Report of Independent
Registered Public Accounting Firm
The Board of Directors
PURE
Bioscience
We have audited the accompanying
consolidated balance sheets of PURE Bioscience as of July 31, 2006 and 2005, and the
related statements of operations, stockholders equity and cash flows for the years
ended July 31, 2006 and 2005. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes
examining on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial
statement presentations. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial
statements referred to above present fairly, in all material respects, the consolidated
financial position of PURE Bioscience and the results of its operations and its cash flows
for the years ended July 31, 2006 and 2005, in conformity with generally accepted
accounting principles in the United States of America.
/s/ MILLER AND McCOLLOM
MILLER AND McCOLLOM
Certified Public
Accountants
4350 Wadsworth Boulevard, Suite 300
Wheat Ridge, Colorado 80033
October 25,
2006
F-3
PURE Bioscience
CONSOLIDATED BALANCE
SHEETS
|
July 31,
|
|
|
2007
|
|
2006
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current Assets
|
|
|
Cash and cash equivalents
|
|
|
$
|
735,654
|
|
$
|
4,720,362
|
|
Short-term investments
|
|
|
|
708,058
|
|
|
|
|
Accounts receivable, net of allowance for doubtful accounts
|
|
|
of $0 at July 31, 2006 and $0 at July 31, 2007
|
|
|
|
7,548
|
|
|
58,075
|
|
Inventories, net
|
|
|
|
242,899
|
|
|
171,939
|
|
Prepaid expenses
|
|
|
|
|
|
|
116,242
|
|
|
|
|
|
|
Total current assets
|
|
|
|
1,694,159
|
|
|
5,066,618
|
|
|
|
|
|
|
Total property, plant and equipment, net
|
|
|
|
968,737
|
|
|
353,272
|
|
|
|
|
|
|
Other Assets
|
|
|
Prepaid consulting
|
|
|
|
13,011
|
|
|
398,915
|
|
Deposits
|
|
|
|
9,744
|
|
|
9,744
|
|
Patents
|
|
|
|
2,176,388
|
|
|
2,136,725
|
|
|
|
|
|
|
Total other assets
|
|
|
|
2,199,143
|
|
|
2,545,384
|
|
|
|
|
|
|
Total assets
|
|
|
$
|
4,862,039
|
|
$
|
7,965,274
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
Current Liabilities
|
|
|
Accounts payable
|
|
|
$
|
422,753
|
|
$
|
334,040
|
|
Accrued liabilities
|
|
|
|
77,228
|
|
|
75,448
|
|
Taxes payable
|
|
|
|
2,400
|
|
|
2,400
|
|
|
|
|
|
|
Total current liabilities
|
|
|
|
502,381
|
|
|
411,888
|
|
|
|
|
|
|
Total liabilities
|
|
|
|
502,381
|
|
|
411,888
|
|
|
|
|
|
|
Stockholders' Equity
|
|
|
Preferred Stock, no par value:
|
|
|
5,000,000 shares authorized, no shares issued
|
|
|
|
|
|
|
|
|
Class A common stock, no par value:
|
|
|
50,000,000 shares authorized
|
|
|
23,983,002 issued and outstanding at July 31, 2006, and
|
|
|
24,961,805 issued and outstanding at July 31, 2007
|
|
|
|
26,519,543
|
|
|
25,801,653
|
|
Additional Paid-In Capital
|
|
|
|
2,486,829
|
|
|
1,743,570
|
|
Warrants:
|
|
|
391,698 issued and outstanding at July 31, 2006 and 2007
|
|
|
|
245,825
|
|
|
245,825
|
|
Accumulated deficit
|
|
|
|
(24,892,539
|
)
|
|
(20,237,662
|
)
|
|
|
|
|
|
Total stockholders' equity
|
|
|
|
4,359,658
|
|
|
7,553,386
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
|
|
$
|
4,862,039
|
|
$
|
7,965,274
|
|
|
|
|
|
|
The accompanying notes
are an integral part of the consolidated financial statements
F-4
PURE Bioscience
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
For the Years Ended July 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
Net revenues
|
|
|
$
|
336,392
|
|
$
|
200,432
|
|
$
|
155,806
|
|
Cost of sales
|
|
|
|
221,108
|
|
|
105,722
|
|
|
51,594
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
|
115,284
|
|
|
94,710
|
|
|
104,212
|
|
|
|
|
|
|
|
|
Selling expenses
|
|
|
|
899,145
|
|
|
570,155
|
|
|
427,452
|
|
General and administrative expenses
|
|
|
|
2,836,224
|
|
|
2,043,307
|
|
|
1,330,828
|
|
Research and development
|
|
|
|
1,220,764
|
|
|
1,193,894
|
|
|
1,357,112
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
|
4,956,133
|
|
|
3,807,356
|
|
|
3,115,392
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
|
(4,840,849
|
)
|
|
(3,712,646
|
)
|
|
(3,011,180
|
)
|
|
|
|
|
|
|
|
Other income and (expense):
|
|
|
Interest income
|
|
|
|
150,878
|
|
|
86,174
|
|
|
146,174
|
|
Interest expense
|
|
|
|
|
|
|
(460
|
)
|
|
(109,608
|
)
|
Other
|
|
|
|
37,494
|
|
|
(53,594
|
)
|
|
(37,204
|
)
|
|
|
|
|
|
|
|
Total other income (expense)
|
|
|
|
188,372
|
|
|
32,120
|
|
|
(638
|
)
|
|
|
|
|
|
|
|
Loss from continuing operations before income taxes
|
|
|
|
(4,652,477
|
)
|
|
(3,680,526
|
)
|
|
(3,011,818
|
)
|
Income tax provision
|
|
|
|
(2,400
|
)
|
|
(132,390
|
)
|
|
1,164,688
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
|
(4,654,877
|
)
|
|
(3,812,916
|
)
|
|
(1,847,130
|
)
|
Discontinued operations:
|
|
|
Gain on sale of Water Treatment Division
|
|
|
|
|
|
|
|
|
|
2,187,136
|
|
Income from operation of Water Treatment Division
|
|
|
|
|
|
|
|
|
|
510,411
|
|
Income taxes on discontinued operations
|
|
|
|
|
|
|
129,990
|
|
|
(1,167,487
|
)
|
|
|
|
|
|
|
|
Income from discontinued operations
|
|
|
|
|
|
|
129,990
|
|
|
1,530,060
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
$
|
(4,654,877
|
)
|
$
|
(3,682,926
|
)
|
$
|
(317,070
|
)
|
|
|
|
|
|
|
|
Net loss per common share, basic and diluted
|
|
|
Continuing operations
|
|
|
$
|
(0.19
|
)
|
$
|
(0.19
|
)
|
$
|
(0.11
|
)
|
Discontinued operations
|
|
|
|
|
|
|
0.01
|
|
|
0.09
|
|
|
|
|
|
|
|
|
Net Loss
|
|
|
$
|
(0.19
|
)
|
$
|
(0.18
|
)
|
$
|
(0.02
|
)
|
|
|
|
|
|
|
|
The accompanying notes
are an integral part of the consolidated financial statements
F-5
PURE Bioscience
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
For the Years Ended
July 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
$
|
(4,654,877
|
)
|
$
|
(3,682,926
|
)
|
$
|
(317,070
|
)
|
|
|
|
Adjustments to reconcile net loss to net cash
|
|
|
used in operating activities:
|
|
|
Amortization and depreciation
|
|
|
|
257,086
|
|
|
257,307
|
|
|
268,330
|
|
Impairment of capitalized assets
|
|
|
|
167,643
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
|
1,371,863
|
|
|
743,843
|
|
|
808,139
|
|
Pre-tax income from discontinued operations
|
|
|
|
|
|
|
|
|
|
(510,411
|
)
|
Pre-tax gain on sale of discontinued operations
|
|
|
|
|
|
|
|
|
|
(2,187,136
|
)
|
Changes in assets and liabilities:
|
|
|
Accounts receivable
|
|
|
|
50,527
|
|
|
15,185
|
|
|
32,705
|
|
Other receivables and interest receivable
|
|
|
|
|
|
|
135,338
|
|
|
189,032
|
|
Notes and other amounts receivable (Water Treatment Division sale)
|
|
|
|
|
|
|
200,000
|
|
|
|
|
Prepaid expense
|
|
|
|
116,242
|
|
|
(43,898
|
)
|
|
(72,344
|
)
|
Inventories
|
|
|
|
(70,960
|
)
|
|
(119,879
|
)
|
|
120,874
|
|
Accounts payable and accrued cash liabilities
|
|
|
|
90,492
|
|
|
58,987
|
|
|
(1,229,548
|
)
|
Income tax payable
|
|
|
|
|
|
|
(400
|
)
|
|
100
|
|
|
|
|
|
|
|
|
Net cash (used) in operating activities
|
|
|
|
(2,671,984
|
)
|
|
(2,436,443
|
)
|
|
(2,897,329
|
)
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
Investment in patents
|
|
|
|
(204,188
|
)
|
|
(111,113
|
)
|
|
(118,913
|
)
|
Purchase of property, plant and equipment
|
|
|
|
(875,668
|
)
|
|
(270,788
|
)
|
|
(94,963
|
)
|
Change in short-term investments
|
|
|
|
(708,058
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used) in investing activities
|
|
|
|
(1,787,914
|
)
|
|
(381,901
|
)
|
|
(213,876
|
)
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
Payment of notes payable
|
|
|
|
|
|
|
|
|
|
(300,000
|
)
|
Proceeds from short-term loans
|
|
|
|
|
|
|
80,000
|
|
|
90,000
|
|
Payment of short-term loans
|
|
|
|
|
|
|
(80,000
|
)
|
|
(690,000
|
)
|
Proceeds from sale of common stock
|
|
|
|
475,190
|
|
|
7,132,818
|
|
|
1,681,000
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
|
475,190
|
|
|
7,132,818
|
|
|
781,000
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from sale of Water Treatment Division
|
|
|
|
|
|
|
|
|
|
2,175,000
|
|
Cash flows from operation of Water Treatment Division
|
|
|
|
|
|
|
|
|
|
543,727
|
|
|
|
|
|
|
|
|
Net cash from discontinued operations
|
|
|
|
|
|
|
|
|
|
2,718,727
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
$
|
(3,984,708
|
)
|
$
|
4,314,474
|
|
$
|
388,522
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at beginning of period
|
|
|
|
4,720,362
|
|
|
405,888
|
|
|
17,366
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
|
$
|
735,654
|
|
$
|
4,720,362
|
|
$
|
405,888
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information
|
|
|
Cash paid for taxes
|
|
|
$
|
2,400
|
|
$
|
6,189
|
|
$
|
3,416
|
|
Cash paid for interest
|
|
|
$
|
|
|
$
|
460
|
|
$
|
149,835
|
|
The accompanying notes
are an integral part of the consolidated financial statements
F-6
PURE Bioscience
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY
|
Common Stock
|
|
Additional
Paid-In
|
|
Warrants
|
|
Accumulated
|
|
Total
Stockholders'
|
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Shares
|
|
Amount
|
|
Deficit
|
|
Equity
|
|
Balance, July 31, 2004
|
|
|
|
15,547,310
|
|
$
|
17,490,239
|
|
$
|
343,900
|
|
|
1,385,223
|
|
$
|
837,894
|
|
$
|
(16,237,666
|
)
|
$
|
2,434,367
|
|
|
|
|
Shares reacquired for trust deed
|
|
|
|
(2,000,000
|
)
|
|
(1,735,700
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,735,700
|
)
|
Private placements
|
|
|
|
2,739,996
|
|
|
1,337,779
|
|
|
|
|
|
112,500
|
|
|
21,547
|
|
|
|
|
|
1,359,326
|
|
Shares issued for patent rights
|
|
|
|
200,000
|
|
|
90,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90,000
|
|
Stock options issued for services
|
|
|
|
|
|
|
|
|
|
396,043
|
|
|
|
|
|
|
|
|
|
|
|
396,043
|
|
Shares issued for services
|
|
|
|
896,000
|
|
|
540,443
|
|
|
|
|
|
142,000
|
|
|
23,827
|
|
|
|
|
|
564,270
|
|
Options exercised
|
|
|
|
330,000
|
|
|
169,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
169,500
|
|
Expired / terminated warrants
|
|
|
|
|
|
|
684,797
|
|
|
|
|
|
(998,794
|
)
|
|
(684,797
|
)
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(317,070
|
)
|
|
(317,070
|
)
|
|
|
|
Balance, July 31, 2005
|
|
|
|
17,713,306
|
|
|
18,577,058
|
|
|
739,943
|
|
|
640,929
|
|
|
198,471
|
|
|
(16,554,736
|
)
|
|
2,960,736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Private placements
|
|
|
|
4,992,208
|
|
|
6,530,755
|
|
|
|
|
|
355,698
|
|
|
235,854
|
|
|
|
|
|
6,766,609
|
|
Common stock issued for services
|
|
|
|
75,000
|
|
|
139,130
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
139,130
|
|
Stock options issued for services
|
|
|
|
|
|
|
|
|
|
1,003,627
|
|
|
|
|
|
|
|
|
|
|
|
1,003,627
|
|
Stock options exercised
|
|
|
|
1,002,488
|
|
|
366,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
366,210
|
|
Expired / terminated warrants
|
|
|
|
|
|
|
69,013
|
|
|
|
|
|
(304,929
|
)
|
|
(69,013
|
)
|
|
|
|
|
|
|
Exercised warrants
|
|
|
|
200,000
|
|
|
119,487
|
|
|
|
|
|
(300,000
|
)
|
|
(119,487
|
)
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,682,926
|
)
|
|
(3,682,926
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, July 31, 2006
|
|
|
|
23,983,002
|
|
|
25,801,653
|
|
|
1,743,570
|
|
|
391,698
|
|
|
245,825
|
|
|
(20,237,662
|
)
|
|
7,553,386
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issued for services
|
|
|
|
30,000
|
|
|
65,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65,100
|
|
Stock options issued for services
|
|
|
|
|
|
|
|
|
|
91,290
|
|
|
|
|
|
|
|
|
|
|
|
91,290
|
|
Share-based compensation - options
|
|
|
|
|
|
|
|
|
|
651,969
|
|
|
|
|
|
|
|
|
|
|
|
651,969
|
|
Share-based compensation - stock grants
|
|
|
|
60,000
|
|
|
177,600
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
177,600
|
|
Stock options exercised
|
|
|
|
978,803
|
|
|
475,190
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
475,190
|
|
Canceled shares
|
|
|
|
(90,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,654,877
|
)
|
|
(4,654,877
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, July 31, 2007
|
|
|
|
24,961,805
|
|
$
|
26,519,543
|
|
$
|
2,486,829
|
|
|
391,698
|
|
$
|
245,825
|
|
$
|
(24,892,539
|
)
|
$
|
4,359,658
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes
are an integral part of the consolidated financial statements
F-7
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 Companys financial statements. The financial
statements and notes are representations of the Companys 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 Companys
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.
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.
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 and statements of stockholders equity at July 31, 2006,
and $739,943 from Common Stock to Additional Paid-In Capital on the statements of
stockholders equity at July 31, 2005. These amounts relate 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
$(132,390). See Note 9 for a further description of this tax provision.
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.
Revenue was recognized for products
and Customer Service Plans within the Water Treatment Division, prior to its divestiture
in May 2005, as revenue from discontinued operations. Customer acceptance provisions and
installation procedures accompanying delivery were minor in nature, and we did not
experience any material expense in satisfying warranties and returns. Most of the
Divisions chain customers had entered into multi-year contracts for the Customer
Service Plan 2000. The Plan provided an extended warranty on Fillmaster pharmacy products;
significant discounts on maintenance item costs; free software upgrades for the Fillmaster
1000e and Scanmaster; automatic replacement filter shipments; and simplified, annual
invoicing. When the customer bought a dispenser on the Customer Service Plan 2000 it
agreed to pay a fixed annual fee that covered replacement filters and parts. The filters
were normally replaced once a year. In order to match income with related costs, and for
simplicity in accounting and billing, we billed the customer the annual fee and recognized
revenue in the same month that we shipped replacement filters to the store. This was done
one year after the store was added to the Plan and each year thereafter. Subsequent to the
sale of the Water Treatment Division in May 2005, we no longer recognized revenue for
Fillmaster or Scanmaster products or Customer Service Plans.
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 and 2006 we deemed all
customer accounts to be collectable and therefore recorded no such allowance.
F-8
|
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, $111,100 and $118,913
for the fiscal years ended July 31, 2007, 2006
and 2005, respectively. Patents are stated net of accumulated amortization of $988,742,
$824,217 and $576,283 at July 31, 2007, 2006 and 2005 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, 2006 and 2005 was $164,500,
$157,400 and $158,146 respectively, and the estimated amortization expense over each of
the next five years is as follows:
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, 2006 or 2005, any stock option awards with market or
performance conditions.
We adopted the accounting provisions
of SFAS No. 123(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. 123(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. During
the year ended July 31, 2005 we recorded $56,384 in selling expense, $307,985 in general
and administrative expense, and $31,674 in research and development expense for stock
options issued to non-employees.
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.
F-9
|
Shipping
and Handling Costs
|
Shipping and handling costs payable
by us are charged to cost of sales.
Inventories are stated at the lower of
cost or net realizable value using the average cost method.
|
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 of 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, 2006 or 2005. All interest and dividends received from
short-term investments are included in interest income.
As of 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
(Moodys) 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.
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, 2006 or 2005.
|
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, 2006
and 2005, 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, 2006 and 2005 are based
on the weighted average number of shares of our common stock outstanding during the
periods.
F-10
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
|
|
July 31, 2005
|
|
Shares outstanding
|
|
|
|
24,961,805
|
|
|
23,983,002
|
|
|
17,713,306
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
|
24,432,905
|
|
|
20,056,721
|
|
|
16,897,118
|
|
Stock options
|
|
|
|
10,293,750
|
|
|
11,634,000
|
|
|
6,485,960
|
|
Warrants
|
|
|
|
391,698
|
|
|
391,698
|
|
|
640,929
|
|
|
|
|
|
|
|
|
Total weighted average shares outstanding
|
|
|
|
35,118,353
|
|
|
32,082,419
|
|
|
24,024,007
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
|
(4,654,877
|
)
|
|
(3,812,916
|
)
|
|
(1,847,430
|
)
|
Income from discontinued operations
|
|
|
|
|
|
|
129,990
|
|
|
1,530,060
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
$
|
(4,654,877
|
)
|
$
|
3,682,926
|
|
$
|
(317,070
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share, basic and diluted
|
|
|
Continuing operations
|
|
|
$
|
(0.19
|
)
|
$
|
(0.19
|
)
|
$
|
(0.11
|
)
|
Discontinued operations
|
|
|
|
|
|
|
0.01
|
|
|
0.09
|
|
|
|
|
|
|
|
|
Net Loss
|
|
|
$
|
(0.19
|
)
|
$
|
(0.18
|
)
|
$
|
(0.02
|
)
|
|
|
|
|
|
|
|
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.
|
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 Taxesan 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
LiabilitiesIncluding 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.
F-11
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
|
|
|
|
|
|
|
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, 2006 and 2005 was $92,600, $69,500 and $137,700, 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, 2006 and 2005, was $173,300, $137,000 and
$152,300 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
|
|
|
$
|
144,800
|
|
2009
|
|
|
$
|
150,600
|
|
2010
|
|
|
$
|
156,600
|
|
2011
|
|
|
$
|
162,900
|
|
2012
|
|
|
$
|
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 Companys 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, 2006 or 2005.
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.
F-12
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.
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 Companys 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 Companys Shareholders approved the Amended PURE
Bioscience 1998 Officers and Directors Stock Option Plan.
2001 Directors And Officers Stock
Option Plan: In January 2001, the Companys 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 Companys 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 Companys 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 Companys 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.
F-13
Non-employee Directors are eligible
to receive stock option or other incentive grants under the Companys 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 Companys 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, 2006 and 2005:
|
For the years ended July 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
Expected price volatility
|
|
|
|
70.88% - 86.35%
|
|
|
72.35% - 82.23%
|
|
|
112.30% - 137.78%
|
|
Risk-free interest rate
|
|
|
|
5.25%
|
|
|
4.25% - 5.25%
|
|
|
2.25% - 3.75%
|
|
Expected rate of forfeiture
|
|
|
|
0%
|
|
|
0%
|
|
|
0%
|
|
Expected dividend yield
|
|
|
|
0%
|
|
|
0%
|
|
|
0%
|
|
Weighted average expected term
|
|
|
|
2.3 years
|
|
|
2.5 years
|
|
|
2.2 years
|
|
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.
F-14
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 fiscal years ending July 31, 2006 and 2005.
|
Twelve months
ended
July 31,2006
|
|
Twelve months
ended
July 31,2005
|
|
|
|
|
Net loss, as reported
|
|
|
$
|
(3,682,926
|
)
|
$
|
(317,070
|
)
|
Employee stock-based compensation expense under fair-value method
|
|
|
|
(436,608
|
)
|
|
(1,076,010
|
)
|
Employee stock-based compensation expense included in reported net
|
|
|
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma net loss
|
|
|
$
|
(4,119,534
|
)
|
$
|
(1,393,080
|
)
|
|
|
|
Net loss per share:
|
|
|
|
|
|
As reported
|
|
|
$
|
(0.18
|
)
|
$
|
(0.02
|
)
|
Pro forma
|
|
|
$
|
(0.21
|
)
|
$
|
(0.08
|
)
|
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, 2004
|
|
|
|
3,983,750
|
|
$1.67
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
3,957,210
|
|
$0.57
|
|
|
|
|
|
Exercised
|
|
|
|
(930,000
|
)
|
$1.31
|
|
|
|
|
|
Forfeited
|
|
|
|
(525,000
|
)
|
$0.56
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
F-15
Cash received from options exercised
for the twelve months ended July 31, 2007, 2006 and 2005 was $475,190, $366,210 and
$494,500, 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. During the year ended July 31, 2005 there were no net option
exercises. The intrinsic value of all options exercised during the twelve months ended
July 31, 2007, 2006 and 2005 was $2,012,600, $1,798,200 and $320,400, respectively. The
weighted-average grant date fair value of equity options granted during the twelve months
ended July 31, 2007, 2006 and 2005 was $1.45, $1.36 and $0.57, 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.
Sittons 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.
Sittons consulting agreement was terminated, and Mr. Sittons 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.
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.
F-16
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 Water Treatment Division had
been reported as a discontinued operation since October 2003 when we made the decision
to dispose of the segment, however we continued to operate and retain the profits from
that division until its sale on May 25, 2005. For details of the results of
operations for the Water Treatment Division for the year ended July 31, 2005 through
the sale of the Division on May 25, 2005, see Note 14.
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.
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, 2006 or 2005.
F-17
Note 13. Trust Deed
In March 2005, we reacquired
2,000,000 shares of our common stock in exchange for our transfer to a third party
of a Trust Deed receivable. The result of the transaction during the year ended July
31, 2005 on the statements of shareholders equity for the year ended July 31, 2005 was
an increase in common stock of $1,735,700, or $0.87 per share, based on the fair value
of the common stock at the time of the transaction.
Note 14. 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 have been operating in a single segment
subsequent to the sale of the Water Treatment Division in May 2005.
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. During the year ended July
31, 2006, 100% of sales were made to U.S. domestic customers.
Prior to the sale of the Water
Treatment Division in May 2005, business activity was divided into two distinct business
segments, the Water Treatment segment and the Bioscience segment. These two
segments were determined by management based upon the inherent differences in the
end use of the products, the inherent differences in the value added processes
made by the Company, the differences in the regulatory requirements and the
inherent differences in the strategies required to successfully market finished
products. The Water Treatment segment included Commercial Water and Residential
Retail products and the Nutripure Water Dealer program. Bioscience included the
silver dihydrogen citrate antimicrobial and the Innovex line of pest control products.
As we had planned for a considerable period of time to sell the Water Treatment
segment, it was reported during the year ended July 31, 2005 as a Discontinued
Operation in the financial statements. For the year ended July 31, 2005, earnings
for the discontinued Water Treatment Division relate to the period from August 1,
2004 to May 25, 2005, the date on which the Division assets were sold. Subsequent
to the sale, we retained no interest in the assets, liabilities or earnings of
Innovative Medical Services LLC, the acquiring entity.
Segment information for the year
ended July 31, 2005 is presented in accordance with SFAS 131, Disclosures about
Segments of an Enterprise and Related Information. This standard is based on a
management approach, which requires segmentation based upon our internal
organization and disclosure of revenue and operating income based upon internal
accounting methods. Our financial reporting systems present various data for
management to run the business, including internal profit and loss statements
prepared on a basis not consistent with U.S. Generally Accepted Accounting
Principles. Reconciling amounts consist of unallocated general and administrative
expenses.
Year Ended July 31, 2005
|
|
Water
Treatment
(Discontinued)
Thru May 25
|
|
Bioscience
Full Year
|
|
Reconciling
Amounts
Full Year
|
|
Consolidated
Full Year
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Water Treatment
|
|
|
Fillmaster Products
|
|
|
$
|
985,187
|
|
$
|
|
|
$
|
|
|
$
|
985,187
|
|
Replacement Filters
|
|
|
|
717,257
|
|
|
|
|
|
|
|
|
717,257
|
|
|
|
|
Residential Water Treatment
|
|
|
|
(2,489
|
)
|
|
|
|
|
|
|
|
(2,489
|
)
|
Water Dealer Program
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Silver Dihydrogen Citrate
|
|
|
|
|
|
|
91,333
|
|
|
|
|
|
91,333
|
|
Pesticide
|
|
|
|
|
|
|
64,473
|
|
|
|
|
|
64,473
|
|
|
|
|
|
|
|
|
|
|
Total Revenues
|
|
|
$
|
1,699,955
|
|
$
|
155,806
|
|
$
|
|
|
$
|
1,855,761
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income/(Loss) before taxes
|
|
|
$
|
510,411
|
|
$
|
(2,819,664
|
)
|
$
|
(191,516
|
)
|
$
|
(2,500,759
|
)
|
|
|
|
|
|
|
|
|
|
Segment Assets (post-sale)
|
|
|
$
|
|
|
$
|
2,508,012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All of our tangible assets are
located in the United States.
F-18
Note 15. Quarterly Financial Data
(Unaudited)
Summarized quarterly data for the
years ended July 31, 2007 and 2006 are as follows:
|
First
Quarter
|
|
Second
Quarter
|
|
Third
Quarter
|
|
Fourth
Quarter
|
|
Full Year
|
|
|
|
|
|
|
|
Year Ended July 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
$
|
27,704
|
|
$
|
168,759
|
|
$
|
132,379
|
|
$
|
7,550
|
|
$
|
336,392
|
|
Gross profit
|
|
|
|
15,542
|
|
|
53,997
|
|
|
43,499
|
|
|
2,246
|
|
|
115,284
|
|
Net loss applicable to common stock
|
|
|
|
(867,290
|
)
|
|
(1,008,112
|
)
|
|
(876,370
|
)
|
|
(1,903,105
|
)
|
|
(4,654,877
|
)
|
Basic and diluted net loss per share (1)
|
|
|
$
|
(0.04
|
)
|
$
|
(0.04
|
)
|
$
|
(0.03
|
)
|
$
|
(0.08
|
)
|
$
|
(0.19
|
)
|
|
|
|
Year Ended July 31, 2006:
|
|
|
Total revenue
|
|
|
$
|
55,169
|
|
$
|
59,442
|
|
$
|
44,314
|
|
$
|
41,507
|
|
$
|
200,432
|
|
Gross profit
|
|
|
|
40,358
|
|
|
30,260
|
|
|
21,722
|
|
|
2,370
|
|
|
94,710
|
|
Net loss applicable to common stock
|
|
|
|
(609,534
|
)
|
|
(919,156
|
)
|
|
(871,452
|
)
|
|
(1,282,784
|
)
|
|
(3,682,926
|
)
|
Basic and diluted net loss per share (1)
|
|
|
$
|
(0.04
|
)
|
$
|
(0.05
|
)
|
$
|
(0.04
|
)
|
$
|
(0.05
|
)
|
$
|
(0.18
|
)
|
(1)
Basic and diluted loss per common share for each of the periods presented is the
same, and is based on the weighted average number of shares of our common stock
outstanding during the periods. As we incurred losses in each of the periods
presented we did not include common stock equivalent shares in the computation
of net loss per share as the effect would have been anti-dilutive.
F-19
PURE Bioscience
CONSOLIDATED BALANCE
SHEETS
|
(Unaudited)
October 31,
2007
|
|
July 31,
2007
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current Assets
|
|
|
Cash and cash equivalents
|
|
|
$
|
3,670,955
|
|
$
|
735,654
|
|
Short-term investments
|
|
|
|
4,759,520
|
|
|
708,058
|
|
Accounts receivable, net of allowance for doubtful accounts
|
|
|
of $0 at July 31, 2007 and $0 at October 31, 2007
|
|
|
|
33,565
|
|
|
7,548
|
|
Inventories, net
|
|
|
|
233,353
|
|
|
242,899
|
|
Prepaid expenses
|
|
|
|
23,000
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
|
8,720,393
|
|
|
1,694,159
|
|
|
|
|
|
|
Total property, plant and equipment, net
|
|
|
|
940,787
|
|
|
968,737
|
|
|
|
|
|
|
Other Assets
|
|
|
Prepaid consulting
|
|
|
|
3,253
|
|
|
13,011
|
|
Deposits
|
|
|
|
7,308
|
|
|
9,744
|
|
Patents
|
|
|
|
2,165,864
|
|
|
2,176,388
|
|
|
|
|
|
|
Total other assets
|
|
|
|
2,176,425
|
|
|
2,199,143
|
|
|
|
|
|
|
Total assets
|
|
|
$
|
11,837,605
|
|
$
|
4,862,039
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
Current Liabilities
|
|
|
Accounts payable
|
|
|
$
|
164,956
|
|
$
|
422,753
|
|
Accrued liabilities
|
|
|
|
108,270
|
|
|
77,228
|
|
Taxes payable
|
|
|
|
2,400
|
|
|
2,400
|
|
|
|
|
|
|
Total current liabilities
|
|
|
|
275,626
|
|
|
502,381
|
|
|
|
|
|
|
Deferred rent
|
|
|
|
9,817
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
|
285,443
|
|
|
502,381
|
|
|
|
|
|
|
Stockholders' Equity
|
|
|
Preferred Stock, no par value:
|
|
|
5,000,000 shares authorized, no shares issued
|
|
|
|
|
|
|
|
|
Class A common stock, no par value:
|
|
|
50,000,000 shares authorized
|
|
|
24,961,805 issued and outstanding at July 31, 2007, and
|
|
|
27,187,883 issued and outstanding at October 31, 2007
|
|
|
|
33,107,924
|
|
|
26,519,543
|
|
Additional Paid-In Capital
|
|
|
|
2,576,964
|
|
|
2,486,829
|
|
Warrants:
|
|
|
391,698 issued and outstanding at July 31,2007, and
|
|
|
880,351 issued and outstanding at October 31, 2007
|
|
|
|
1,766,159
|
|
|
245,825
|
|
Accumulated other comprehensive income
|
|
|
|
2,358
|
|
|
|
|
Accumulated deficit
|
|
|
|
(25,901,243
|
)
|
|
(24,892,539
|
)
|
|
|
|
|
|
Total stockholders' equity
|
|
|
|
11,552,162
|
|
|
4,359,658
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
|
|
$
|
11,837,605
|
|
$
|
4,862,039
|
|
|
|
|
|
|
The accompanying notes
are an integral part of the consolidated financial statements
F-20
PURE Bioscience
CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)
|
For the Three Months Ended
October 31,
|
|
|
2007
|
|
2006
|
|
Net revenues
|
|
|
$
|
95,290
|
|
$
|
27,704
|
|
Cost of sales
|
|
|
|
31,693
|
|
|
12,162
|
|
|
|
|
|
|
Gross profit
|
|
|
|
63,597
|
|
|
15,542
|
|
|
|
|
|
|
Selling expenses
|
|
|
|
88,202
|
|
|
182,166
|
|
General and administrative expenses
|
|
|
|
707,609
|
|
|
468,665
|
|
Research and development
|
|
|
|
288,205
|
|
|
274,350
|
|
|
|
|
|
|
Total operating expenses
|
|
|
|
1,084,016
|
|
|
925,181
|
|
|
|
|
|
|
Loss from operations
|
|
|
|
(1,020,419
|
)
|
|
(909,639
|
)
|
|
|
|
|
|
Other income and (expense):
|
|
|
Interest income
|
|
|
|
11,657
|
|
|
47,349
|
|
Other
|
|
|
|
58
|
|
|
(5,000
|
)
|
|
|
|
|
|
Total other income (expense)
|
|
|
|
11,715
|
|
|
42,349
|
|
|
|
|
|
|
Net loss before income taxes
|
|
|
|
(1,008,704
|
)
|
|
(867,290
|
)
|
Income tax provision
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
(1,008,704
|
)
|
|
(867,290
|
)
|
|
|
|
|
|
Net loss per common share, basic and diluted
|
|
|
$
|
(0.04
|
)
|
$
|
(0.04
|
)
|
|
|
|
|
|
Shares used in computing basic and diluted net loss per share
|
|
|
|
25,333,567
|
|
|
24,014,073
|
|
|
|
|
|
|
The accompanying notes
are an integral part of the consolidated financial statements
F-21
PURE Bioscience
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
|
For the Three Months
Ended October 31,
|
|
|
2007
|
|
2006
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
$
|
(1,008,704
|
)
|
$
|
(867,290
|
)
|
Adjustments to reconcile net loss to net cash
|
|
|
used in operating activities:
|
|
|
Amortization and depreciation
|
|
|
|
97,373
|
|
|
60,111
|
|
Stock-based compensation
|
|
|
|
78,331
|
|
|
166,047
|
|
Changes in assets and liabilities:
|
|
|
Accounts receivable
|
|
|
|
(26,017
|
)
|
|
6,218
|
|
Prepaid expense
|
|
|
|
(20,564
|
)
|
|
61,242
|
|
Inventories
|
|
|
|
9,546
|
|
|
(41,402
|
)
|
Deferred rent
|
|
|
|
9,817
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
|
|
(226,755
|
)
|
|
(160,747
|
)
|
|
|
|
|
|
Net cash (used) in operating activities
|
|
|
|
(1,086,973
|
)
|
|
(775,821
|
)
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
Investment in patents
|
|
|
|
(32,873
|
)
|
|
(15,867
|
)
|
Purchase of property, plant and equipment
|
|
|
|
(26,026
|
)
|
|
(103,664
|
)
|
Purchases of short-term investments
|
|
|
|
(4,749,973
|
)
|
|
(2,000,000
|
)
|
Sales of short-term investments
|
|
|
|
700,869
|
|
|
|
|
|
|
|
|
|
Net cash (used) in investing activities
|
|
|
|
(4,108,003
|
)
|
|
(2,119,531
|
)
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
Net proceeds from the sale of common stock
|
|
|
|
7,740,967
|
|
|
|
|
Proceeds from exercise of options and warrants
|
|
|
|
389,310
|
|
|
51,500
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
|
8,130,277
|
|
|
51,500
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
|
2,935,301
|
|
|
(2,843,852
|
)
|
|
|
|
Cash and cash equivalents at beginning of period
|
|
|
|
735,654
|
|
|
4,720,362
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
|
$
|
3,670,955
|
|
$
|
1,876,510
|
|
|
|
|
|
|
The accompanying notes
are an integral part of the consolidated financial statements
F-22
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Note 1. Basis of
Presentation
The financial statements included herein
have been prepared by PURE Bioscience without audit, in accordance with the instructions
to Securities and Exchange Commission (SEC) Form 10-Q and Article 10 of
Regulation S-X. Certain information and footnote disclosures normally included in the
financial statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted as allowed by such rules and regulations, however we
believe that the accompanying unaudited financial statements contain all adjustments
(including normal recurring adjustments) necessary to present fairly the financial
condition, results of operations and cash flows for the periods presented. These unaudited
consolidated financial statements presented herein should be read in conjunction with our
audited financial statements for the period ended July 31, 2007, and their accompanying
notes, as filed with the Securities and Exchange Commission in our 10K-SB on October 29,
2007.
While
management believes the procedures followed in preparing the financial statements included
in this quarterly report on Form 10Q are reasonable, the accuracy of the amounts are at
least partially dependent upon facts that will exist and results that will be accomplished
in subsequent periods. The preparation of the consolidated financial statements requires
management to make estimates and assumptions that affect the amounts reported in the
statements and accompanying notes, and actual results could differ materially from those
estimates. The results of operations for the three months ended October 31, 2007 are not
necessarily indicative of the results of operations for the full year, or any future
periods.
The accompanying unaudited financial
statements include the consolidated accounts of PURE Bioscience and its subsidiaries. All
inter-company balances and transactions have been eliminated.
Note 2. Summary of
Significant Accounting Policies
Certain comparative figures for prior
periods have been reclassified. Specifically, we have reclassified $2,000,000 from cash
and cash equivalents to short-term investments on the consolidated balance sheets at
October 31, 2006. The balance sheets at October 31, 2006 are not presented herein, however
the reclassification resulted in a $2,000,000 increase in short-term investments and a
corresponding decrease in cash and cash equivalents at the end of the period, as reflected
on the consolidated statement of cash flows for the three months ended October 31, 2006.
During the periods presented herein
our revenue was derived from the sale of SDC concentrate and the sale of finished packaged
products containing SDC. 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.
|
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 $32,873 and $15,867 in the three month periods ended October 31, 2007 and
2006, respectively. Patents are stated net of accumulated amortization of $1,032,139 and
$988,742 at October 31, 2007 and July 31, 2007, 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 October 31,
2007 the weighted average remaining amortization period for all patents was approximately
12.5 years. Amortization expense for the three month periods ended October 31, 2007 and
2006 was $43,396 and $40,631, respectively.
|
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. 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 three month periods ended October 31, 2007 or 2006, any stock option awards
with market or performance conditions.
We adopted the accounting provisions
of SFAS No. 123(R) in the three month period 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. 123(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 6).
F-23
|
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 Option Pricing Model. For such stock options, during
the three month period ended October 31, 2007 we recorded $9,758 in research and
development expense; and during the three month period ended October 31, 2006 we recorded
$65,038 in selling expense, $91,250 in general and administrative expense, and $9,758 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 6.
|
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
or October 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. Realized gains and losses recorded for the
three month periods ended October 31, 2007 and 2006 were $5,902 and zero, respectively.
All interest and dividends received from short-term investments are included in interest
income.
As at October 31 and July 31, 2007
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
(Moodys) 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.
SFAS 130, Reporting Comprehensive
Income, requires us to display comprehensive income or loss and its components as part of
our consolidated financial statements. Our 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 income or
loss. Our comprehensive loss was $1,006,346 and $867,290 for the three month periods ended
October 31, 2007 and 2006, respectively, and includes unrealized holding gains on
available-for-sale securities of $2,358 and zero for the three month periods ended October
31, 2007 and 2006, respectively .
|
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 three month periods ended
October 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 three month periods ended October
31, 2007 and July 31, 2006 are based on the weighted average number of shares of our
common stock outstanding during the periods.
|
Recent
Accounting Pronouncements
|
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.
In February 2007, the FASB issued
SFAS No. 159, The Fair Value Option for Financial Assets and Financial
LiabilitiesIncluding 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.
F-24
In December 2007, the FASB issued
SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R). This Statement
replaces SFAS No. 141, Business Combinations and requires an acquirer in a business
combination to recognize the assets acquired, the liabilities assumed, including those
arising from contractual contingencies, any contingent consideration, and any
non-controlling interest in the acquiree at the acquisition date, measured at their fair
values as of that date, with limited exceptions specified in the Statement. SFAS 141R also
requires the acquirer in a business combination achieved in stages (sometimes referred to
as a step acquisition) to recognize the identifiable assets and liabilities, as well as
the non-controlling interest in the acquiree, at the full amounts of their fair values (or
other amounts determined in accordance with SFAS 141R). In addition, SFAS 141Rs
requirement to measure the non-controlling interest in the acquiree at fair value will
result in recognizing the goodwill attributable to the non-controlling interest in
addition to that attributable to the acquirer. SFAS 141R amends SFAS No. 109, Accounting
for Income Taxes, to require the acquirer to recognize changes in the amount of its
deferred tax benefits that are recognizable because of a business combination either in
income from continuing operations in the period of the combination, or directly in
contributed capital, depending on the circumstances. It also amends SFAS 142, Goodwill and
Other Intangible Assets, to provide guidance on the impairment testing of acquired
research and development intangible assets and assets that the acquirer intends not to
use. SFAS 141R applies prospectively to business combinations for which the acquisition
date is on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008 (our fiscal year commencing August 1, 2009). We do not currently
expect the adoption of the provisions of SFAS 141R to have a material effect on our
financial condition, results of operations or cash flows.
In December 2007, the FASB issued
Statement of Financial Accounting Standards No. 160, Non-controlling Interests in
Consolidated Financial Statements (SFAS 160). SFAS 160 amends Accounting
Research Bulletin 51, Consolidated Financial Statements, to establish accounting and
reporting standards for the non-controlling interest in a subsidiary and for the
deconsolidation of a subsidiary. It also clarifies that a non-controlling interest in a
subsidiary is an ownership interest in the consolidated entity that should be reported as
equity in the consolidated financial statements. SFAS 160 also changes the way the
consolidated income statement is presented by requiring consolidated net income to be
reported at amounts that include the amounts attributable to both the parent and the
non-controlling interest. It also requires disclosure, on the face of the consolidated
statement of income, of the amounts of consolidated net income attributable to the parent
and to the non-controlling interest. SFAS 160 requires that a parent recognize a gain or
loss in net income when a subsidiary is deconsolidated and requires expanded disclosures
in the consolidated financial statements that clearly identify and distinguish between the
interests of the parent owners and the interests of the non-controlling owners of a
subsidiary. SFAS 160 is effective for fiscal periods, and interim periods within those
fiscal years, beginning on or after December 15, 2008 (our fiscal year commencing August
1, 2009). We do not currently expect the adoption of the provisions of SFAS No. 160 to
have a material effect on our financial condition, results of operations or cash flows.
Note 3. Private Placement
On October 19, 2007 we sold 1,677,596
unregistered securities units to accredited investors, at $5.03 per unit. Each unit
consisted of one share of our common stock and one quarter of a five-year warrant to
purchase our common stock at $7.17 per share. A total of 419,394 such five-year warrants
were issued to the investors and the fair value of the warrants, based on their fair value
relative to the common stock issued, was $1,143,676 (based on the Black-Scholes Option
Pricing Model assuming no dividend yield, volatility of 95.38% and a risk-free interest
rate of 4.75%). Additionally, Taglich Brothers, Inc. acted as placement agent and in
accordance with the placement agent agreement, they received a cash fee of $675,065 and a
five-year warrant to purchase 167,759 shares of our common stock at $8.60 per share. The
fair value of the 167,759 placement agent warrants, based on their fair value relative to
the common stock issued, was $441,970 (based on the Black-Scholes Option Pricing Model
assuming no dividend yield, volatility of 95.38% and a risk-free interest rate of 4.75%).
Other cash fees paid to third parties, for legal and other fees associated with the
private placement, were $22,277. The gross proceeds of the private placement were
$8,438,308 and the net proceeds to us, after fees and expenses, were $7,740,967.
Under the terms of the placement
agreement, we are required to file a registration statement with the Securities and
Exchange Commission within 90 days of the private placement, or by January 17, 2008, for
the resale of shares issued in the private placement and the shares to be issued upon the
exercise of the warrants. We plan to file the registration statement on Form S-1 by that
date, however if the registration statement is not filed within the 90-day period, we
would be required to repay 2% of the gross proceeds (or $168,767) for each thirty day
period, or any part thereof, beyond the 90-day period until the registration statement is
filed. In addition, if the registration statement is not declared effective, or the common
stock may not be sold without any restriction pursuant to Rule 144, within 210 days after
the filing date, we would be required to repay 2% of the gross proceeds (or $168,767) for
each thirty day period (or any part of a 30-day period) beyond the 210-day period until
the shares are registered, up to a maximum repayment of 18% of the gross proceeds (or
$1,518,899). No registration penalties are payable with respect to the shares underlying
either the investor or the placement agent warrants.
In December 2006, the FASB approved
FASB Staff Position (FSP) No. EITF 00-19-2, Accounting for Registration Payment
Arrangements, or FSP EITF 00-19-2, which specifies that the contingent obligation to
make future payments or otherwise transfer consideration under a registration payment
arrangement, whether issued as a separate agreement or included as a provision of a
financial instrument or other agreement, should be separately recognized and measured in
accordance with SFAS No. 5, Accounting for Contingencies. FSP EITF 00-19-2
also requires additional disclosure regarding the current carrying amount of the
liability, if any. The guidance in FSP EITF 00-19-2 amends FASB Statements No. 133,
Accounting for Derivative Instruments and Hedging Activities, and No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity, and FASB Interpretation No. 45, Guarantors
Accounting and Disclosure requirement for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, to include scope exceptions for registration payment
arrangements. We do not currently believe that the transfer of consideration under the
October 2007 private placement agreement is probable and have therefore not recorded any
amount as a contingent liability on the consolidated balance sheets as at October 31,
2007. Based on the relative fair value of the common stock and warrants, we booked
$6,155,321 to common stock and $1,585,646 to warrants; a total of $7,740,967 of net
proceeds recorded within shareholders equity on the consolidated balance sheets at
October 31, 2007.
Note 4. Other Equity and
Common Stock Transactions
We paid no cash dividends during any
of the periods presented, and have never paid cash dividends.
In August 2007 we issued 12,500
unregistered shares of common sock to a third party as part of a legal settlement, with an
estimated fair value of $43,750 based on a market price of $3.50 per share.
F-25
During the three months ended October
31, 2007 we received an aggregate of $318,750 from the exercise of non-employee options on
390,000 shares of common stock at an average exercise price of $0.82, received $45,000
from the exercise of options on 75,000 shares of common stock issued under employee stock
option plans, received $25,560 from the exercise of common stock warrants on 10,000 shares
of common stock at an average exercise price of $2.56, and recorded $24,822 of employee
stock option expense. Additionally during the three months ended October 31, 2007 there
were net exercises of 88,500 warrants that resulted in the issuance of 60,982 shares of
common stock based on the exercise price of the warrants and the market price of our
common stock on the date of exercise.
Note 5. 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: the 1998 Directors And
Officers Stock Option Plan; the 2001 Directors And Officers Stock Option Plan: the 2001
ETIH2O Stock Option Plan; the 2001 Consultants and Advisors Stock Option Plan; the 2002
Non-Qualified Stock Option Plan; the 2002 Employee Incentive Stock Option Plan; the 2004
Consultants and Advisors 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. 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 6). 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 three month periods
ended October 31, 2007 and 2006:
|
For the Three month periods ended October 31,
|
|
2007
|
|
2006
|
Expected volatility
|
|
|
|
|
88.27% - 91.36%
|
|
|
70.88% - 70.88%
|
Risk-free interest rate
|
|
|
|
|
5.25%
|
|
|
5.25%
|
Expected rate of forfeiture
|
|
|
|
|
0.0%
|
|
|
0.0%
|
Expected dividend yield
|
|
|
|
|
0.0%
|
|
|
0.0%
|
Weighted average expected term
|
|
|
|
|
1.63 years
|
|
|
3.0 years
|
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 subsequent to July 31, 2006 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.
F-26
The following table sets forth the
share-based compensation expense recorded in our consolidated statements of operations for
the three months ended October 31, 2007 and 2006 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 6:
|
Three Months Ended
October 31, 2007
|
|
Three Months Ended
October 31, 2006
|
|
Share-based compensation for employees and directors:
|
|
|
|
|
|
|
|
|
Selling expense
|
|
|
$
|
|
|
$
|
|
|
General and administrative expenses
|
|
|
|
24,822
|
|
|
|
|
Research and development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total share-based compensation for employees and directors
|
|
|
|
24,822
|
|
|
|
|
|
|
|
Share-based compensation for third party service providers:
|
|
|
Selling expense
|
|
|
$
|
|
|
$
|
|
|
General and administrative expenses
|
|
|
|
43,750
|
|
|
91,290
|
|
Research and development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total share-based compensation for third party service providers
|
|
|
|
43,750
|
|
|
91,290
|
|
|
|
|
|
|
Total share-based compensation expense
|
|
|
$
|
68,572
|
|
$
|
91,290
|
|
|
|
|
|
|
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, 2007
|
|
|
|
10,293,750
|
|
|
$1
|
.18
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
38,300
|
|
|
$3
|
.69
|
|
|
|
Exercised
|
|
|
|
(465,000
|
)
|
|
$0
|
.78
|
|
|
|
Forfeited / Cancelled
|
|
|
|
(650,000
|
)
|
|
$1
|
.42
|
|
|
|
|
|
|
|
|
Balance at October 31, 2007
|
|
|
|
9,217,050
|
|
|
$1
|
.19
|
|
$
|
62,400
|
|
|
|
|
|
|
|
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
|
|
|
|
3,860,000
|
|
|
1
|
.92
|
$
|
0
|
.53
|
|
3,860,000
|
|
$
|
0
|
.53
|
$0.80 to $1.20
|
|
|
|
1,411,100
|
|
|
2
|
.38
|
$
|
0
|
.89
|
|
1,411,100
|
|
$
|
0
|
.89
|
$1.50 to $3.95
|
|
|
|
3,945,950
|
|
|
2
|
.88
|
$
|
1
|
.94
|
|
3,313,900
|
|
$
|
1
|
.83
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,217,050
|
|
|
2
|
.40
|
$
|
1
|
.19
|
|
8,585,000
|
|
$
|
1
|
.09
|
|
|
|
|
|
|
|
|
|
|
|
Cash received from options exercised
for the three month periods ended October 31, 2007 and 2006, was $363,750 and $51,500,
respectively. The intrinsic value of all options exercised during the three month periods
ended October 31, 2007 and 2006, was $3,337,650 and $52,530, respectively, and the
weighted-average grant date fair value of equity options granted during the three month
periods ended October 31, 2007 and 2006, was $3.69 and $1.83, respectively.
As of October 31, 2007, there was
$157,277 of unrecognized non-cash compensation cost related to unvested options to be
recognized over a weighted average period of 1.6 years.
Note 6. 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, vesting 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, vesting 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 the
beneficial owner of 1,000,000 of these options.
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 three months ended October
31, 2007 we amortized $9,758 of the prepaid asset to selling expense, and reported a
prepaid asset of $3,253 as Prepaid consulting on the face of the consolidated
balance sheets at October 31, 2007. In August 2007, Mr. Sittons consulting agreement
was terminated, and Mr. Sittons 1,300,000 options are no longer exercisable.
F-27
Note 7. Inventory
Inventories are stated at the lower
of cost or net realizable value using the average cost method. Inventories at October 31,
2007 and 2006 consisted of:
|
October 31, 2007
|
|
July 31, 2007
|
|
Raw Materials
|
|
|
$
|
79,235
|
|
$
|
78,816
|
|
Work in Progress
|
|
|
|
|
|
|
|
|
Finished Goods
|
|
|
|
154,118
|
|
|
164,083
|
|
|
|
|
|
|
|
|
|
$
|
233,353
|
|
$
|
242,899
|
|
|
|
|
|
|
Note 8. Commitments and
Contingencies
During the three months ended October
31, 2007 we issued 12,500 shares of common stock with a fair value of $43,750 and paid an
additional $30,000, for a legal settlement.
Note 9. Taxes
In June 2006, the Financial
Accounting Standards Board, or FASB, issued FASB Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxesan 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. Under
FIN 48, we must recognize the tax benefit from an uncertain tax position if it is more
likely than not that the tax position will be sustained on examination by the taxing
authorities, based on the technical merits of the position.
FIN 48 became effective for us on
August 1, 2007, however the adoption of FIN 48 did not have a material impact on our
consolidated results of operations and financial position as we had no unrecognized tax
benefits that, if recognized, would affect our effective income tax rate in future
periods. Our practice is to recognize interest and/or penalties related to income tax
matters in income tax expense, however we had no accrued interest or penalties at either
August 1 or October 31, 2007. We are subject to taxation in the United States and in
California, and our historical tax years remain subject to future examination by the U.S.
and California tax authorities.
At October 31, 2007 we had federal
and California tax net operating loss carry-forwards of approximately $25,564,000 and
$15,462,700, 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.
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
we establish a 100% valuation allowance.
Note 10. 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 three month period ended
October 31, 2007, 99% of sales were made to two strategic partners that are also
developing markets for our products. 99% of sales for the period were made to U.S.
domestic customers, and 1% were made to international customers.
All of our tangible assets are
located in the United States.
Note 11. Subsequent
Events
In November, 2007 we received $12,000
from the exercise of an employee stock option on 6,250 shares of common stock.
F-28
Part II Information
Not Required in Prospectus