Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2002

OR

For the transition period from ____________________to______________________

Commission File No.      0-22803

PROLONG INTERNATIONAL CORPORATION
(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

There were 29,789,598 shares of the registrant’s common stock ($0.001 par value) outstanding as of November 8, 2002.

Page 1 of 23 pages
Exhibit Index on Sequentially Numbered Page 19

Table of Contents

PROLONG INTERNATIONAL CORPORATION
FORM 10-Q
TABLE OF CONTENTS

2

Table of Contents

Item 1. Financial Statements

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS

See notes to consolidated condensed financial statements

3

Table of Contents

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)

See notes to consolidated condensed financial statements

4

Table of Contents

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES
During the nine months ended September 30, 2002, the Company completed the following transactions:
Provided an affiliate with office space, and recorded increases in other income and investment in affiliate of $74,997.  Completed the sale of its corporate headquarters at a one time-gain of $983,400.  The transaction resulted in a net decrease in property and equipment (land, building & improvements) of approximately $2,414,000 and a reduction in long-term liabilities, (notes payable & deposits under sales contracts) of approximately $3,398,000.

See notes to consolidated condensed financial statements

5

Table of Contents

PROLONG INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

6

Table of Contents

7

Table of Contents

8

Table of Contents

9

Table of Contents

10

Table of Contents

ITEM 2:

PROLONG INTERNATIONAL CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

RISK FACTORS AND FORWARD LOOKING STATEMENTS

This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties.  In addition, the Company may from time to time make oral forward looking statements.  The words “estimate,” “project,” “potential,” “intended,” “expect,” “anticipate,” “believe” and similar expressions or words are intended to identify forward looking statements.  The forward looking statements included herein are based on current expectations, which involve a number of risks and uncertainties and assumptions regarding the Company’s business and technology.  These assumptions involve judgments with respect to, among other things, future economic and competitive conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company.  Although the Company believes that the assumptions underlying the forward looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated in forward looking statements will be realized and actual results may differ materially.  In light of the significant uncertainties inherent in the forward looking information included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved.  The Company undertakes no obligation to publicly release the result of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

Actual results are uncertain and may be impacted by the factors discussed in more detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 and other periodic reports filed with the Securities and Exchange Commission.  In particular, there are certain risks and uncertainties that may impact the accuracy of the forward looking statements with respect to revenues, expenses and operating results including without limitation, the risks set forth in the risk factors section of the Annual Report on Form 10-K for the year ended December 31, 2001, which risk factors are hereby incorporated into this report by this reference.  As a result, the actual results may differ materially from those projected in the forward looking statements.

Because of these and other factors that may affect the Company’s operating results, past financial performance should not be considered an indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the

11

Table of Contents

reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period.  We regularly evaluate our estimates and assumptions related to allowances for doubtful accounts, sales returns and allowances, inventory reserves, goodwill and purchased intangible asset valuations, deferred income tax asset valuation allowances, warranty reserves, litigation and other contingencies.  We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.  We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our unaudited condensed consolidated financial statements:

Revenue, Receivables and Inventory - We recognize product revenue upon concluding that all of the fundamental criteria for revenue recognition have been met.  The criteria are usually met at the time of product shipment.  In addition, we record reductions to revenue for estimated product returns and allowances such as competitive pricing programs.  Should actual product returns or pricing adjustments exceed our estimates, additional reductions to revenue would result.  We provide reserves for estimated product warranty costs at the time revenue is recognized.  We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments.  If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required.  We write down our inventory for estimated obsolescence.  If actual market conditions are less favorable than those projected by management, additional inventory write-downs could be required.

Goodwill and Purchased Intangible Assets - - The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired. Goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests.  The amounts and useful lives assigned to intangible assets impact future amortization.

Deferred Taxes - If we determine that we will not realize all or part of our net deferred tax assets in the future, we will make an adjustment to the deferred tax assets, which adjustment will be charged to income tax expense in the period of such determination.

12

Table of Contents

RESULTS OF OPERATIONS

Three Months Ended September 30, 2002 vs. Three Months Ended September 30, 2001

Net revenues for the three months ended September 30, 2002 were approximately $2,628,000 as compared to approximately $2,858,000 for the comparable period of the prior year, a decrease of $230,000 or 8.0%.  Revenues for the three month period ended September 30, 2002 were derived from the following sources:  Retail sales of $2,269,000 and international and other sales of $359,000.  Revenues for the three month period ended September 30, 2001 were derived from the following sources: Retail sales of $2,604,000, and international and other sales of $254,000.

During the third quarter of 2002, retail sales were 86.3% of total revenues while international and other sales comprised 13.7% of total revenues.  During the third quarter of 2001, retail sales were 91.1% of total revenues while international and other sales comprised 8.9% of total revenues.  The lower retail sales for the period ended September 30, 2002 versus the same period a year ago are attributable to a decrease in lubricant sales of approximately $335,000.  The lubricant retail sales decline is attributable to a continuing soft market for specialty lubricants, competitive factors and reduced advertising exposure.

Cost of goods sold for the three months ended September 30, 2002 was approximately $934,000 as compared to $930,000 for the comparable period of the prior year, an increase of $4,000 or 0.4%.  As a percentage of sales, cost of goods sold increased from 32.5% for the three months ended September 30, 2001 to 35.5% for the three months ended September 30, 2002.  The increase was mainly attributable to a shift in product mix in the retail lubricants sales and to an increase in international sales, which carry a lower gross margin.

13

Table of Contents

Selling and marketing expenses of $974,000 for the three months ended September 30, 2002 represented a decrease of $423,000 over the comparable period of the prior year.  This 30.3% decrease was primarily the result of decreased expenses for endorsement and sponsorship payments, promotional activities to promote product awareness and salaries.  Selling and marketing expenses as a percentage of sales were 37.1% for the three months ended September 30, 2002 versus 48.9% for the comparable period of the previous year.

General and administrative expenses for the three months ended September 30, 2002 were approximately $639,000 as compared to $909,000 for the three months ended September 30, 2001, a decrease of $270,000 or 29.7%.  This decrease is primarily attributable to a decrease in audit fees, amortization expenses, financing costs and salaries.  As a percentage of sales, general and administrative expenses decreased from 31.8% in 2001 to 24.3% in 2002.

Net interest expense of $71,200 for the three months ended September 30, 2002 represented a decrease of $76,500 over the comparable period in 2001.  The decrease is attributable to a lower average balance in bank loans and notes payable during the period.  Other income for the three months ended September 30, 2002 was $40,000 as compared to none for the three months ended September 30, 2001, an increase of $40,000.  This increase was the result of rent income from sub-tenants.

Net income for the three month period ended September 30, 2002 was approximately $30,600 as compared to a net loss of approximately $(420,000) for the comparable period in the prior year, an increase of $450,600.  The increase is a result of the factors discussed above.

Nine Months Ended September 30, 2002 vs. Nine Months Ended September 30, 2001

Net revenues for the nine months ended September 30, 2002 were approximately $8,001,000 as compared to approximately $10,939,000 for the comparable period in the prior year, a decrease of $2,938,000 or 26.9%.  Revenues for the nine month period ended September 30, 2002 were derived from the following sources:  Retail sales of $7,083,000 and international and other sales of $918,000.  Revenues for the nine month period ended September 30, 2001 were derived from the following sources: Retail sales of $9,707,000 and international and other sales of $1,232,000.

For the nine-month period ended September 30, 2002, retail sales were 88.5% of total revenues while international and other sales comprised 11.5% of total revenues.  During the comparable period in 2001, retail sales were 88.7% of total revenues while international and other sales comprised 11.3% of total revenues.  The lower retail sales for the nine month period ended September 30, 2002 versus the same period a year ago are attributable to a decrease in lubricant sales of approximately $2,624,000.  The lubricant retail sales decline is attributable to a continuing soft market for specialty lubricants, competitive factors and reduced advertising exposure.  International and other sales decreased due to a slower demand in South Africa, Asia and South America.

Cost of goods sold for the nine months ended September 30, 2002 was approximately $2,722,000 as compared to $3,402,000 for the comparable period of the prior year, a decrease of $680,000 or 20.0%.  As a percentage of sales, cost of goods sold increased from 31.1% for the nine months ended September 30, 2001 to 34.0% for the nine months ended September 30, 2002.  The increase was mainly attributable to a shift in product mix in the retail lubricants sales, and increases related to purchased materials and overhead warehouse costs.

14

Table of Contents

Selling and marketing expenses of $2,982,000 for the nine months ended September 30, 2002 represented a decrease of $1,745,000 over the comparable period of the prior year.  This decrease was primarily the result of decreased expenses for endorsement and sponsorship payments, promotional activities to promote product awareness and salaries.  Selling and marketing expenses as a percentage of sales were 37.3% for the nine months ended September 30, 2002 versus 43.2% for the comparable period of the previous year.

General and administrative expenses for the nine months ended September 30, 2002 were approximately $2,070,000 as compared to $2,800,000 for the nine months ended September 30, 2001, a decrease of $730,000 or 26.1%.  This decrease is primarily attributable to a decrease in amortization expenses, financing costs and salaries.  As a percentage of sales, general and administrative expenses increased from 25.6% in 2001 to 25.9% in 2002.  Even though the aggregate expenses declined during the period, the ratio of expenses as a percentage of sales increased due to the more than expected decline in sales during the period.

Net interest expense of $270,000 for the nine months ended September 30, 2002 represented a decrease of $147,000 over the comparable period in 2001.  The decrease is attributable to a lower average balance in bank loans and notes payable during the period.  Other income for the nine months ended September 30, 2002 was $149,000 as compared to none for the nine months ended September 30, 2001.  This increase was the result of rent income from sub-tenants.  Gain on sale of building for the nine months ended September 30, 2002 in the amount of $983,400 represents the one time net gain on the sale of the Company’s corporate headquarters.

Extraordinary item – gain from forgiveness of debt, net of income taxes of $271,000 for the nine months ended September 30, 2002 was approximately $406,000 as compared to none for the nine months ended September 30, 2001.  This gain resulted from the executed settlements during the period of the Company’s “Accounts Payable Discounted Debt Restructure Program” (Note 1 to the consolidated condensed financial statements).

Net income for the nine month period ended September 30, 2002 was approximately $1,061,000 as compared to a net loss of approximately $(395,000) for the comparable period in the prior year, an increase of $1,456,000.  The increase is a result of the factors discussed above.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2002, the Company had a net working capital of approximately $1,223,000 as compared to a negative working capital of $149,000 at December 31, 2001, representing an increase of $1,372,000.  Operating activities generated cash of $2,100 during the nine month period ended September 30, 2002, primarily from a decrease in accounts receivable, inventories and deferred taxes which was partially offset by a decrease in accounts payable.  Additionally, the Company provided $7,400 in investing activities and used $394,000 in financing activities which were primarily net reductions in notes payable and line of credit from bank offset by proceeds received from new sub-debt notes payable.

The Company has a $5,000,000 credit facility with a financial institution, expiring in May 2003.  Such facility is collateralized by eligible accounts receivable and inventories.  Interest is currently payable monthly at the default rate of the financial institution’s prime rate (4.75% at September 30, 2002), plus 7.00% subject to a minimum interest charge of $50,000 per quarter.

15

Table of Contents

The credit facility contains certain defined net income and tangible net worth financial covenants.  At September 30, 2002 the Company was in default with certain financial covenants under the credit agreement.  The Company is currently discussing remedies with the lender and is also actively pursuing a replacement senior secured lender.  There can be no assurance that the Company will successfully secure a replacement senior secured lender on favorable terms, or at all.  As of September 30, 2002, $1,107,209 was outstanding and approximately $136,000 was available under the terms of the line of credit.

At September 30, 2002, the Company had an accumulated deficit of approximately $5,464,000.  During 2001 and 2002 to date, the Company has reduced personnel, discontinued certain of its endorsement and sponsorship contracts and aggressively reduced selling and general and administrative expenses.  The Company anticipates realizing the full impact of these expense reductions in the remainder of 2002 and beyond.  Additionally, the Company improved its credit and collections function and worked with its vendors to improve payment terms.  The Company’s business plan for 2002 provides for positive cash generation from operations.  The Company initiated an “Accounts Payable Discounted Debt Restructure Program”, which was successfully executed and the program reduced the accounts payable balance by approximately $1,300,000 and recognized debt forgiveness income of $677,000 (before taxes), during the nine month period ended September 30, 2002.  The Company also recognized a one-time gain of $983,400 on the sale of its corporate headquarters during the period ended September 30, 2002.  The Company is currently seeking additional working capital through a private placement offering of subordinated secured promissory notes to accredited investors.  As of September 30, 2002, the Company raised $375,000 through this private placement.  If these measures are not adequate, the Company will pursue additional expense reductions.  The Company cannot guarantee that the timing of further reductions in operating expenses will be adequate to return to profitability for 2002 and beyond.  The Company is continuing to seek financing on favorable terms, including senior secured debt, subordinated debt and/or equity placements.  Management cannot guarantee that it will be able to obtain adequate funds when needed or on acceptable terms, if at all.  Any inability to obtain funds when needed would have a material adverse effect on the Company’s financial condition.  Further, if additional funds are raised by issuing equity securities, dilution to existing stockholders is likely to result.  Management believes that the aforementioned plans, if successfully executed, will provide adequate financial resources to sustain the Company’s operations and enable the Company to continue as a going concern.

ITEM 3:

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

PIC’s financial instruments include cash and long-term debt.  At September 30, 2002 and December 31, 2001, respectively the carrying values of PIC’s financial instruments approximated their fair values based on current market prices and rates.  It is PIC’s policy not to enter into derivative financial instruments.  PIC does not currently have any significant foreign currency exposure since it does not transact business in foreign currencies.  As a result, PIC did not have significant overall currency exposure at September 30, 2002 and December 31, 2001.

16

Table of Contents

ITEM 4:

CONTROLS AND PROCEDURES

We maintain a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report.  Within the 90-day period prior to the date of this report, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (the “CEO”) and the Chief Financial Officer (the “CFO”), we evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934 (the “1934 Act”). Based upon that evaluation, our CEO and our CFO concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings under the 1934 Act.

There have been no significant changes in our internal controls or in other factors, which could significantly affect internal controls subsequent to the date that we carried out our evaluation.

17

Table of Contents

PROLONG INTERNATIONAL CORPORATION
PART II—OTHER INFORMATION

Item 1.   Legal Proceedings

Reference is made to Note 8 of the notes to consolidated condensed financial statements.

Item 2.   Changes in Securities and Use of Proceeds

During the nine month period ended September 30, 2002, the Company issued an aggregate of 460,000 common stock warrants in connection with the sale and issuance of an aggregate principal amount of $375,000 of 15.00% subordinated promissory notes to a total of nine accredited investors and the settlement of certain accounts payable.  The warrants have three-year terms and entitle the holder to acquire shares of the Company’s common stock at prices ranging from $0.15 to $0.50 per share.  Additionally, each warrant may be exercised as a result of a “net issue” or “easy sale” exercise by the holder.  The proceeds received by the Company from the sale of the 15.00% subordinated promissory notes were used to pay certain outstanding accounts payable.

The sales of the warrants and 15.00% subordinated promissory notes were deemed to be exempt from registration under the Securities Act of 1933, as amended (the “1933 Act”), in reliance on Section 4(2) of the Securities Act or Regulation D promulgated thereunder.  The Company has reason to believe that each purchaser was familiar with or had access to information concerning the operations and financial condition of the Company, and each purchaser represented that it was an accredited investor and was acquiring the securities for investment only and not with a view to or for sale in connection with any distribution thereof.  At the time of the issuances, the warrants and the 15% subordinated promissory notes were deemed to be restricted securities for purposes of the 1933 Act and the instruments representing such securities (and the share certificates to be issued upon exercise of the warrants) bear legends to that effect.

Item 3.   Defaults upon Senior Securities

The Company has a $5,000,000 credit facility with a financial institution, expiring in May 2003.  Such facility is collateralized by eligible accounts receivable and inventories.  Interest is currently payable monthly at the default rate of the financial institution’s prime rate (4.75% at September 30, 2002), plus 7.00% subject to a minimum interest charge of $50,000 per quarter.  The credit facility contains certain defined net income and tangible net worth financial covenants.  At September 30, 2002 the Company was in default with certain financial covenants under the credit agreement.  The Company is currently discussing remedies with the lender and is also actively pursuing a replacement senior secured lender.  As of November 7, 2002, $976,00 was outstanding and approximately $75,000 was available under the terms of the line of credit.

18

Table of Contents

PROLONG INTERNATIONAL CORPORATION
PART II—OTHER INFORMATION

Item 6.   Exhibits and Reports on Form 8-K

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

19

Table of Contents

CERTIFICATIONS PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002

I, Elton Alderman, certify that:

20

Table of Contents

21

Table of Contents

CERTIFICATIONS PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002

I, Nicholas Rosier, certify that:

22

Table of Contents

23