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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
---------
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2005
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from to
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33-23617
- --------
(Commission file number)
Material Technologies, Inc.
- ---------------------------
(Exact name of issuer as specified in its charter)
Delaware
- --------
(State or other jurisdiction
of incorporation or organization)
95-4622822
- ----------
(IRS Employer
Identification No.)
11661 San Vicente Boulevard
Suite 707
Los Angeles, California 90049
- -----------------------------
(Address of principal executive offices)
(310) 208-5589
- --------------
(Issuer's telephone number)
(Former name, former address and former fiscal year, if changed since last
report)
[X] Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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.
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of each of the issuer's classes of common
equity as of March 31, 2005:
Class A Common Stock - 88,162,524 shares outstanding
Class B Common Stock - 600,000 shares outstanding
INDEX
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Page
------
Part 1. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2005
(Unaudited) and December 31, 2004 F-1 - F-2
Consolidated Statements of Operations for the Three
Months Ended March 31, 2005 and 2004 and From The
Company's Inception (October 21, 1983) Through March
31, 2005 (Unaudited) F-3
Consolidated Statements of Comprehensive Loss for the
Three Months Ended March 31, 2005 and 2004 and From The
Company's Inception (October 21, 1983) Through March
31, 2005 (Unaudited) F-4
Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2005 and 2004 and From The
Company's Inception (October 21, 1983) Through March
31, 2005 (Unaudited) F-5 - F-6
Notes to Consolidated Financial Statements F-7 - F-26
Item 2. Management's Discussion and Analysis 1
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 3
Item 4. Controls and Procedures 3
Part 2. Other Information
Item 2. Changes in Securities 4
Part 1. Financial Information
- ------------------------------
Item 1. Financial Statements
- -----------------------------
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
===================================================================================================================
March 31, December 31,
ASSETS 2005 2004
---------------- ----------------
(Unaudited)
Current assets:
Cash and cash equivalents $ 364,109 $ 100,800
Investments in marketable securities held for trading 186,400 988,990
Certificates of deposit 200,248 -
Receivable due on research contract 16,613 15,895
Receivable from officer 1,998 1,950
---------------- ----------------
Total current assets 769,368 1,107,635
---------------- ----------------
Investments in marketable securities available for sale 993,534 1,034,380
Property and equipment, net 15,899 14,838
Intangible assets, net 7,359 7,888
Deposit 2,348 2,348
---------------- ----------------
Total Assets $ 1,788,508 $ 2,167,089
================ ================
Continued...
F-1
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS - CONTINUED
===================================================================================================================
March 31, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 2005 2004
---------------- ----------------
(Unaudited)
Current liabilities:
Accounts payable and accrued expenses $ 297,364 $ 344,702
Research and development sponsorship payable 795,068 760,831
Notes payable 87,298 86,892
---------------- ----------------
Total current liabilities 1,179,730 1,192,425
Convertible debentures, net of discount of $698,985 and $798,839,
respectively 554,634 424,612
---------------- ----------------
Total liabilities 1,734,364 1,617,037
---------------- ----------------
Minority interest in consolidated subsidiary 825 825
---------------- ----------------
Commitments and contingencies
Stockholders' equity:
Class A preferred stock - $.001 par value; liquidation preference
of $720 per share; 350,000 shares authorized; 337 shares issued
and outstanding at March 31, 2005 and December 31, 2004 - -
Class B preferred stock - $.001 par value; liquidation preference of
$10,000 per share; 15 shares authorized; 0 shares issued and
outstanding at March 31, 2005 and December 31, 2004 - -
Class C preferred stock - $.001 par value; liquidation preference of
$0.001 per share; 25,000,000 shares authorized; 1,517
shares issued and outstanding at March 31, 2005 and December 31, 2004 1 1
Class D preferred stock - $.001 par value; liquidation preference of
$0.001 per share; 20,000,000 shares authorized; 1,420,000 and
1,920,000 shares issued and outstanding at March 31, 2005 and
December 31, 2004, respectively 1,420 1,920
Class A common stock - $.001 par value; 1,699,400,000 shares authorized;
108,995,367 and 107,517,617 shares issued, 88,162,524 and 86,684,774
shares outstanding at March 31, 2005 and December 31, 2004, respectively 88,163 86,685
Class B common stock - $.001 par value; 600,000 shares authorized, issued
and outstanding at March 31, 2005 and December 31, 2004 600 600
Additional paid-in capital 42,942,241 41,717,219
Deficit accumulated during the development stage (41,714,551) (40,034,486)
Notes receivable - common stock (56,093) (55,096)
Accumulated other comprehensive loss (1,208,462) (1,167,616)
---------------- ----------------
Total stockholders' equity 53,319 549,227
---------------- ----------------
Total Liabilities and Stockholder's Equity $ 1,788,508 $ 2,167,089
================ ================
See accompanying notes to the consolidated financial statements
F-2
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
=================================================================================================================
From Inception
(October 21, 1983)
Three Months Ended March 31, Through
----------------------------------- March 31,
2005 2004 2005
---------------- ---------------- ----------------
(Restated)
Revenues:
Research and development $ 18,308 $ 67,270 $ 5,231,601
Other - - 274,125
---------------- ---------------- ----------------
Total revenues 18,308 67,270 5,505,726
---------------- ---------------- ----------------
Costs and expenses:
Research and development 1,212,182 161,586 14,078,009
General and administrative 321,562 1,523,769 22,317,864
---------------- ---------------- ----------------
Total costs and expenses 1,533,744 1,685,355 36,395,873
---------------- ---------------- ----------------
Loss from operations (1,515,436) (1,618,085) (30,890,147)
---------------- ---------------- ----------------
Other income (expense):
Net realized and unrealized losses on
marketable securities held for trading (3,499) - (5,195,659)
Other-than-temporary write-down of marketable
securities available for sale - - (4,284,760)
Interest expense (165,353) (83,225) (1,412,556)
Interest income 5,023 3,090 359,761
Loss on settlement of indebtedness - - (244,790)
Loss on abandonment of interest in joint venture - - (33,000)
---------------- ---------------- ----------------
Other expense, net (163,829) (80,135) (10,811,004)
---------------- ---------------- ----------------
Loss before provision for income taxes (1,679,265) (1,698,220) (41,701,151)
Provision for income taxes 800 800 13,400
---------------- ---------------- ----------------
Net loss $ (1,680,065) $ (1,699,020) $ (41,714,551)
================ ================ ================
Per share data:
Basic and diluted net loss per share $ (0.02) $ (0.03)
================ ================
Weighted average Class A common shares
outstanding (basic and diluted) 87,216,240 67,006,008
================ ================
See accompanying notes to the consolidated financial statements
F-3
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)
==================================================================================================================
From Inception
(October 21, 1983)
Three Months Ended March 31, Through
----------------------------------- March 31,
2005 2004 2005
---------------- ---------------- ----------------
(Restated)
Net loss $ (1,680,065) $ (1,699,020) $ (41,714,551)
Other comprehensive loss:
Decrease in market value of securities
available for sale (40,846) - (1,208,462)
---------------- ---------------- ----------------
Net comprehensive loss $ (1,720,911) $ (1,699,020) $ (42,923,013)
================ ================ ================
See accompanying notes to the consolidated financial statements
F-4
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
=======================================================================================================================
From Inception
(October 21, 1983)
Three Months Ended March 31, Through
----------------------------------- March 31,
2005 2004 2005
---------------- ---------------- ----------------
(Restated)
Cash flows from operating activities:
Net loss $ (1,680,065) $ (1,699,020) $ (41,714,551)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 1,225,000 1,292,550 22,677,956
Net realized and unrealized losses on marketable
securities held for trading 3,499 - 5,195,659
Other-than-temporary write-down of marketable
securities available for sale - - 4,284,760
Legal fees incurred for note payable - - 1,456,142
Accrued interest expense added to principal 64,811 44,966 869,227
Amortization of discount on convertible debentures 99,854 37,572 426,015
Accrued interest income added to principal (1,045) (3,090) (300,674)
Loss on settlement of indebtedness - - 244,790
Depreciation and amortization 2,066 2,107 205,397
Other non-cash adjustments - - (107,722)
Increase in receivable due on research contract (718) (6,303) (66,941)
Decrease in prepaid expenses and other current assets - 1,188 -
Increase in deposits - - (2,348)
(Decrease) increase in accounts payable and
accrued expenses (47,338) (64,501) 1,173,643
---------------- ---------------- ----------------
Net cash used in operating activities (333,936) (394,531) (5,658,647)
---------------- ---------------- ----------------
Cash flows from investing activities:
Proceeds from sale of securities 802,498 - 2,291,706
Purchase of securities (203,655) - (1,193,661)
Payment received on officer loans - - 876,255
Funds advanced to officers - - (549,379)
Purchase of property and equipment (2,598) - (269,746)
Investment in joint ventures - - (102,069)
Proceeds from foreclosure - - 44,450
Proceeds from sale of equipment - - 10,250
Payment for license agreement - - (6,250)
---------------- ---------------- ----------------
Net cash provided by investing activities 596,245 - 1,101,556
---------------- ---------------- ----------------
Continued ...
F-5
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
=======================================================================================================================
From Inception
(October 21, 1983)
Three Months Ended March 31, Through
----------------------------------- March 31,
2005 2004 2005
---------------- ---------------- ----------------
(Restated)
Cash flows from financing activities:
Proceeds from sale of common stock 1,000 - 3,341,858
Proceeds from convertible debentures and other
notes payable - 375,000 1,307,069
Proceeds from sale of preferred stock - - 473,005
Costs incurred in offerings - - (468,201)
Capital contributions - - 301,068
Repurchase of common stock for
cancellation - - (28,599)
Payment on proposed reorganization - - (5,000)
---------------- ---------------- ----------------
Net cash provided by financing activities 1,000 375,000 4,921,200
---------------- ---------------- ----------------
Net change in cash and cash equivalents 263,309 (19,531) 364,109
Cash and cash equivalents, beginning of period 100,800 47,664 -
---------------- ---------------- ----------------
Cash and cash equivalents, end of period $ 364,109 $ 28,133 $ 364,109
================ ================ ================
Supplemental disclosure of cash flow information:
Interest paid during the period $ 688 $ 688
================ ================
Income taxes paid during the period $ 800 $ 800
================ ================
Supplemental disclosure of non-cash investing and financing activities:
2005
- ----
The Company issued 975,750 shares of its Class A common stock as compensation
valued at $1,225,000.
The Company issued 500,000 shares of its Class A common stock through the
conversion of 500,000 shares of Class D preferred stock.
2004
- ----
The Company issued 450,000 shares of its Class A common stock through the
conversion of 450,000 shares of its Class D preferred stock.
The Company issued 625,000 shares of its Class A common stock in as compensation
valued at $1,292,550.
The Company issued 25,000 shares of its Class A common stock in settlement of
accounting fees payable of $25,000.
See accompanying notes to the consolidated financial statements for additional
non-cash investing and financing activities.
See accompanying notes to the consolidated financial statements
F-6
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 1 - BASIS OF PRESENTATION AND ORGANIZATION
- -----------------------------------------------
Basis of Presentation
- ---------------------
The accompanying interim consolidated financial statements have been prepared by
the Company pursuant to the rules and regulations of the Securities and Exchange
Commission (the "SEC") for interim financial reporting. These interim
consolidated financial statements are unaudited and, in the opinion of
management, include all adjustments (consisting of normal recurring adjustments
and accruals) necessary to present fairly the consolidated balance sheets,
consolidated operating results and consolidated cash flows for the periods
presented in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). Operating results for the three months ended
March 31, 2005 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2005 or for any other interim period
during such year. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with GAAP have been omitted in
accordance with the rules and regulations of the SEC. These interim consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and notes thereto contained in the Company's Form 10-K for
the year ended December 31, 2004.
Restatement of March 31, 2004 Net Loss
- --------------------------------------
The accompanying statement of operations for the three months ended March 31,
2004 has been restated to reflect amortization of the discount on the Company's
convertible debenture as of December 31, 2004 (see Note 6) and to properly
reflect the value of certain shares granted to consultants during the three
months ended March 31, 2004.
A reconciliation of the restated net loss for the three months ended March 31,
2004 is as follows:
Net loss as originally reported $ (922,098)
Issuance of common stock for services (739,350)
Amortization of discount on convertible debenture (37,572)
---------------
Net loss as restated $ (1,699,020)
===============
Net loss per share:
As originally reported $ (0.01)
Adjustment for increased expense (0.02)
---------------
As restated $ (0.03)
===============
In addition, the accompanying statement of cash flows for the three months ended
March 31, 2004 has been restated to reflect the above adjustments.
F-7
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 1 - BASIS OF PRESENTATION AND ORGANIZATION, continued
- ----------------------------------------------------------
Organization
- ------------
Material Technologies, Inc. (the "Company") was organized on October 21, 1983,
under the laws of the state of Delaware.
The Company is in the development stage, as defined in Statement of Financial
Accounting Standards ("SFAS") No. 7, "Accounting and Reporting by Development
Stage Enterprises," with its principal activity being research and development
in the area of metal fatigue technology with the intent of future commercial
application. The Company has not paid any dividends, and dividends that may be
paid in the future will depend on the financial requirements of the Company and
other relevant factors.
On September 23, 2003, the Company's Board of Directors affected a 1,000 for 1
reverse stock split of its Class A common stock and all classes of its preferred
stock. The financial statements presented herein have been restated to reflect
the reverse stock split as if it had occurred at the beginning of each period
presented. Unless otherwise noted, common stock refers to Class A common stock.
Going Concern
- -------------
The Company's consolidated financial statements are prepared using the accrual
method of accounting in accordance with accounting principles generally accepted
in the United States of America and have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
in the normal course of business. The Company has sustained operating losses
since its inception (October 21, 1983). In addition, the Company has used
substantial amounts of working capital in its operations. Further, at March 31,
2005, current liabilities exceed current assets by approximately $410,000 and
the deficit accumulated during the development stage amounted to approximately
$42,000,000.
In view of these matters, realization of a major portion of the assets in the
accompanying consolidated balance sheet is dependent upon the Company's ability
to meet its financing requirements and the success of its future operations. The
Company has entered into a $215,000 contract to provide research services over a
two-year period, of which approximately $138,000 is still available to be
collected. During 2005, the Company netted approximately $600,000 from sale of
marketable securities. At March 31, 2005, the Company has approximately $364,000
of cash and cash equivalents and $387,000 of marketable securities held for
trading and certificates of deposit. Management believes that these sources of
funds and current liquid assets will allow the Company to continue as a going
concern through the end of 2005. Management of the Company will need to raise
additional debt and/or equity capital to finance future activities beyond 2005.
However, no assurances can be made that current or anticipated future sources of
funds will enable the Company to finance future periods' operations. These
financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets or liabilities that might
be necessary should the Company be unable to continue as a going concern.
F-8
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Principles of Consolidation
- ---------------------------
The accompanying financial statements include the accounts and transactions of
Material Technologies, Inc. and its subsidiaries. Intercompany transactions and
balances have been eliminated in consolidation. The minority owners' interests
in a subsidiary have been reflected as minority interest in the accompanying
consolidated balance sheets.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, 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. Significant estimates include the fair value of marketable
securities. Accordingly, actual results could differ from those estimates.
Marketable Securities
- ---------------------
Marketable securities purchased with the intent of selling them in the near term
are classified as trading securities. Trading securities are initially recorded
at cost and are adjusted to their fair value, with the change in fair value
during the period included in earnings as unrealized gains or losses. Realized
gains or losses on dispositions are based upon the net proceeds and the adjusted
book value of the securities sold, using the specific identification method, and
are recorded as realized gains or losses in the consolidated statement of
operations. Securities that are not classified as trading securities are
classified as available-for-sale securities. Available-for-sale securities are
initially recorded at cost and adjusted to their fair value. Any change in fair
value during the period is excluded from earnings and recorded, net of tax, as a
component of accumulated other comprehensive income (loss). Any decline in value
of available-for-sale securities below cost that is considered to be "other than
temporary" is recorded as a reduction of the cost basis of the security and is
included in the statement of operations as a write down of the market value.
Long-Lived Assets
- -----------------
The Company accounts for its long-lived assets in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144
requires that long-lived assets be reviewed for impairment whenever events or
changes in circumstances indicate that the historical cost carrying value of an
asset may no longer be appropriate. The Company assesses recoverability of the
carrying value of an asset by estimating the future net cash flows expected to
result from the asset, including eventual disposition. If the future net cash
flows are less than the carrying value of the asset, an impairment loss is
recorded equal to the difference between the asset's carrying value and fair
value or disposable value. As of March 31, 2005, the Company does not believe
there has been any impairment of its long-lived assets.
F-9
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Intangible Assets
- -----------------
Intangible assets consist of patents, license agreements and website design
costs and are recorded at cost. Patents and license agreements are amortized
over 17 years and website design costs are amortized over 5 years. In accordance
with SFAS No. 142, "Goodwill and Other Intangible Assets," the carrying values
of intangible assets are evaluated for impairment annually or whenever events or
changes in circumstances indicate that the historical cost carrying value may no
longer be appropriate. As of March 31, 2005, the Company does not believe there
has been any impairment of its intangible assets.
Beneficial Conversion Feature
- -----------------------------
The convertible feature of the Debentures (see Note 6) provides for a rate of
conversion that is below market value. This feature is normally characterized as
a beneficial conversion feature ("BCF"), which is recorded by the Company
pursuant to Emerging Issues Task Forces ("EITF") Issue No. 98-5 ("EITF 98-05"),
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios," and EITF Issue No. 00-27,
"Application of EITF Issue No. 98-5 to Certain Convertible Instruments."
Convertible Debentures
- ----------------------
The Company's convertible debentures are recorded net of the debt discount
related to the BCF (see Note 6). The Company records the debt discount in
proportion to principal advances and amortizes the discount to interest expense
over the life of the debentures on a straight-line basis, which approximates the
effective interest method.
Fair Value of Financial Instruments
- -----------------------------------
The Company's financial instruments consist of cash and cash equivalents,
investments in certificate of deposits with terms longer then three-months,
marketable securities, accounts receivable, receivable from officer, accounts
payable and accrued expenses, notes payable and convertible debentures. Pursuant
to SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," the
Company is required to estimate the fair value of all financial instruments at
the balance sheet date. The Company cannot determine the estimated fair value of
receivable from officer as the transaction originated with a related party and
instruments similar to the convertible debentures could not be found. Other than
these items, the Company considers the carrying values of its financial
instruments in the financial statements to approximate their fair values.
F-10
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Revenue Recognition
- -------------------
The Company recognizes revenue in accordance with Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition in Financial Statements," as revised by
SAB No. 104. As such, the Company recognizes revenue when persuasive evidence of
an arrangement exists, title transfer has occurred, the price is fixed or
readily determinable and collectibility is probable. Sales are recorded net of
sales discounts.
Substantially all of the Company's revenue is derived from the Company's
contracts relating to the further development of the Electrochemical Fatigue
Sensor ("EFS"). Revenue on the contracts is recognized at the time services are
rendered. The Company bills monthly for services pursuant to these contracts at
which time revenue is recognized for the period that the respective invoice
relates. In October 2003, the Company entered into a contract to provide
research services to a third party in connection with the application of the
Company's EFS to detect stress on military vehicles. The contract expires in
September 2005 and has an approved budget of $215,281. As of March 31, 2005,
$93,244 has been billed on this contract. This gross amount includes
out-of-pocket expenses relating to third party engineering and other related
costs.
All other revenue is reported in the period that the income is earned.
In the past, the Company has received research and development funding from
various agencies of the U.S. government. U.S. government contracts are subject
to government audits. Such audits could lead to inquiries from the government
regarding the allowability of costs under U.S. government regulations and
potential adjustments of contract revenues. To date, the Company has not been
involved in any such audits.
Net Loss per Share
- ------------------
The Company adopted the provisions of SFAS No. 128, "Earnings Per Share"
("EPS"). SFAS No. 128 provides for the calculation of basic and diluted earnings
per share. Basic EPS includes no dilution and is computed by dividing income or
loss available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
of securities that could share in the earnings or losses of the entity. For the
quarters ended March 31, 2005 and 2004, basic and diluted loss per share are the
same, since the calculation of diluted per share amounts would result in an
anti-dilutive calculation that is not permitted and therefore not included. If
such shares were included in diluted EPS, they would have resulted in
weighted-average common shares of 140,453,819 and 80,638,323 in 2005 and 2004,
respectively. Such amounts include shares potentially issuable pursuant to
shares held in escrow (see Note 8), convertible debentures (see Note 6),
convertible preferred stock (see Note 8) and outstanding options and warrants.
F-11
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Issuance of Stock for Non-Cash Consideration
- --------------------------------------------
All issuances of the Company's stock for non-cash consideration have been
assigned a per share amount equaling either the market value of the shares
issued or the value of consideration received, whichever is more readily
determinable. The majority of the non-cash consideration received pertains to
services rendered by consultants and others and has been valued at the market
value of the shares on the dates issued. In certain instances, the Company has
discounted the values assigned to the issued shares for illiquidity and/or
restrictions on resale (see Note 8).
Stock-Based Compensation
- ------------------------
The Company accounts for stock-based compensation under SFAS No. 123,
"Accounting for Stock-Based Compensation" and SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure--An amendment to SFAS No.
123." These standards define a fair value based method of accounting for
stock-based compensation. In accordance with SFAS Nos. 123 and 148, the cost of
stock-based employee compensation is measured at the grant date based on the
value of the award and is recognized over the vesting period. The value of the
stock-based award is determined using the Black-Scholes option-pricing model,
whereby compensation cost is the excess of the fair value of the award as
determined by the pricing model at the grant date or other measurement date over
the amount an employee must pay to acquire the stock. The resulting amount is
charged to expense on the straight-line basis over the period in which the
Company expects to receive the benefit, which is generally the vesting period.
During the quarters ended March 31, 2005 and 2004, the Company recognized no
compensation expense under SFAS No. 123 for options issued to employees as no
options were granted to employees during these periods.
Concentrations of Credit Risk
- -----------------------------
The Company maintains its cash balances at financial institutions that are
insured by the Federal Deposit Insurance Corporation ("FDIC") up to $100,000.
From time-to-time, the Company's cash balances exceed the amount insured by the
FDIC. Management believes the risk of loss of cash balances in excess of the
insured limit to be low.
The Company's 2005 and 2004 revenues were generated from one and two customers,
respectively.
Reclassifications
- -----------------
Certain amounts in the March 31, 2004 financial statements have been
reclassified to conform with the March 31, 2005 presentation. Such
reclassifications had no effect on net loss as previously reported, except as
disclosed in Note 1 above.
F-12
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Recent Accounting Pronouncements
- --------------------------------
In December 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. ("FIN") 46R, "Consolidation of Variable Interest Entities."
This statement requires that the assets, liabilities and results of the
activities of variable interest entities be consolidated into the financial
statements of the company that has a controlling financial interest. It also
provides the framework for determining whether an entity should be consolidated
based on voting interest or significant financial support provided to it. In
general, for all entities that were previously considered special purpose
entities, FIN 46R should be applied in periods ending after December 15, 2003.
Otherwise, FIN 46R is applicable to all public entities for periods ending after
March 15, 2004. The adoption of FIN 46R did not have a material impact on the
Company's financial condition or results of operations.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-Monetary
Assets, an amendment of APB Opinion 29, Accounting for Non-Monetary
Transactions." The amendments made by SFAS No. 153 are based on the principle
that exchanges of non-monetary assets should be measured based on the fair value
of the assets exchanged. Further, the amendments eliminate the narrow exception
for non-monetary exchanges of similar productive assets and replace it with a
broader exception for exchanges of non-monetary assets that do not have
"commercial substance." The provisions in SFAS No. 153 are effective for
non-monetary asset exchanges occurring in fiscal periods beginning after June
15, 2005. Early application is permitted and companies must apply the standard
prospectively. The Company adopted this statement on January 1, 2005. The
adoption of the statement did result in a significant change in the current
manner in which the Company accounts for its exchanges of non-monetary assets.
The FASB has issued SFAS No. 123R, "Share-Based Payment." The new rule requires
that the compensation cost relating to share-based payment transactions be
recognized in the financial statements. That cost will be measured based on the
fair value of the equity or liability instruments issued. This statement
precludes the recognition of compensation expense under APB Opinion No. 25's
intrinsic value method. Public entities will be required to apply Statement 123R
in the first annual reporting period that begins after June 15, 2005. Since the
Company has been accounting for its share-based compensation under SFAS No. 123,
management believes SFAS No. 123R should not have a significant impact on the
way it accounts for its stock-based compensation.
F-13
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 3 - INVESTMENTS
- --------------------
On October 1, 2004, the Company consummated a Stock Purchase Agreement (the
"Agreement") with Langley Park Investments, PLC ("Langley"), a corporation
organized under the laws of England and Wales. The Langley shares are traded on
the London Stock Exchange ("LSE"). Pursuant to the Agreement, the Company issued
8,666,666 shares of its common stock in exchange for 7,158,590 shares of Langley
common stock. The number of Langley shares issued was based on the Company's
shares having a value of $1.50 per share and the Langley shares having a value
of one British Pound Sterling per share and the conversion rate of the British
Pound Sterling to the U.S. Dollar in effect as of the close of business on the
day preceding the closing date. The Company initially recorded the Langley
shares at $12,973,513. This amount was determined by multiplying the number of
Langley shares issued by the market value of the Langley shares of one British
Pound Sterling and the applicable exchange rate. The Agreement further provides
that of the Langley shares purchased, one half of the shares (3,579,295) are
immediately saleable and the remaining half will be held in an escrow account
for a period of two years. For financial reporting purposes, the Company
considers the 3,579,295 shares held in escrow as shares available for sale. If,
at the end of the two-year period, the shares of the Company do not have a
market price greater than or equal to $1.50, the Company will be required to
sell back some or all of the Langley shares held in escrow, based on a formula
as defined in the Agreement. However, if at the end of the two-year period, the
market value of the Company's common stock equals or exceeds $1.50, the Langley
shares will be released from escrow and transferred to the Company. At March 31,
2005, the Company's common stock closing price was less than $1.50. Based upon
the formula in the Agreement, the Company would be obligated to offer to sell
back approximately 119,000 of the escrow shares to Langley at a nominal price.
As of March 31, 2005, the Company recorded an unrealized loss related to these
shares of $40,846 in other comprehensive loss.
During 2004, the Company sold 2,579,295 of its Langley trading shares for net
proceeds of $1,005,606 and recognized a loss on these sales of $3,668,850, which
was charged to operations. The Company has also determined that $4,284,760 of
the decline in the value of available-for-sale investments is other than
temporary and therefore, included the decline in operations as a write-down. The
Company charged the $1,167,616 decline in market value of the Langley trading
shares that was considered temporary at December 31, 2004 to other comprehensive
loss.
During the quarter ended March 31, 2005, the Company sold its currently saleable
shares for $281,861 and recognized a loss from the sale totaling $3,474.
As of March 31, 2005, the Company's investment in an open-end mutual fund
approximated its cost of $186,400. The Company considers its investment in this
account as being held for trading. During the quarter ended March 31, 2005, the
Company sold 516,982 shares for $516,982 and recognized a net loss on the
transaction totaling $25, which was charged to operations and paid $3,655 for
new investments.
F-14
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 3 - INVESTMENTS, continued
- -------------------------------
Investments in marketable securities as of March 31, 2005 are as follows:
Trading securities:
Cost $ 186,400
Unrealized loss -
---------------
Fair value $ 186,400
===============
Available-for-sale securities:
Adjusted cost $ 2,201,996
Unrealized loss (1,208,462)
---------------
Fair value $ 993,534
===============
In addition, during the three-months ended March 31, 2005, the Company invested
$200,000 in certificates of deposits with two different financial institutions.
The certificates of deposit mature in September 2005 and bear interest at 3
percent per annum. The balance of these investments including accrued interest
at March 31, 2005 totaled $200,248.
NOTE 4 - LICENSE AGREEMENT
- --------------------------
The Company has entered into a license agreement with the University of
Pennsylvania ("the University") for the development and marketing of EFS. EFS is
designed to measure electrochemically the state of fatigue damage in a metal
structural member. The Company is in the final stage of developing EFS.
Under the terms of the agreement, the Company issued to the University 13 shares
of its common stock, and a 5% royalty on sales of the product. The Company
valued the license agreement at $6,250. The license terminates upon the
expiration of the underlying patents, unless sooner terminated as provided in
the agreement. The Company is amortizing the license over 17 years.
In addition to the license agreement, the Company also agreed to sponsor the
development of EFS. Under the sponsorship agreement, the Company agreed to
reimburse the University development costs totaling approximately $200,000, to
be paid in 18 monthly installments of $11,112. Under the agreement, the Company
reimbursed the University $10,000 in 1996 for the cost it incurred in the
procurement and maintenance of its patents on EFS.
F-15
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 4 - LICENSE AGREEMENT, continued
- -------------------------------------
The Company and the University agreed to modify the terms of the license and
sponsorship agreements and related obligation. The modification of the license
agreement increased the University's royalty to 7% of the sale of related
products and provided for the issuance of additional shares of the Company's
common stock to equal 5% of the outstanding stock of the Company as of the
effective date of the modification, subject to anti-dilution adjustments. The
modification of the sponsorship agreement included paying the University 30% of
any amounts raised by the Company in excess of $150,000 (excluding amounts
received on government grants or contracts) up to the amount owing to the
University.
The parties agreed that the balance owed on the sponsorship agreement was
$200,000 and commencing June 30, 1997, the balance will accrue compound interest
at a rate of 1.5% per month (19.6% effective annual rate) until maturity on
December 16, 2001, when the loan balance and accrued interest became fully due
and payable. In addition, the Company's president agreed to limit his
compensation from the Company to $150,000 per year until the loan and accrued
interest was fully paid. The obligation is currently in default. The Company
continues to accrue interest under the terms of the agreement. Interest charged
to operations for the three-months ended March 31, 2005 and 2004 relating to
this obligation was $34,237 and $28,710, respectively. The balance of the
obligation (including accrued interest) at March 31, 2005 and December 31, 2004
was $795,068 and $760,831, respectively, and is reflected in Research and
Development Sponsorship Payable in the accompanying consolidated balance sheets.
Pursuant to the anti-dilution provision of the sponsorship agreement, the
Company was required to issue an additional 5,338 shares to the University
through December 31, 2003. The Company has made no additional issuance of shares
in 2005 or 2004. The Company is currently in negotiations with the University
regarding the default and other related matters.
NOTE 5 - NOTES PAYABLE
- ----------------------
On May 27, 1994, the Company borrowed $25,000 from a shareholder. The loan is
evidenced by a promissory note bearing interest at major bank prime rate. The
note is secured by the Company's patents and matured on May 31, 2002. The loan
has not been paid and is now in default. As additional consideration for the
loan, the Company granted to the shareholder a 1% royalty interest in the
Fatigue Fuse and a 0.5% royalty interest in EFS (see Note 7). The balance due on
this loan as of March 31, 2005 and December 31, 2004 was $52,298 and $51,892,
respectively. Interest charged to operations for the quarters ended March 31,
2005 and 2004 was $406.
F-16
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 5 - NOTES PAYABLE, continued
- ---------------------------------
In October 1996, the Company borrowed $25,000 from an unrelated third party. The
loan bears interest at an annual rate of 11% and matured on October 15, 2000.
The Company issued warrants to the lender for the purchase of 25 shares of the
Company's common stock at a price of $1.00 per share. The loan balance as of
March 31, 2005 and December 31, 2004 was $25,000 and $25,000, respectively.
Interest charged to operations on this loan was $688 for the three months ended
March 31, 2005 and 2004. The Company did not pay any principal amounts due on
this note when it matured on October 15, 2000 and the note is in default. In
2004, the Company issued the note holder 25,000 shares of its common stock as
additional compensation for the failure to payoff the indebtedness. The shares
are subject to a three-year lockup agreement and were valued at $59,500 and
charged to interest expense in 2004.
On April 28, 2003, the Company borrowed $10,000 from an unrelated third party.
The loan is unsecured, non-interest bearing and due on demand.
NOTE 6 - CONVERTIBLE DEBENTURES
- -------------------------------
On September 23, 2003, the Company entered into a Class A Secured Convertible
Debenture (the "Debentures") with Palisades Capital, LLC or its registered
assigns ("Palisades"), pursuant to which Palisades has agreed to loan the
Company up to $1,500,000. On December 1, 2003, after Palisades had funded
$240,000 of the original Debenture, the Company entered into additional Class A
Secured Convertible Debentures with two additional investors, pursuant to which
such investors would loan the Company up to $650,000 each, and the Company
agreed with Palisades that Palisades would not make additional advances under
the Debenture. At March 31, 2005, the Company has received a total of $1,125,000
under the Debentures.
Under the Debentures, each holder has to option to convert the principal amount
of all monies loaned under the Debenture, together with accrued interest, into
common stock of the Company at the lesser of (i) 50% of the average ten closing
prices for the Company's common stock for the ten days immediately preceding the
conversion date or (ii) $0.10 (the lesser of the two being referred to as the
"Conversion Price.") In the event the holders of the three Debentures loan at
least $1,500,000 to the Company and subsequently elect to exercise their right
to convert the Debentures into the Company's common stock at a time when the
conversion price is less than six cents per share, the three holders would
receive at least 50 million shares of common stock, resulting in a change in
control of the Company. However, Mr. Bernstein, the Company's president, would
still retain voting control as a result of his holding 100 percent of the
Company's Class B common stock. In addition, the Debentures provide that in the
event the conversion price is less than $0.10 per share when the holder elects
to convert, the Company would have the right, at any time during the 75 days
following the date of the holder's notice of conversion, to prepay all or a
portion of the Debenture that has been requested to be converted and the Company
would therefore not be required to issue the conversion shares.
F-17
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 6 - CONVERTIBLE DEBENTURES, continued
- ------------------------------------------
Since the Debentures allow the holders to convert the outstanding principal
amount into shares of the Company's common stock at a discount to fair value,
the Company has recorded a BCF in the amount of $1,125,000 during 2004. The
amount was recorded as a debt discount and is being amortized as interest
expense over the life of the Debentures. Total interest expense related to the
amortization of the discount was $99,855 and $37,572 for the quarters ended
March 31, 2005 and 2004, respectively.
The Company's president entered into a voting agreement and irrevocable proxy,
which provides that as of September 23, 2006, if an event of default (as defined
in the Debentures) continues for a period of not less than 30 days, all Class B
common stock which Mr. Bernstein owns of record, or becomes the owner of record
in the future will be voted in accordance with the direction of Mr. Monty
Freedman or his designated successor. This loss of Mr. Bernstein's voting rights
would affect a change in the voting control of the Company.
The Debentures bear interest at an annual rate of 10%, are secured by
substantially all assets of the Company and mature on December 31, 2006, when
all principal and accrued interest becomes payable. Advances to the Company
totaled $0 and $375,000 during the three-months ended March 31, 2005 and 2004,
respectively. The balance of the Debentures, including accrued interest, at
March 31, 2005 and December 31, 2004 was $554,634 and $424,612 (net of
unamortized discount of $698,985 and $798,839, respectively). Interest expense
on the Debentures, excluding amortization of the discount, was $30,167 and
$11,918 during the three months ended March 31, 2005 and 2004, respectively.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
- --------------------------------------
Royalties
- ---------
On December 24, 1985, to provide funding for research and development of the
Fatigue Fuse, the Company entered into various agreements with the Tensiodyne
1985-I R & D Partnership (the "Partnership.") These agreements were amended on
October 9, 1989, and under the revised terms, obligated the Company to pay the
Partnership a royalty of 10% of future gross sales. The Company's obligation to
the Partnership is limited to the capital contributed to it by its partners of
approximately $912,500 plus accrued interest.
On August 30, 1986, the Company entered into a funding agreement with the
Advanced Technology Center ("ATC"), whereby ATC paid $45,000 to the Company for
the purchase of a royalty of 3% of future gross sales and 6% of sublicense
revenue. The royalty is limited to the $45,000 plus an 11% annual rate of
return. At December 31, 2004, the future royalty commitment was approximately
$310,000. The payment of future royalties is secured by equipment used by the
Company in the development of technology as specified in the funding agreement.
F-18
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 7 - COMMITMENTS AND CONTINGENCIES, continued
- -------------------------------------------------
On May 4, 1987, the Company entered into another funding agreement with ATC,
whereby ATC provided $63,775 to the Company for the purchase of a royalty of 3%
of future gross sales and 6% of sublicense revenues. The agreement was amended
August 28, 1987, and as amended, the royalty cannot exceed the lesser of (1) the
amount of the advance plus a 26% annual rate of return or, (2) total royalties
earned for a term of 17 years. At December 31, 2004, the total future royalty
commitments, including the accumulated 26% annual rate of return, were
approximately $4,875,000. If the Company defaults on the agreement, then the
obligation relating to this agreement becomes secured by the Company's patents,
products, and accounts receivable that are related to the technology developed
with the funding.
In 1994, the Company issued to Variety Investments, Ltd. of Vancouver, Canada
("Variety") a 22.5% royalty interest on the Fatigue Fuse in consideration for
the cash advances made to the Company by Variety. In December 1996, in exchange
for the Company issuing 250 shares of its common stock to Variety, Variety
reduced its royalty interest to 20%. In 1998, in exchange for the Company
issuing 733 shares of its common stock to Variety, Variety reduced its royalty
interest to 5%.
As discussed in Note 5, the Company granted a 1% royalty interest in the
Company's Fatigue Fuse and a 0.5% royalty interest in EFS to a shareholder as
partial consideration on a $25,000 loan made by the shareholder to the Company.
A summary of royalty interests that the Company has granted and are outstanding
as of March 31, 2005 follows:
Fatigue Fuse EFS
---------------- ---------
Tensiodyne 1985-1 R&D Partnership 10.00% * -
Advanced Technology Center:
Future gross sales 6.00% * -
Sublicensing fees 12.00% ** -
Variety Investments, Ltd. 5.00% -
University of Pennsylvania (see Note 7)
Net sales of licensed products - 7.00%
Net sales of services - 2.50%
Shareholder 1.00% 0.50%
* Royalties limited to specific rates of return as discussed above.
** The Company granted 12% royalties on sales from sublicense. These royalties
are also limited to specific rates of return as discussed above.
Through March 31, 2005, the Company owes no royalties under any agreements as
sales of the products have not yet begun.
F-19
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 7 - COMMITMENTS AND CONTINGENCIES, continued
- -------------------------------------------------
Litigation
- ----------
In July 2002, the Company settled its pending lawsuit related to a contract
dispute with Mr. Stephen Beck. Under the terms of the settlement, Mr. Beck
received 1,000 shares of the Company's common stock. The shares to be issued are
subject to anti-dilution provisions for a period of 18 months. The Company
valued the shares issued to Mr. Beck at $40,000, the quoted price of the shares
on date of issuance and charged the cost to operations. During 2002 and 2003,
the Company issued Mr. Beck an additional 657 shares of common stock pursuant to
the anti-dilutive provision of the settlement agreement. No additional shares
were issued in 2004 or 2005.
Mr. Beck has recently contacted the Company concerning an alleged breach of the
above settlement. The Company believes that it has a counter claim against Mr.
Beck for a breach of a consulting agreement. Currently negotiations regarding
these matters are ongoing.
Stock Purchase Agreement
- ------------------------
In August 2004, the Company entered into a Stock Purchase Agreement with Seaside
Investments, PLC ("Seaside"). The agreement obligates the Company to issue and
sell 10,332,000 shares of its common stock to Seaside for a purchase price of
$0.55 per share. The purchase price for the shares will be the issuance to the
Company of 4,920,000 shares of Seaside, net of a 9.1% finder's fee. The
agreement provides that 1,623,600 shares will be held in an escrow account and
the balance of 3,296,400 shares will be saleable on the LSE. The shares of the
Company will be restricted stock for a period of one year from the date of
issuance. If the shares of the Company do not have a market price of at least
$0.55 per share at the end of the restricted period, the Company will be
required to return some or all of the Seaside shares based on a formula as
defined in the agreement.
The agreement is subject to a number of material conditions precedent before the
obligation of any of the parties under the agreement matures. As of March 31,
2005, none of the conditions precedent were satisfied.
Indemnities and Guarantees
- --------------------------
During the normal course of business, the Company has made certain indemnities
and guarantees under which it may be required to make payments in relation to
certain transactions. These indemnities include certain agreements with the
Company's officers under which the Company may be required to indemnify such
person for liabilities arising out of their employment relationship. The
duration of these indemnities and guarantees varies, and in certain cases, is
indefinite. The majority of these indemnities and guarantees do not provide for
any limitation of the maximum potential future payments the Company would be
obligated to make. Historically, the Company has not been obligated to make
significant payments for these obligations and no liability has been recorded
for these indemnities and guarantees in the accompanying consolidated balance
sheet.
F-20
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 8 - STOCKHOLDERS' EQUITY
- -----------------------------
Class A Common Stock
- --------------------
The holders of the Company's Class A common stock are entitled to one vote per
share of common stock held.
Class B Common Stock
- --------------------
The holders of the Company's Class B common stock are not entitled to dividends,
nor are they entitled to participate in any proceeds in the event of a
liquidation of the Company. However, the holders are entitled to 2,000 votes for
each share of Class B common stock held.
Class A Preferred Stock
- -----------------------
The holders of the Class A convertible preferred stock have a liquidation
preference of $720 per share. Such amounts shall be paid on all outstanding
Class A preferred shares before any payment shall be made or any assets
distributed to the holders of the common stock or any other stock of any other
series or class ranking junior to the shares as to dividends or assets.
These shares are convertible to shares of the Company's Class A common stock at
a conversion price of $0.72 ("initial conversion price") per share of Class A
preferred stock that will be adjusted depending upon the occurrence of certain
events. The holders of these preferred shares shall have the right to vote and
cast that number of votes which the holder would have been entitled to cast had
such holder converted the shares immediately prior to the record date for such
vote. The holders of these shares shall participate in all dividends declared
and paid with respect to the common stock to the same extent had such holder
converted the shares immediately prior to the record date for such dividend.
Class B Preferred Stock
- -----------------------
The Company has designated 15 shares of Class B preferred stock, of which no
shares have been issued. Holders of Class B preferred shares are entitled to a
liquidation preference of $10,000 per share. Such amounts shall be paid on all
outstanding Class B preferred shares before any payment shall be made or any
assets distributed to the holders of common stock or of any other stock of any
series or class junior to the shares as to dividends or assets, but junior to
Class A preferred shareholders. Holders of Class B preferred shares are not
entitled to any liquidation distributions in excess of $10,000 per share.
The shares are redeemable by the holder or the Company at $10,000 per share. The
holders of these shares shall have the right to vote at one vote per Class B
preferred share and shall participate in all common stock dividends declared and
paid according to a formula as defined in the series designation.
F-21
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 8 - STOCKHOLDERS' EQUITY, continued
- ----------------------------------------
Class C Preferred Stock
- -----------------------
The Class C preferred stock was offered as a unit. Each unit consisted of one
share of the Company's Class C preferred stock, one Class A warrant and one
Class B warrant. Each warrant entitles the holder to purchase one share of the
Company's Class A common stock. Class A warrants expired one year after issuance
and entitled the warrant holder the right to purchase one share of the Company's
Class A common stock at a price set forth in the respective warrant, which was
dependent on the date on which the unit was purchased. Exercise prices for the
Class A common stock warrants ranged from $0.05 per share to the greater of
$0.35 or 1.5 times the average bid price. Class B warrants expire two years
after issuance and entitle the warrant holder the right to purchase one share of
the Company's Class A common stock at a price set forth in the respective
warrant, which is dependent on the date on which the unit was purchased.
Exercise prices for the Class B warrants range from $0.10 per share to the
greater of $0.35 per share or 1.5 times the average bid price.
Each shareholder of Class C preferred stock is entitled to receive a cumulative
dividend of 8% per annum for a period of two years. Dividends do not accrue or
are payable except out of Earnings Before Interest, Taxes, Depreciation and
Amortization ("EBITDA"). At March 31, 2005, no dividends are payable to Class C
preferred shareholders. Holders of the Class C preferred stock are junior to
holders of the Company's Class A and B preferred stock, but hold a higher
position than common shareholders in terms of liquidation rights. Holders of
Class C preferred stock have no voting rights. Holders of Class C preferred
stock have the right to convert their shares to Class A common stock on a
one-to-one basis.
The Company requires an approval of at least two-thirds of the holders of Class
C preferred shareholders to alter or change their rights or privileges by way of
a reverse stock split, reclassification, merger, consolidation or otherwise, so
as to adversely affect the manner by which the shares of Class C preferred stock
are converted into common shares.
Class D Preferred Stock
- -----------------------
On December 29, 2003, certain shareholders exchanged 7,440,000 shares of common
stock for 5,440,000 shares of Class D preferred stock. Holders of Class D
preferred stock have a $0.001 liquidation preference, no voting rights and are
junior to holders of all classes of preferred stock but senior to common
shareholders in terms of liquidation rights. Class D preferred stockholders are
entitled to dividends as declared by the Company's Board of Directors, which
have not been declared as of March 31, 2005. Each share of Class D preferred
stock is convertible at the holder's option into one share of the Company's
Class A common stock.
During the three months ended March 31, 2005, 500,000 shares of Class D
preferred stock were converted into 500,000 shares of the Company's common
stock.
F-22
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 8 - STOCKHOLDERS' EQUITY, continued
- ----------------------------------------
Issued and Outstanding Common Shares
- ------------------------------------
From time to time, the Company issues its Class A common shares and holds the
shares in escrow on behalf of another party until consummation of certain
transactions. The following is a reconciliation of shares issued and outstanding
as of March 31, 2005:
Issued shares 108,995,367
Less shares held in escrow:
Shares held for Seaside stock purchase agreement (see Note 7) (9,840,000)
Shares held as finders' fee for Seaside stock purchase agreement (see Note 7) (492,000)
Shares held as consideration for contemplated debt financing (6,300,000)
Shares held as collateral for contemplated debt financing (4,200,000)
Other (843)
---------------
(20,832,843)
---------------
Outstanding shares 88,162,524
===============
Class A Common Stock Issuances Involving Non-cash Consideration
- ---------------------------------------------------------------
The value assigned to shares issued for services were charged to operations in
the period issued.
2005
- ----
On January 14, 2005, the Company issued 500,000 shares through the conversion of
500,000 shares of its Series D preferred stock. On February 7, 2005, the Company
issued 400,000 shares for consulting services. These shares are subject to a
30-month lock-up agreement and were valued at $555,000. On March 11, 2005, the
Company issued 75,750 shares for consulting services. These shares are subject
to a 2-year lock-up agreement and were valued at $90,000. On March 24, 2005, the
Company issued 500,000 shares for consulting services. These shares are subject
to a 2-year lock-up agreement and were valued at $580,000.
F-23
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 8 - STOCKHOLDERS' EQUITY, continued
- ----------------------------------------
2004
- ----
On January 7, 2004, the Company issued its administrative assistant 25,000
shares of its common stock for services rendered. These shares are subject to a
three-year lockup agreement and were valued at 70% of their quoted market price
at date of issuance amounting to $48,125. On February 11, 2004, the Company
cancelled 250,000 shares of its Class D preferred stock in exchange for issuing
250,000 shares of its common stock. On February 12, 2004, the Company issued to
two consultants a total of 550,000 shares of its common stock for services
rendered. These shares are subject to a three-year lockup agreement and were
valued at 70% of their quoted market price at date of issuance amounting to
$1,135,750. On February 12, 2004, the Company issued its outside accountant
25,000 shares of its common stock as payment on past due invoices. These shares
are subject to a three-year lockup agreement and were valued at the amount of
indebtedness cancelled of $25,000. On March 8, 2004, the Company cancelled
200,000 shares of its Class D preferred stock in exchange for 200,000 shares of
its common stock. On March 16, 2004, the Company issued to a consultant 25,000
shares of its common stock for services rendered. These shares are subject to a
three-year lockup agreement and were valued at 70% of their quoted market price
at date of issuance amounting to $53,550. On March 26, 2004, the Company issued
to a consultant 25,000 shares of its common stock for services rendered. These
shares are subject to a three-year lockup agreement and were valued at 70% of
their quoted market price at date of issuance amounting to $55,125.
NOTE 9 - RELATED PARTY TRANSACTIONS
- -----------------------------------
During the three months ended March 31, 2005 and 2004, the Company credited to
operations interest accrued on the balance due it from its president (accrued at
an annual rate of 8 percent per annum) amounting to $48 and $2,093,
respectively. The balance owed the Company from its president as of March 31,
2005 and December 31, 2004 was $1,998 and $1,950, respectively.
The balance on the stock subscription due from the Company's president at March
31, 2005 and December 31, 2004 were $56,093 and $55,096, respectively. Interest
credited to operations (at a rate of 8 percent per annum) on this receivable for
the three-months ended March 31, 2005 and 2004 amounted to $997.
NOTE 10 - STOCK-BASED COMPENSATION PLANS
- ----------------------------------------
Stock Options
- -------------
The Company has three stock option plans: The 1998 Stock Plan ("the 1998 Plan"),
the 2002 Stock Issuance/Stock Plan ("the 2002 Plan") and the 2003 Stock Option,
SAR and Stock Bonus Consultant Plan ("the 2003 Plan").
F-24
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 10 - STOCK-BASED COMPENSATION PLANS, continued
- ---------------------------------------------------
In September 1998, the Company adopted the 1998 Plan and reserved 800,000 shares
of its common stock for grant under the plan. Eligible participants include
employees, advisors, consultants, and officers who provide services to the
Company. The option price is 100% of the fair market value of a share of common
stock at either the date of grant or such other day as the as the Board may
determine. During 2005 and 2004, there were no options granted under the 1998
Plan. The 1998 Plan expires upon the earlier of all reserved shares being
granted or September 10, 2008.
In February 2002, the Company adopted the 2002 Plan and reserved 20,000,000
shares of its common stock for grant under the plan. Eligible plan participants
include employees, advisors, consultants, and officers who provide services to
the Company. The option price is 100% of the fair market value of a share of
common stock at either the date of grant or such other day as the Board may
determine. There were no options granted under the 2002 Plan in 2005 or 2004.
The 2002 Plan expires upon the earlier of all reserved shares being awarded or
December 31, 2007.
In September 2003, the Company adopted the 2003 Plan and reserved and 10,000,000
shares of its common stock for grant. Eligible plan participants include
independent consultants. The option price shall be no less than 85% of the fair
market value of a share of common stock at date of grant. During 2005 and 2004,
there were no options granted under the 2003 Plan. The 2003 Plan expires upon
the earlier of all reserved shares being granted or September 23, 2006.
The Company also has agreements with two consultants whereby the Company will
grant options to purchase shares of its common stock upon the Company increasing
its annual revenue by $5 million in any fiscal year over its revenues in 2002.
The collective number of shares to be issued will give the two consultants a
fifteen percent interest in the outstanding shares of the Company's common
stock. No grants have been made pursuant to these agreements as the Company has
not achieved the required revenues. The agreements expire in March 2008.
In determining the fair value of the options granted during the respective
years, the Black-Scholes Option Pricing Model was used with the following
assumptions determined:
2005 2004
---- ----
Risk free interest rate n/a n/a
Expected life n/a n/a
Expected volatility n/a n/a
F-25
MATERIAL TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
================================================================================
NOTE 10 - STOCK-BASED COMPENSATION PLANS, continued
- ---------------------------------------------------
Stock Warrants
- --------------
As a condition to enter into the Debentures (see Note 6), Palisades required the
Company to settle its legal obligation of $1,583,128 to two attorneys. In 2003,
the Company issued 22,000,000 shares of common stock and warrants to acquire up
to 30,000,000 shares of common stock for $0.10 per share to seven investors in
settlement of the $1,583,128 obligation (see Note 6). The warrants contain a
provision limiting the exercise of the warrants to a number of shares that do
not exceed an amount that would cause the holder of each such warrant to
beneficially own 4.99% of the outstanding common stock of the Company. In
addition, the warrants are granted only in proportion to the amount ultimately
funded under the Debenture as a percentage of the $1,500,000 face value and
expire December 31, 2010. At March 31, 2005, 22,500,000 of these warrants have
been granted and are exercisable. During the three months ended March 31, 2005,
warrants to purchase 2,000 shares of common stock were exercised at $0.50 per
share.
NOTE 11 - SUBSEQUENT EVENTS
- ---------------------------
On April 1, 2005, the Company granted 5,000 shares of its Class A common stock
to a consultant as compensation. The shares are subject to a two-year lock-up
and were valued at their market price at date of issuance, less a discount for
restrictions on transfer, amounting to $5,800.
On April 19, 2005, the Company granted 10,000 shares of its Class A common stock
with a one-year lock-up to a consultant as additional consideration to hold the
shares he already owned and the newly issued shares for a period of one year.
The shares were valued at their market price at date of issuance, less a
discount for restrictions on transfer, amounting to $12,150.
On April 12, 2005, the Company granted 50,000 shares of its Class A common stock
to an employee as compensation. The shares are subject to a two-year lock-up and
a two-year employment term and were valued at their market price at date of
issuance, less a discount for restrictions on transfer, amounting to $54,000.
On April 26, 2005, the Company granted 125,000 shares of its Class A common
stock to a consultant as compensation. The shares are subject to a two-year
lock-up and were valued at their market price at date of issuance, less a
discount for restrictions on transfer, amounting to $130,000.
F-26
Item 2. Management's Discussion and Analysis of Financial Conditions and Results
- --------------------------------------------------------------------------------
of Operations
- -------------
Critical Accounting Policies
----------------------------
The discussion and analysis of the Company's financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these
financial statements requires the Company to make estimates and judgments
that affect the reported amounts of assets, liabilities, revenues and
expenses. In consultation with its Board of Directors, the Company has
identified four accounting policies that it believes are key to an
understanding of its financial statements. These are important accounting
policies that require management's most difficult, subjective judgments.
The first critical accounting policy relates to revenue recognition. Income
from the Company's research is recognized at the time services are rendered
and billed for.
The second critical accounting policy relates to research and development
expense. Costs incurred in the development of the Company's Electrochemical
Fatigue Sensor and Videoscope are expensed as incurred.
The third critical accounting policy relates to the valuation of
non-monetary consideration issued for services rendered. The Company values
all services rendered in exchange for its common stock at the quoted price
of the shares at date of issuance or at the fair value of the services
rendered, whichever is more readily determinable. In certain issuances, the
Company may discount the value assigned to the shares for illiquidity and
restrictions on resale. All other services provided in exchange for other
non-monetary consideration are valued at either the fair value of the
services received or the fair value of the consideration relinquished,
whichever is more readily determinable.
The fourth critical accounting policy is the Company's accounting for the
beneficial conversion feature ("BCF") of its convertible debenture. The
Company accounts for its BCF pursuant to Emerging Issues Task Force
("EITF") 98-5 and 00-27, whereas the beneficial conversion feature is
calculated at its intrinsic value at the commitment date (that is, the
difference between the conversion price and the fair value of the common
stock into which the debt is convertible, multiplied by the number of
shares into which the debt is convertible). A portion of the proceeds from
issuance of the convertible debt, equal to the intrinsic value, is then
allocated to additional paid-in capital. The Company amortizes the debt
discount to interest expense over the life of the conversion period, which
equals the remaining term of the debenture.
1
Results of Operations for the Three Months Ended March 31, 2005 and 2004
------------------------------------------------------------------------
Revenue generated by the Company during the quarter ended March 31, 2005
came from its research contracts with Northrop-Gruman amounting to $18,308.
In addition, interest income during the same quarter totaled $5,023 of
which $1,045 was accrued on amounts due it from its president and $3,978
was earned on its investments.
Revenue generated by the Company during the quarter ended March 31, 2004
came from its research contracts with Northrop-Gruman amounting to $25,715
and URS Corporation amounting to $41,555. In addition, the Company accrued
interest income during the same quarter on amounts due it from its
president in the amount of $3,090.
During the three-month periods ended March 31, 2005 and 2004, the Company
incurred development costs of $1,212,182 and $161,586, respectively. Of the
$1,212,182 incurred in 2005, $1,135,000 was related to the issuance of
900,000 shares of the Company's common stock for services provided.
General and administrative costs were $321,562 and $1,523,769,
respectively, for the three-month periods ended March 31, 2005 and 2004.
The major expenses incurred during 2005 consisted of consulting in the
amount of $126,602, officer's salary of $54,000, secretarial salary of
$10,574, professional fees of $64,508, travel expenses of $16,226,
telephone expense of $7,886, rent of $7,044, franchise and other taxes of
$8,243 and payroll taxes of $9,491. Of the $126,602 incurred for consulting
expense, $90,000 related to the issuance of 75,750 shares of the Company's
common stock. The shares are subject to a two-year lock up agreement.
The major expenses incurred during 2004 consisted of consulting in the
amount of $1,330,769, officer's salary of $48,000, secretarial salary of
$11,658, professional fees of $81,863, travel expenses of $9,913, and
telephone expense of $3,736. Of the $1,330,769 incurred for consulting
expense, $1,292,550 was related to the issuance of 625,000 shares of the
Company's common stock. Included in the 675,000 shares is 550,000 shares
issued to two consultants for services rendered in connection with Matech
Aerospace and for the overseeing the design, utilization and marketing of
the Company's Videoscope. The shares are subject to a three-year lock up
agreement and were valued at $1,135,750, which is based on 70% of the
quoted market value of the shares on the date of issuance.
Interest charged to operations for the quarter ended March 31, 2005 of
$165,353 consists of accrued interest due on the Company's various
obligations totaling $65,498 and the amortization of the discount on its
convertible debenture totaling $99,855. Interest charged to operations for
the quarter ended March 31, 2004 of $83,225 consists of accrued interest
due on the Company's various obligations totaling $45,653 and the
amortization of the discount on its convertible debenture totaling $37,572.
Liquidity and Capital Resources
-------------------------------
Cash and cash equivalents as of March 31, 2005 and 2004 were $364,109 and
$28,133, respectively.
During the quarter ended March 31, 2005, the Company received a total of
$10,583 on services rendered on its research contract, $802,498 from the
sale of marketable securities and $1,000 from the sale of its common stock.
During the quarter, the Company spent $344,519 in its operations, paid
$3,655 to acquire shares in its mutual fund investment, invested $200,000
in certificate of deposits with terms longer than three-months and
purchased equipment totaling $2,598.
2
During the quarter ended March 31, 2004, the Company received a total of
$435,967 in cash. $60,967 was received on services rendered on its two
research contracts and $375,000 was advanced on its Class A Senior
Convertible Debenture. During the quarter, the Company spent $455,498 in
its operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- ------------------------------------------------------------------
n/a.
Item 4. Controls and Procedures
- -------------------------------
As of March 31, 2005, an evaluation was carried out under the supervision
and with the participation of the Company's management, including our Chief
Executive Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934). Based upon that
evaluation, the Chief Executive Officer concluded that the design and
operation of these disclosure controls and procedures were effective. No
significant changes were made in our internal controls or in other factors
that could significantly affect these controls subsequent to March 31,
2005.
(a) Evaluation of Disclosure Controls and Procedures. The Company carried
out an evaluation under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer
("CEO") of the effectiveness of the Company's disclosure controls and
procedures. Based upon that evaluation, the CEO concluded that as of March
31, 2005 our disclosure controls and procedures were effective in timely
alerting them to the material information relating to the Company (or the
Company's consolidated subsidiaries) required to be included in the
Company's periodic filings with the SEC, subject to the various limitations
on effectiveness set forth below under the heading, "LIMITATIONS ON THE
EFFECTIVENESS OF INTERNAL CONTROLS," such that the information relating to
the Company, required to be disclosed in SEC reports (i) is recorded,
processed, summarized and reported within the time periods specified in SEC
rules and forms, and (ii) is accumulated and communicated to the Company's
management, including our CEO, as appropriate to allow timely decisions
regarding required disclosure.
(b) Changes in internal control over financial reporting. There has been no
change in the Company's internal control over financial reporting that
occurred during the fiscal quarter ended March 31, 2005 that has materially
affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
LIMITATIONS ON THE EFFECTIVENESS OF INTERNAL CONTROLS
-----------------------------------------------------
The Company's management, including the CEO, does not expect that our
disclosure controls and procedures or our internal control over financial
reporting will necessarily prevent all fraud and material error. An
internal control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of the control system must
reflect the fact that there are resource constraints and the benefits of
controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud,
if any, within the Company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty and
that breakdowns can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the internal
control. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals
under all potential future conditions. Over time, control may become
inadequate because of changes in conditions, and/or the degree of
compliance with the policies or procedures may deteriorate.
3
Part II. Other Information
- --------------------------
Item 2. Changes in Securities
- -----------------------------
On January 14, 2005, the Company issued 500,000 shares through the
conversion of 500,000 shares of its Series D preferred stock. On February
7, 2005, the Company issued 400,000 shares for consulting services. These
shares are subject to a thirty-month lock-up agreement and were valued at
$555,000. On March 11, 2005, the Company issued 75,750 shares for
consulting services. These shares are subject to a 2-year lock-up agreement
and were valued at $90,000. On March 24, 2005, the Company issued 500,000
shares for consulting services. These shares are subject to a 2-year
lock-up agreement and were valued at $580,000.
The above issuances were unregistered, as the Company was relying on the
exemptions from registration contained in Section 4(2) of the Securities
Act, and Regulation D promulgated thereunder, on the basis that such
transactions did not involve public offerings of securities.
4
Pursuant to the requirements of Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Material Technologies, Inc.
---------------------------
Registrant
/s/ Robert M. Bernstein
-----------------------
Robert M. Bernstein, President and Chief
Financial Officer
5