directors. Mr.
Sitton’s consulting agreement was not affected by his resignation from our Board of
Directors.
On their granting in January 2006, we
recorded the value of the aggregate of 2,300,000 unvested options as a prepaid asset to be
amortized over the life of the consulting agreements. The options were valued at an
aggregate of $598,372 based on their weighted average exercise prices of between $1.00 to
$2.75, and the Black-Scholes Option Pricing Model assuming no dividend yield, volatility of
82.23% and a risk-free interest rate of 4.25%, to be amortized over the two year life of
the consulting agreements at $24,932 per month.
During the year ended July 31, 2007
we amortized $385,900 of the prepaid asset to selling expense. To date we have amortized
$585,361 of the asset to selling expense and as a result we reported a prepaid asset of
$13,011 as “Prepaid consulting” on the face of the consolidated balance sheets
as at July 31, 2007. Subsequent to the end of the fiscal year, in August 2007, Mr.
Sitton’s consulting agreement was terminated, and Mr. Sitton’s 1,300,000
options are no longer exercisable.
Note 9.
Taxes
We file federal and California
consolidated tax returns with our subsidiaries. Taxable income is different from the income
reported in our financial statements due to temporary tax differences and certain other
differences between tax laws and generally accepted accounting principles.
29
The sale of the Water Treatment
Division to Innovative Medical Services, LLC (IMS LLC) was a transaction taxable for United
States federal and California income tax purposes. We recognized taxable income equal to
the amount realized on the sale, consisting of the cash received plus the amount of related
liabilities assumed by IMS LLC, in excess of the tax basis in the assets sold. The realized
gain to us on the sale was $2,187,136, giving rise to an estimated tax liability at July
31, 2005 of $937,500. In addition, income tax related to the operation of the Division
through May 25, 2005 was estimated to be $230,500. The total estimated taxes relating to
the discontinued operation were therefore approximately $1,167,500. This amount was offset
by the realization of a tax benefit of approximately $1,167,500 from losses incurred during
the fiscal year ended July 31, 2005 and available net operating loss carry-forwards
relating to our continuing operations. During the year ended July 31, 2006, we determined
the actual income tax on the operation and sale of the Division for the year ended July 31,
2005 to be $1,037,497. An adjustment of $129,990 is therefore shown on the face of the
Income Statement for the year ended July 31, 2006 as a reduction to “Income taxes on
discontinued operations,” with a corresponding and offsetting reduction to the
“Income tax benefit” to continuing operations.
The net tax effect of our tax
liabilities gives rise to the current provision for income taxes of $2,400 for the years
ended July 31, 2007 and 2006, which is the minimum franchise tax we pay to the State of
California regardless of income or loss.
At July 31, 2007, we had federal and
California tax net operating loss carry-forwards of approximately $22,354,000 and
$12,255,000 respectively. At July 31, 2006, we had federal and California tax net operating
loss carry-forwards of approximately $18,855,300 and $8,758,700 respectively. The
difference between federal and California tax loss carry-forwards is primarily due to
limitations on California loss carry-forwards. The federal tax loss carry-forwards will
begin expiring in the year ending July 31, 2017 unless previously utilized, and will
completely expire in the year ending July 31, 2027. The California tax loss carry-forwards
will begin to expire in the year ended July 31, 2013 and will completely expire in the year
ending July 31, 2017.
Significant components of our
deferred tax assets are as follows:
|
July 31, 2007
|
|
July 31, 2006
|
|
|
|
|
Net
operating loss carry-forward
|
|
|
$
|
8,683,700
|
|
$
|
6,948,200
|
|
Stock options
and warrants
|
|
|
|
579,500
|
|
|
101,000
|
|
Other timing
differences and allowances
|
|
|
|
(275,900
|
)
|
|
(164,100
|
)
|
|
|
|
|
|
Total deferred
tax assets
|
|
|
|
8,987,300
|
|
|
6,885,100
|
|
Valuation
allowance for deferred tax assets
|
|
|
|
(8,987,300
|
)
|
|
(6,885,100
|
)
|
|
|
|
|
|
Net
deferred tax assets
|
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
Realization of our deferred tax
assets, which relate to operating loss carry-forwards and timing differences, is dependant
on future earnings. The timing and amount of future earnings are uncertain and therefore a
valuation allowance has been established. The increase in the valuation allowance on the
deferred tax asset during the year ended July 31, 2007 was $2,102,200
A reconciliation of income taxes
computed using the statutory income tax, compared to the effective tax rate is as
follows:
|
2007
|
|
2006
|
|
|
|
Federal tax benefit at the
expected statutory rate
|
|
|
|
34
|
%
|
|
34
|
%
|
State income
tax, net of federal tax benefit
|
|
|
|
9
|
|
|
9
|
|
Valuation
allowance
|
|
|
|
(43
|
)
|
|
(43
|
)
|
|
|
|
|
|
Income tax
benefit - effective rate
|
|
|
|
0
|
%
|
|
0
|
%
|
|
|
|
|
|
Note 10. Sale of Water
Treatment Division and Discontinued Operations
Effective May 25, 2005, we sold the
assets of our Water Treatment Division to Maryland-based Innovative Medical Services, LLC
(IMS LLC) for $2,375,000. IMS LLC also assumed all liabilities associated with the
Division. At closing, we received $1,950,000 in cash and a promissory note in the amount of
$425,000. In June 2005, we received a cash payment of $225,000. During the year ended July
31, 2006, we received the balance of $200,000 plus interest on the promissory
note.
In addition, we agreed to continue to
fund the working capital of IMS LLC for a limited period of time subsequent to the sale of
the Water Treatment Division. During the year ended July 31, 2006, in addition to the
payment of the promissory note IMS LLC reimbursed us for the working capital we had
provided subsequent to the sale.
The realized gain to us on the sale
of the Water Treatment Division was $2,187,136 before the effect of taxes. The sale of the
Water Treatment Division assets to Innovative Medical Services, LLC was a transaction
taxable for United States federal and California income tax purposes. The estimated tax
liability related to the sale was $1,167,487, however this was offset by losses incurred in
the respective fiscal year, and available net operating loss carry-forwards relating to our
continuing operations. During the year ended July 31, 2006, we determined the actual income
tax on the operation and sale of the Division for the year ended July 31, 2005 to be
$1,037,497. An adjustment of $129,990 is therefore shown on the face of the Income
Statement for the year ended July 31, 2006 as a reduction to “Income taxes on
discontinued operations,” with a corresponding and offsetting reduction to the
“Income tax benefit” to continuing operations. For a further discussion of the
tax consequences of the sale, see Note 9.
Note 11. Legal
Proceedings
In November 2001, we acquired the
patent for silver dihydrogen citrate (SDC), a silver ion based technology which is the
basis for our silver ion products, from NVID International, Inc. In October 2003, we filed
an arbitration action against NVID International and other parties and in November 2004 we
won a $14.2 million award against NVID International through the American Arbitration
Association International Centre for Dispute Resolution. We believe it is unlikely that we
will ever be able to collect any part of this award, and we have therefore not recorded any
amount as an asset on the consolidated balance sheets as at July 31, 2006 or
2007.
30
In October 2005, we received a
further $3.4 million award plus costs of $241,000 resulting from a binding arbitration
proceeding against Falken Industries. In October 2006, we entered into a settlement
agreement with Falken Industries, and all arbitrations and any related appeals between or
among the parties have subsequently been dismissed. No part of this award was recorded as
an asset on our consolidated balance sheets at July 31, 2006.
During the year ended July 31, 2007
we received approximately $205,000 in proceeds from legal settlements and recorded this
amount as “Other” within “Other income and (expense)” in the
consolidated statements of operations for the year ended July 31, 2007.
Note 12. Retirement
Plan
We participate in a Small SEP program
under which we are entitled to make contributions on an employee’s behalf. The
program includes a salary reduction arrangement (SARSEP), which may be used only in years
in which the SEP meets requirements that the IRS may impose to ensure distribution of
excess contributions. Annual contributions made by employers under a SEP may be excluded
from the participating employee’s gross income, however we made no contributions
during the years ending July 31, 2007 or July 31, 2006.
Note 13. Business
Segment and Sales Concentrations
In accordance with the provisions of
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, certain
information may be disclosed based on the way we organize financial information for making
operating decisions and assessing performance. SFAS 131 requires that we apply standards
based on a management approach, and requires segmentation based upon our internal
organization and disclosure of revenue and operating income based upon internal accounting
methods. In determining operating segments, we have reviewed the current management
structure reporting to the chief operating decision-maker (‘CODM’) and analyzed
the reporting the CODM receives to allocate resources and measure performance.
We have determined that based upon
the end use of our products, the value added contributions made by us, the regulatory
requirements, the customers and partners, and the strategy required to successfully market
finished products, we are operating in a single segment.
During the year ended July 31, 2007,
90% of sales were made to four strategic partners that are also developing markets for our
products. 76% of sales for the year were made to U.S. domestic customers, and 24% were made
to international customers.
All of our tangible assets are
located in the United States.
Note 14. Subsequent
Events
Subsequent to July 31, 2007 we
received an aggregate of $216,500 from the exercise of options on 302,000 shares of common
stock, and $25,560 from the exercise of warrants on 10,000 shares of common
stock.
In August, the consulting agreement
of Mr. Michael Sitton was terminated, resulting in the forfeiture of 1,300,000 stock
options. See Note 8 for further information regarding the consulting agreement and stock
options.
On October 19, 2007, subsequent to
the end of the fiscal year, we closed on the sale of 1,677,596 unregistered securities
units to accredited investors, at $5.03 per unit. Each unit consisted of one share of PURE
Bioscience common stock and one quarter of a five-year warrant to purchase PURE Bioscience
common stock at $7.17 per share. A total of 419,394 such five-year warrants were issued to
the investors. Additionally, a five-year warrant to purchase 167,776 shares of common stock
at $8.60 per share was issued to Taglich Brothers, Inc. as the placement agent. The gross
proceeds of the sale were $8,438,328 and the net proceeds to us, after fees and expense,
were $7,720,743. If the shares of common stock are not registered within 210 days of the filing
date, we would be required to repay 2% of the gross proceeds for each thirty day period
until the shares are registered, up to a maximum repayment of 18% of the gross proceeds. No
registration penalties are payable with respect to the shares underlying the
warrants.