Convergence Ethanol, Inc.
U.S.
SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-KSB
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[X]
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
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For
the
fiscal year ended September
30, 2006
OR
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[
]
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
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For
the
transition period from to
Commission
file number 0-4846-3
CONVERGENCE
ETHANOL, INC.
(Name
of small business issuer in its charter)
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Nevada
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82-0288840
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(State
or other jurisdiction of incorporation or
organization)
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(I.R.S.
employer identification no.)
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5701
Lindero Canyon Road, Suite 2-100
Westlake
Village, California
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91362
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(Address
of principal executive offices)
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(Zip
code)
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Issuer’s
telephone number, including area code (818)
735-4750
Securities
to be registered under Section 12(b) of the Act:
Title
of each class to be so
registered
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Name
of each exchange on which each class is to be
registered
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None
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N/A
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Securities
to be registered under Section 12(g) of the Act:
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Common
Stock, $.001 par value
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(Title
of
class)
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Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Exchange Act of 1934 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. Yes ___
No
X
Check
if
there is no disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K contained in this form, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment
to this Form 10-KSB. [__]
The
registrant’s revenues for its most recent fiscal year were:
$9,210,755
The
aggregate market value of the voting and non-voting stock held by non-affiliates
of the registrant as of December 14, 2006 was approximately
$14,627,341.
The
number of shares of the common stock outstanding as of December 14, 2006 was
17,623,303.
Documents
incorporated by reference: None.
Convergence
Ethanol, Inc.
TABLE
OF CONTENTS
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Part
I
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Page
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Item
1.
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Description
of Business
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1
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Item
2.
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Description
of Property
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10
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Item
3.
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Legal
Proceedings
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11
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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11
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Part
II
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Item
5.
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Market
for Common Equity and Related Stockholder Matters
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12
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Item
6.
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Management's
Plan of Operation
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13
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Item
7.
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Financial
Statements
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18
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Item
8.
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Changes
In and Disagreements With Accountants on Accounting and Financial
Disclosure
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42
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Item
8A.
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Controls
and Procedures
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42
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Item
8B.
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Other
Information
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43
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Part
III
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Item
9.
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Directors,
Executive Officers, Promoters and Control Persons; Compliance With
Section
16(a) of the Exchange Act
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Item
10.
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Executive
Compensation
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44
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Item
11.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder
Matters
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Item
12.
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Certain
Relationships and Related Transactions
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46
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Item
13.
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Exhibits
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47
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Item
14.
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Principal
Accountant Fees and Services
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47
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Signatures
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49
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Index
to Consolidated Financial Statements
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18
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Part
I
Item
1. Description
of Business.
This
annual report contains forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Securities Exchange Act. These
statements relate to future events or our future financial performance. In
some
cases, you can identify forward-looking statements by terminology such as “may”,
“should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”,
“predicts”, “potential” or “continue” or the negative of these terms or other
comparable terminology. These statements are only predictions and involve known
and unknown risks, uncertainties and other factors, including the risks in
the
section entitled “Risk Factors”, that may cause our or our industry’s actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by these forward-looking
statements.
Although
we believe that the expectations reflected in the forward-looking statements
are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. Except as required by applicable law, including the securities
laws of the United States, we do not intend to update any of the forward-looking
statements to conform these statements to actual results.
Our
financial statements are stated in United States dollars and are prepared in
accordance with United States generally accepted accounting
principles.
In
this
annual report, unless otherwise specified, all dollar amounts are expressed
in
United States dollars and, unless otherwise indicated, all references to “we”,
“us”, “our” and “The Company” means Convergence Ethanol, Inc. and our
wholly-owned subsidiaries.
CORPORATE
OVERVIEW
We
were
incorporated in the State of Nevada on April 12, 2002. On November 29, 2006,
we
incorporated a wholly-owned Nevada subsidiary for the sole purpose of effecting
a name change of our company through a merger with our subsidiary. On December
5, 2006, we merged our subsidiary with into our company, with our company
carrying on as the surviving corporation under the name Convergence Ethanol,
Inc. Our name change was effected with NASDAQ on December 13, 2006 and our
ticker symbol on the OTC Bulletin Board was changed to “CETH”.
California-based
Convergence Ethanol, Inc. is comprised of three wholly owned subsidiaries,
California MEMS USA, Inc., bda Convergence Ethanol Corp. (“CA MEMS”) a
California corporation, Bott Equipment Company, Inc. (“Bott”) and Gulfgate
Equipment, Inc. (“Gulfgate”), Texas
corporations,
and a
fourth majority-owned subsidiary, Hearst Ethanol One, Inc., a Federal Canadian
Corporation (“HEO”).
CURRENT
BUSINESS SUMMARY
We
are a
renewable energy company with a mission to support the energy industry’s
production of cleaner burning fuels, through the development of profitable,
bio-renewable energy refineries and through the engineering, fabrication and
sale of environmentally focused refinery systems and equipment.
Our
subsidiary, Hearst Ethanol One Inc. (HEO), is working on plans for a
woodwaste-to-ethanol refinery to be built in Hearst Ontario Canada. The company
owns 87% of HEO. We intend that the refinery will use modern catalytic
processing, as used in oil refineries, to synthetically convert cellulosic
woodwaste into ethanol. Given the high and rising price of corn, we believe
that
the conversion of low-cost woodwaste will be important in future ethanol
production. Our plan of operation is to focus in geographic areas which offer
abundant supplies of cellulosic woodwaste, superior transportation
infrastructure, expedited permitting processes, high local demand for Ethanol
and favorable, provincial and federal tax incentives. The Company's ability
to
complete this project is wholly dependent, however, on the successful
fulfillment of several conditions, including receipt of all necessary
environmental and other permits and the acquisition of capital for the
development and construction of the plant.
OUR
OPERATING SUBSIDIARIES:
HEO
The
Company is currently developing a project that is expected to produce 120
million gallons a year of bio-renewable fuel-grade alcohol/ethanol. In December
2005, the Company incorporated Hearst Ethanol One, Inc., a Federal Canadian
Corporation (“HEO”). HEO, which owns 720 acres in Hearst, Ontario, Canada and
nearly 1.5 million metric tons of woodwaste.
HEO
plans
to build an ecologically sound woodwaste refinery to produce bio-renewable,
fuel-grade alcohol or ethanol. Organic woodwaste (organic chips or fiber),
the
raw material for fuel-grade alcohol/ethanol, is an overabundant waste stream
of
the Canadian forest products industries. The proposed refinery will use modern
catalytic processing, as used in oil refineries, to synthetically convert
organic woodwaste into fuel-grade alcohol or ethanol. We believe the convergence
of technologies will enable the continuous production of bio renewable
fuel-grade alcohol in high volume, at low cost. Currently, HEO is 87% owned
by
parent.
Fuel-grade
alcohol/ethanol is the world's most used alternative liquid fuel. Worldwide
demand is more than double production capacity and grows at over 25% per year.
Next year’s market for fuel-grade alcohol/ethanol in Canada is eight times
greater than last year’s production capability.
The
Province of Ontario where our HEO facility will be located has mandated that
all
motor gasoline sold in Ontario must contain at least 5% ethanol by 2007, with
the goal of 10% by 2010. We believe this will provide an assured market for
fuel-grade alcohol/ethanol. HEO, owns 720 acres in Hearst, Ontario, has obtained
forest resources, acquired construction permits, acquired a quarry for
construction aggregate and owns a woodwaste repository containing nearly 1.5
million tons of woodwaste. We believe that the existing woodwaste on site will
be sufficient to run the future plant for more than one year for production
of
120 million gallons of fuel-grade alcohol/ethanol.
Formation
of HEO
In
December 2005, the Company incorporated Hearst Ethanol One, Inc., an Ontario
corporation (“HEO”) for the purpose of building, owning and operating an ethanol
production facility in Canada. On December 21, 2005, HEO entered into a land
purchase agreement with C. Villeneuve Construction Company, Ltd. The transaction
closed on April 7, 2006 and the Company owns 87% of HEO.
CA
MEMS
Our
CA
MEMS subsidiary engineers, designs and oversees the construction of “Intelligent
Filtration Systems” (“IFS™”) for the gas and oil industry. These systems are
utilized to filter wastes from oil or water streams. Our IFS™ systems are fully
integrated and are composed of a “Smart Backflush Filtration System” with an
integral electronic decanting system, a carbon bed filter and an ion-exchange
resin bed system. This equipment will purify the amine fluid by removing
particulate, chemical contaminants, and heat stable salts to allow the amine
to
more effectively remove carbon dioxide and sulfur compounds during refining.
Unlike a typical canister filter system, such as the oil filter in an
automobile, which needs to be periodically replaced and disposed of, the filters
utilized in Intelligent Filtration Systems can last for decades. Furthermore,
the filter system is self cleaning. Once the system recognizes that its filter
is becoming clogged by debris filtered from the fluid flow, it turns the fluid
flow through the filter off and “back flushes” the debris caked on the filter
into a collection decanter. The system then turns the fluid flow through the
system back on through the freshly cleaned filter. The filter cleaning process
takes only seconds to complete and repeats as necessary to assure optimum
filtration. A facility utilizing IFS™ technology needn’t dispose of contaminated
filters, but only need dispose of the contaminate itself. Thus, while a
filtration system based upon IFS™ technology typically requires a greater
capital investment on the part of the purchaser, these costs are offset in
the
long run by savings in filter replacement and disposal costs.
The
U.S.
EPA and California CARB requirements for cleaner burning fuels have opened
up
additional opportunities for our IFS™. We believe our IFS™ product can help our
customers achieve lower operating costs and minimize wastes while enhancing
their ability to meet the more stringent government requirements for cleaner
burning fuels. The system dramatically reduces hazardous waste disposal
costs.
The
Company anticipates that it may be able to utilize its intelligent filtration
systems as an integral part of any ethanol production facility that it may
design. The Company is presently aware of three competitors offering similar
technologies to CA MEMS IFS™ technology.
GULFGATE
Our
Gulfgate subsidiary engineers, designs, fabricates and commissions eco-focused
energy systems including particulate filtration equipment for the oil and power
industries. Gulfgate also makes and sells vacuum dehydration and
coalescing systems that remove water from turbine engine oils. These same
systems are used by electric power generation facilities to remove water from
transformer oils. To help meet its customers’ diverse needs, Gulfgate
maintains and operates a rental fleet of filtration and dehydration
systems. All Convergence Ethanol is ISO 9001:2000 certified and is a
qualified international vendor to the oil and gas industries. Gulfgate has
served customers throughout the energy sector since 1952; we acquired Gulfgate
in 2004.
BOTT
Our
Bott
subsidiary is a stocking distributor for premier lines of industrial pumps,
compressors, flow meters, valves and instrumentation. Bott specializes in the
construction of aviation refueling systems for helicopter refueling on oil
rigs
throughout the world. Bott and Gulfgate have a combined direct sales force
as well as commissioned sales representatives that sell their products. Gulfgate
also constructs refueling systems that Bott sells for commercial marine
vessels. Bott’s customers include chemical manufacturers, refineries,
power plants and other industrial customers.
Bott
has
served customers throughout the energy sector since 1952; we acquired Bott
in
2004.
MARKETING
CA
MEMS,
Bott and Gulfgate have a combined direct sales force as well as commissioned
sales representatives that sell their products.
Former
Subsidiary
We
created Can Am to manufacture, own and operate one ethanol production facility
in British Columbia Canada. In June 2005, the Company and its Canadian
counterpart each made a CN$25,000 at risk deposit to open escrow toward purchase
of 2,150 acres of land intended to serve as a plant site in British Columbia,
Canada.
Subsequently,
the Company paid an additional at-risk deposit of CN$50,000 for an extension
of
the closing date of the purchase agreement. This project was
discontinued.
Company
History:
We
were
incorporated in the State of Nevada on April 12, 2002. Prior
to
the reverse acquisition described below, our corporate name was Lumalite
Holdings, Inc. and we had not generated significant revenues and were considered
a development stage company as defined in Statement of Financial Accounting
Standards No. 7.
Pursuant
to a Merger Agreement and Plan of Reorganization dated January 28, 2004 between
us and MEMS USA, Inc., a California corporation (“CA MEMS”), we acquired all of
the outstanding capital shares of CA MEMS in exchange for 10 million shares
of
our common stock. Since the stockholders of CA MEMS acquired approximately
75%
of our issued and outstanding shares and the CA MEMS management team and board
of directors became our management team and board of directors, according to
FASB Statement No. 141 - "Business Combinations," this acquisition has been
treated as a recapitalization for accounting purposes, in a manner similar
to
reverse acquisition accounting. In accounting for this transaction:
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CA
MEMS is deemed to be the purchaser and surviving company for accounting
purposes. Accordingly, its net assets are included in our consolidated
balance sheet at their historical book values and the results of
operations of CA MEMS have been presented for all prior periods;
and
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Control
of the net assets and business of our company were acquired effective
February 18, 2004. This transaction has been accounted for as a purchase
of our assets and liabilities by CA MEMS. The historical cost of
the net
liabilities assumed was $-0-.
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Pursuant
to the transaction described above, we changed our name from Lumalite Holdings,
Inc to MEMS USA, Inc. As described above, in 2006, we merged into a wholly
owned
subsidiary to change our name to Convergence Ethanol, Inc.
On
October 26, 2004 (“Closing Date”), effective October 1, 2004, the Company
purchased 100% of the outstanding shares of two Texas corporations, Bott
Equipment Company, Inc. (“Bott”) and Gulfgate Equipment, Inc. (“Gulfgate”) from
their president and sole shareholder, Mr. Mark Trumble.
On
December 15, 2005, the Company assumed Weisdorn Sr.’s obligation to purchase
165,054 shares from Mr. Trumble at $1.86 per share.
ITEM
1A.
Cautionary Statement Regarding Future Results, Forward-Looking Information
and
Certain Important Factors
We
make
written and oral statements from time to time regarding our business and
prospects, such as projections of future performance, statements of management’s
plans and objectives,
forecasts of market
trends, and other matters that are forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Statements containing the words or phrases
“will likely result,” “are expected to,” “will continue,” “is anticipated,”
“estimates,” “projects,” “believes,” “expects,” “anticipates,” “intends,”
“target,” “goal,” “plans,” “objective,” “should” or similar expressions identify
forward-looking statements, which may appear in documents, reports, filings
with
the Securities and Exchange Commission, news releases, written or oral
presentations made by officers or other representatives made by us to analysts,
stockholders, investors, news organizations and others, and discussions with
management and other representatives of us.
Our
future results, including results related to forward-looking statements, involve
a number of risks and uncertainties. No assurance can be given that the results
reflected in any forward-looking statements will be achieved. Any
forward-looking statement made by or on behalf of us speaks only as of the
date
on which such statement is made. Our forward-looking statements are based upon
assumptions that are sometimes based upon estimates, data, communications and
other information from suppliers, government agencies and other sources that
may
be subject to revision. Except as required by law, we do not undertake any
obligation to update or keep current either (i) any forward-looking
statement to reflect events or circumstances arising after the date of such
statement, or (ii) the important factors that could cause our future
results to differ materially from historical results or trends, results
anticipated or planned by us, or which are reflected from time to time in any
forward-looking statement which may be made by or on behalf of us.
In
addition to other matters identified or described by us from time to time in
filings with the SEC, there are several important factors that could cause
our
future results to differ materially from historical results or trends, results
anticipated or planned by us, or results that are reflected from time to time
in
any forward-looking statement that may be made by or on behalf of us. Some
of
these important factors, but not necessarily all important factors, include
the
following:
We
are an emerging growth company with limited operating history, accordingly
there
is limited historical information available upon which you can judge the merits
of an investment in our company.
We
have generated net losses since inception, which may continue for the
foreseeable future as we try to grow our business, which means that you may
be
unable to realize a return on your investment for a long period of time, if
ever.
Our
present business operations commenced in February 2004. From inception through
September 30, 2006, incurred a cumulative net loss of $16,473,023 which included
non-cash net asset impairment charges of $10,900,000. We expect to continue
incurring operating losses until we are able to derive meaningful revenues
from
our proposed business relating to ethanol production, energy generation and
supply.
We
have limited available working capital and require significant additional
capital in order to sustain our operations, and if we cannot obtain additional
financing we might cease to continue.
As of
September 30, 2006, we had total current assets of $ 3,990,546
and a working capital deficit of $507,500 before including a liability for
common stock subscribed of $1,194,376. We believe that we require a minimum
of
$1,800,000 in order to fund our planned operations over the next 12 months,
in
addition to the capital required for the establishment of any ethanol production
facilities. We plan to obtain the additional working capital through private
placement sales of our equity securities. We have not received any funds, nor
can there be any assurance that such funds will be forthcoming. Should we be
unable to raise the required funds, our ability to finance our continued
operations will be materially adversely affected.
Our
independent auditors' report raises substantial doubt about our ability to
continue as a going concern.
Our
independent auditors have prepared their report on our 2006 financial statements
assuming that we will continue as a going concern. Their report has an
explanatory paragraph stating that our recurring losses from operations since
inception, limited operating revenue and limited capital resources raise
substantial doubt about our ability to continue as a going concern. Realization
of a major portion of the assets reflected on the accompanying balance sheet
is
dependent upon continued operations of the Company which, in turn, is dependent
upon the Company's ability to meet its financing requirements and succeed in
its
future operations. Management believes that actions presently being taken to
revise the Company's operating and financial requirements provide them with
the
opportunity for the Company to continue as a going concern.
The
accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplate continuation of the Company as a going concern. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts, or amounts and classification of
liabilities that might be necessary, should the Company be unable to continue
as
a going concern.
Because
we have few proprietary rights, others can provide products and services
substantially equivalent to ours.
We hold
a provisional patent application relating to our MEMS operations, however we
hold no patents or patents applications relating to our energy generation and
supply business or our proposed ethanol production business. We believe that
most of the technology used in the design and building of ethanol production
facilities and in the area of the energy generation and supply business is
generally known and available to others. Consequently, others will be able
to
compete with us in these areas. We rely on a combination of confidentiality
agreements and trade secret law to protect our confidential information. In
addition, we restrict access to confidential information on a ‘‘need to know’’
basis. However, there can be no assurance that we will be able to maintain
the
confidentiality of our proprietary information. If our proprietary rights are
violated, or if a third party claims that we violate their trademark or other
proprietary rights, we may be required to engage in litigation. Proprietary
rights litigation tends to be costly and time consuming. Bringing or defending
claims related to our proprietary rights may require us to redirect our human
and monetary resources to address those claims.
We
may not be able to compete effectively or competitive pressures faced by us
may
materially adversely affect our business, financial condition, and results
of
operations.
We
expect to face significant competition in our ethanol production, energy
generation and supply and MEMS operations. Virtually all of our competitors
have
greater marketing and financial resources than us and, accordingly, there can
be
no assurance that we will be able to compete effectively or that competitive
pressures faced by us will not materially adversely affect our business,
financial condition, and results of operations.
We
are dependent upon our key personnel. Our
performance is substantially dependent on the continued services and on the
performance of our senior management and other key personnel. We plan to obtain
“key person” life insurance for our key personnel, however, at this time, no
such policies are in effect. Our performance will also depend upon our ability
to retain and motivate other officers and key employees. The loss of the
services of any of our executive officers or other key employees could have
a
material adverse effect on our business, prospects, financial condition and
results of operations. Our future success also depends on our ability to
identify, attract, hire, train, retain and motivate other highly skilled
technical and managerial personnel. Competition for such personnel is intense,
and there can be no assurance that we will be able to successfully attract,
assimilate or retain sufficiently qualified personnel. The failure
to retain
and attract the necessary technical, and managerial personnel could have a
material adverse effect on our business, prospects, financial condition and
results of operations.
Because
we are smaller and have fewer financial and other resources than many ethanol
producers, we may not be able to successfully compete in the very competitive
ethanol industry. Ethanol
is a commodity. There is significant competition among existing ethanol
producers. Our business faces competition from a number of producers that can
produce significantly greater volumes of ethanol than we can or expect to
produce, producers that can produce a wider range of products than we can,
and
producers that have the financial and other resources that would enable them
to
expand their production rapidly if they chose to. These producers may be able
to
achieve substantial economies of scale and scope, thereby substantially reducing
their fixed production costs and their marginal productions costs. If these
producers are able to substantially reduce their marginal production costs,
the
market price of ethanol may decline and we may be not be able to produce ethanol
at a cost that allows us to operate profitably. Even if we are able to operate
profitably, these other producers may be substantially more profitable than
us,
which may make it more difficult for us to raise any financing necessary for
us
to achieve our business plan and may have a materially adverse effect on the
market price of our common stock.
Competition
from large producers of petroleum-based gasoline additives and other competitive
products may impact our profitability. Our
success depends substantially upon continued demand for ethanol from major
oil
refiners. There are other gasoline additives that have octane and oxygenate
values similar to those of ethanol but which currently cannot be produced at
a
cost that makes them competitive. The major oil refiners have significantly
greater financial, technological and personal resources than we have to reduce
the costs of producing these alternative products or to develop other
alternative products that may be produced at lower cost. The major oil refiners
also have significantly greater resources than we have to influence legislation
and public perception of ethanol. If the major oil refiners are able to produce
ethanol substitutes at a cost that is lower than the cost of ethanol production,
the demand for ethanol may substantially decrease. A substantial decrease in
the
demand for ethanol will reduce the price of ethanol, adversely affect our
profitability and decrease the value of your stock.
If
ethanol and gasoline prices drop significantly, we will also be forced to reduce
our prices, which potentially may lead to losses. Prices
for ethanol products can vary significantly over time and decreases in price
levels could adversely affect our profitability and viability. The price of
ethanol has some relation to the price of gasoline. The price of ethanol tends
to increase as the price of gasoline increases, and the price of ethanol tends
to decrease as the price of gasoline decreases. Any lowering of gasoline prices
will likely also lead to lower prices for ethanol and adversely affect our
operating results. We cannot assure you that we will be able to sell our ethanol
profitably, or at all.
Lax
enforcement of environmental and energy policy regulations may adversely affect
the demand for ethanol. Our
success will depend, in part, on effective enforcement of existing environmental
and energy policy regulations. Many of our potential customers are unlikely
to
switch from the use of conventional fuels unless compliance with applicable
regulatory requirements leads, directly or indirectly, to the use of ethanol.
Both additional regulation and enforcement of such regulatory provisions are
likely to be vigorously opposed by the entities affected by such requirements.
If existing emissions-reducing standards are weakened, or if governments are
not
active and effective in enforcing such standards, our business and results
of
operations could be adversely affected. Even if the current trend toward more
stringent emissions standards continues, our future prospects will depend on
the
ability of ethanol to satisfy these emissions standards more efficiently than
other alternative technologies. Certain standards imposed by regulatory programs
may limit or preclude the use of our products to comply with environmental
or
energy requirements. Any decrease in the emission standards or the failure
to
enforce existing emission standards and other regulations could result in a
reduced demand for ethanol. A significant decrease in the demand for ethanol
will reduce the price of ethanol, adversely affect our profitability and
decrease the value of your stock.
Price
increases or interruptions in needed energy supplies could cause loss of
customers and impair our profitability. Ethanol
production requires a constant and consistent supply of energy. If there is
any
interruption in our supply of energy for whatever reason, such as availability,
delivery or mechanical problems, we may be required to halt production. If
we
halt production for any extended period of time, it will have a material,
adverse effect on our business. Natural gas and electricity prices have
historically fluctuated significantly. We purchase significant amounts of these
resources as part of our ethanol production. Increases in the price of natural
gas or electricity would harm our business and financial results by increasing
our energy costs.
Our
common stock may be thinly traded, so you may be unable to sell at or near
ask
prices or at all if you need to sell your shares to raise money or otherwise
desire to liquidate your shares.
Our
common stock is thinly traded and we will be required to undertake efforts
to
develop market recognition for us and support for our shares of common stock
in
the public market. The price and volume for our common stock that will develop
cannot be assured.
The
number of persons interested in purchasing our common stock at or near ask
prices at any given time may be relatively small or non-existent. This situation
may be attributable to a number of factors, including the fact that we are
a
small company which is relatively unknown to stock analysts, stock brokers,
institutional investors and others in the investment community that generate
or
influence sales volume, and that even if we came to the attention of such
persons, they tend to be risk-averse and would be reluctant to follow an
unproven company such as ours or purchase or recommend the purchase of our
shares until such time as we became more seasoned and viable. As a consequence,
there may be periods of several days, weeks, months, or more when trading
activity in our shares is minimal or non-existent, as compared to a seasoned
issuer which has a large and steady volume of trading activity that will
generally support continuous sales without an adverse effect on share price.
We
cannot give you any assurance that a broader or more active public trading
market for our common stock will develop or be sustained. While we are trading
on the OTC Bulletin Board, the trading volume we will develop may be limited
by
the fact that many major institutional investment funds, including mutual funds,
as well as individual investors follow a policy of not investing in Bulletin
Board stocks and certain major brokerage firms restrict their brokers from
recommending Bulletin Board stocks because they are considered speculative,
volatile and thinly traded.
Our
common stock is subject to the “penny stock” rules which could limit the trading
and liquidity of the common stock, adversely affect the market price of our
common stock and increase your transaction costs to sell those
shares.
The
trading price of our common stock is below $5 per share; and therefore, the
open-market trading of our common stock will be subject to the “penny stock”
rules, unless we otherwise qualify for an exemption from the “penny stock”
definition. The “penny stock” rules impose additional sales practice
requirements on certain broker-dealers who sell securities to persons other
than
established customers and accredited investors (generally those with assets
in
excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
with their spouse). These regulations, if they apply, require the delivery,
prior to any transaction involving a penny stock, of a disclosure schedule
explaining the penny stock market and the associated risks. Under these
regulations, certain brokers who recommend such securities to persons other
than
established customers or certain accredited investors must make a special
written suitability determination regarding such a purchaser and receive such
purchaser’s written agreement to a transaction prior to sale. These regulations
may have the effect of limiting the trading activity of our common stock,
reducing the liquidity of an investment in our common stock and increasing
the
transaction costs for sales and purchases of our common stock as compared to
other securities.
The
market price for our common stock may be particularly volatile given our status
as a relatively unknown company with a small and thinly traded public float
and
lack of history as a public company which could lead to wide fluctuations in
our
share price.
The
market for our common stock may be characterized by significant price volatility
when compared to seasoned issuers, and we expect that our share price could
continue to be more volatile than a seasoned issuer for the indefinite future.
The potential volatility in our share price is attributable to a number of
factors. First, as noted above, our shares of common stock may be sporadically
and thinly traded. As a consequence of this lack of liquidity, the trading
of
relatively small quantities of shares by our stockholders may disproportionately
influence the price of those shares in either direction. The price for our
shares could, for example, decline precipitously in the event that a large
number of our shares of common stock are sold on the market without commensurate
demand, as compared to a seasoned issuer which could better absorb those sales
without adverse impact on its share price. Many of these factors will be beyond
our control and may decrease the market price of our common shares, regardless
of our operating performance. We cannot make any predictions or projections
as
to what the prevailing market price for our common stock will be at any
time.
In
addition, the market price of our common stock could be subject to wide
fluctuations in response to:
| ·
|
quarterly
variations in our revenues and operating
expenses;
|
| ·
|
announcements
of new products or services by us;
|
| ·
|
fluctuations
in interest rates;
|
| ·
|
significant
sales of our common stock, including “short”
sales;
|
| ·
|
the
operating and stock price performance of other companies that investors
may deem comparable to us; and
|
| ·
|
news
reports relating to trends in our markets or general economic
conditions
|
The
stock
market, in general, and the market prices for penny stock companies in
particular, have experienced volatility that often has been unrelated to the
operating performance of such companies. These broad market and industry
fluctuations may adversely affect the price of our stock, regardless of our
operating performance.
Stockholders
should be aware that, according to SEC Release No. 34-29093, the market for
penny stocks has suffered in recent years from patterns of fraud and abuse.
Such
patterns include (1) control of the market for the security by one or a few
broker-dealers that are often related to the promoter or issuer; (2)
manipulation of prices through prearranged matching of purchases and sales
and
false and misleading press releases; (3) boiler room practices involving
high-pressure sales tactics and unrealistic price projections by inexperienced
sales persons; (4) excessive and undisclosed bid-ask differential and markups
by
selling broker-dealers; and (5) the wholesale dumping of the same securities
by
promoters and broker-dealers after prices have been manipulated to a desired
level, along with the resulting inevitable collapse of those prices and with
consequent investor losses. Our management is aware of the abuses that have
occurred historically in the penny stock market. Although we do not expect
to be
in a position to dictate the behavior of the market or of broker-dealers who
participate in the market, management will strive within the confines of
practical limitations to prevent the described patterns from being established
with respect to our securities. The occurrence of these patterns or practices
could increase the volatility of our share price.
Limitations
on director and officer liability and indemnification of our officers and
directors by us may discourage stockholders from bringing suit against a
director.
Our
bylaws provide, with certain exceptions as permitted by governing state law,
that a director or officer shall not be personally liable to us or our
stockholders for breach of fiduciary duty as a director, except for acts or
omissions which involve intentional misconduct, fraud or knowing violation
of
law, or unlawful payments of dividends. These provisions may discourage
stockholders from bringing suit against a director for breach of fiduciary
duty
and may reduce the likelihood of derivative litigation brought by stockholders
on our behalf against a director. In addition, our articles of incorporation
and
bylaws may provide for mandatory indemnification of directors and officers
to
the fullest extent permitted by governing state law.
We
do not expect to pay dividends for the foreseeable future, and we may never
pay
dividends.
We
currently intend to retain any future earnings to support the development and
expansion of our business and do not anticipate paying cash dividends in the
foreseeable future. Our payment of any future dividends will be at the
discretion of our board of directors after taking into account various factors,
including but not limited to our financial condition, operating results, cash
needs, growth plans and the terms of any credit agreements that we may be a
party to at the time. In addition, our ability to pay dividends on our common
stock may be limited by state law. Accordingly, investors must rely on sales
of
their common stock after price appreciation, which may never occur, as the
only
way to realize their investment.
Our
management owns 29.7% and an investment group may own a significant percentage
of our outstanding common stock, which may limit your ability and the ability
of
our other shareholders, whether acting alone or together, to propose or direct
the management or overall direction of our Company.
Such
concentrated control of the Company may adversely affect the price of our common
stock. Our principal stockholders may be able to control matters requiring
approval by our shareholders, including the election of directors, mergers
or
other business combinations. Such concentrated control may also make it
difficult for our shareholders to receive a premium for their shares of our
common stock in the event we merge with a third party or enter into different
transactions which require shareholder approval. These provisions could also
limit the price that investors might be willing to pay in the future for shares
of our common stock. Accordingly, if all of our officers and directors exercise
outstanding option this shareholder together with our directors and executive
officers could have the power to control the election of our directors and
the
approval of actions for which the approval of our shareholders is required.
If
you acquire shares, you may have no effective voice in the management of the
Company.
Future
sales of our equity securities could put downward selling pressure on our
securities, and adversely affect the stock price. There is a risk that this
downward pressure may make it impossible for an investor to sell his securities
at any reasonable price, if at all.
Future
sales of substantial amounts of our equity securities in the public market,
or
the perception that such sales could occur, could put downward selling pressure
on our securities, and adversely affect the market price of our common
stock.
Item
2. Description
of Property
Our
executive offices are located in Westlake Village, California and consist of
approximately 9,100 square feet. The lease has an initial term of five years
ending on December 31, 2008, subject to one five year renewal option.
We
also
maintain two separate facilities in Houston, Texas from which we conduct the
operations of our subsidiaries, Bott and Gulfgate. We own both facilities in
fee
simple. The Bott facility consists of approximately 91,000 square feet of real
estate and 61,000 square feet of
buildings. The Gulfgate facility
consists of approximately 67,500 square feet of real estate and 34,000 square
feet of buildings.
Our
HEO
subsidiary owns 720 acres of land in Hearst, Ontario which includes a
significant wood waste repository, an agate rock quarry, a small forest area
and
certain structures. We intend to use this property to build an ethanol plant.
Item
3. Legal
Proceedings.
As
a
normal incident of the businesses in which the Company is engaged, various
claims, charges and litigation are asserted or commenced from time to time
against the Company. The Company believes that final judgments, if any, which
might be rendered against the Company in current litigation are adequately
reserved, covered by insurance, or would not have a material adverse effect
on
its financial statements. In addition, we are subject to the following
proceedings:
On
December 12, 2006, the Company filed a Form 8-K with the United States
Securities and Exchange Commission disclosing the resignation and termination
of
Daniel Moscaritolo as a director and officer of the Company.
On
December 13, 2006, Mr. Moscaritolo presented management with a purported action
by written consent of the shareholders of the Company indicating that the
shareholders had elected to remove the current board of directors and elect
Daniel Moscaritolo and Thomas Hemingway as directors in their place. Mr.
Moscaritolo also presented management with two separate purported actions by
written consent of the new purported board of directors indicating that the
Company's current officers, James A. Latty and Richard W. York, were terminated
and that Mr. Moscaritolo was elected to serve as Secretary of the Company and
Mr. Hemingway was elected to serve as President and Chief Executive Officer
of
the Company. The Company rejected the purported shareholder action on the
grounds that, on its face, the purported action showed an insufficient number
of
votes had been obtained to approve the requested action, and on the further
grounds that the consenting shareholders had violated the proxy rules set forth
in Section 14 of the Securities Exchange Act of 1934, as amended (the “Act”). In
light of the invalidity of the purported shareholder action, the Company also
rejected the actions of the new purported board of directors terminating and
replacing the officers of the Company.
On
December 14, 2006, the Company filed a lawsuit in the United States District
Court, Central District of California, Western Division (Case No.: CV06-07971)
against Daniel Moscaritolo for violations of the Act, declaratory relief, breach
of fiduciary duty, intentional interference with contract, and conversion (the
“Company Action”). Specifically, the Company alleged that Mr. Moscaritolo's
actions to wrest control of the Board of Directors were invalid and
unlawful.
On
December 15, 2006, Mr. Moscaritolo and Mr. Hemingway, individually, and
purporting to act derivatively on behalf of the shareholders of the Company,
filed a lawsuit in Nevada State Court, County of Washoe (Case No.: CV0603002)
against Mr. Latty and Mr. York for injunctive relief, declaratory relief,
receivership, and accounting relating to the failed effort to remove them from
the Board of Directors of the Company and seeking a court order approving their
removal (the “Moscaritolo Action”). The Moscaritolo action has been dismissed,
but on January 10, 2007 Mr. Moscaritolo and Charles L. Christensen filed a
second lawsuit in Nevada District Court against the Company, Dr. Latty, and
Mr.
Newsom for injunctive relief to hold Annual Shareholders Meeting.
The
Company intends to pursue the claims set forth in the Company Action and to
oppose the claims set forth in the Moscaritolo Action.
Item
4. Submission
of Matters to a Vote of Security Holders.
There
were no matters submitted to our security holders during the fourth quarter
of
the fiscal year ended September 30, 2006.
Part
II
Item
5. Market
for Common Equity and Related Shareholder
Matters.
Market
Information
Our
common stock is listed on the OTC Bulletin Board under the symbol “CETH.OB.” Set
forth below are high and low closing prices for our common stock for each
quarter during the two fiscal years ended September 30, 2006. We consider
our common stock to be thinly traded and that any reported bid or sale prices
may not be a true market-based valuation of the common stock.
|
Quarter
Ended
|
High
|
Low
|
| December
31, 2005 |
$1.80
|
$0.87
|
| March
31, 2006 |
$1.80
|
$0.95
|
| June
30, 2006 |
$3.50
|
$1.02
|
| September
30, 2006 |
$1.91
|
$0.82
|
| |
|
|
| December
31, 2004 |
$2.32
|
$1.51
|
| March
31, 2005 |
$3.30
|
$2.10
|
| June
30, 2005 |
$2.59
|
$1.70
|
| September
30, 2005 |
$2.45
|
$1.50
|
Holders
As
of
December 14, 2006, there were 3,361 record holders of our common stock.
Dividends
We
have
not declared or paid any cash dividends on our common stock since our inception
and do not contemplate paying dividends in the foreseeable future. It is
anticipated that earnings, if any, will be retained for the operation of our
business.
TRANSFER
AGENT
Our
transfer agent is Interwest Stock Transfer Company who is located at 1981 E.
Murray Holladay Rd. #1, Salt Lake City, UT 84117 and can be reached at 801
272-9294.
Sales
of Unregistered Securities
During
the fiscal year ended September 30, 2006, we sold unregistered shares of our
securities in the following transactions which were not previously
reported:
Exemption
from the registration provisions of the Securities Act of 1933 for the
transactions described above is claimed under Section 4(2) of the Securities
Act
of 1933, among others, on the basis that such transactions did not involve
any
public offering and the purchasers were sophisticated or accredited with access
to the kind of information registration would provide.
Item
6.
Management’s Discussion and Analysis or Plan of Operation.
Unless
otherwise indicated, all references to our company include our wholly-owned
subsidiaries, MEMS USA, Inc., a California corporation,, Bott Equipment Company,
Inc., a Texas corporation and Gulfgate Equipment, Inc., a Texas corporation
as
well as an 87.0% equity interest in Hearst Ethanol One, Inc., a Canadian Federal
corporation (“HEO”).
Overview
We
are
engaged in the business of developing bio-renewable energy projects and
providing professional engineered systems to the energy industry. The Company’s
mission is to support the energy industry in producing cleaner burning fuels.
Each of three company-operating divisions has a specific eco-energy focus:
(1)
development of a woodwaste to bio-renewable fuel-grade alcohol/ethanol project,
(2) selling engineered products; and (3) engineering, fabrication and sale
of
eco-focused energy systems. ISO 9001:2000-certified, operating divisions have
served customers throughout the energy sector since 1952.
We
were
incorporated in the State of Nevada on April 12, 2002. On November 29, 2006,
we
incorporated a wholly-owned Nevada subsidiary for the sole purpose of effecting
a name change of our company through a merger with our subsidiary. On December
5, 2006, we merged our subsidiary with and into our company, with our company
carrying on as the surviving corporation under the name Convergence Ethanol,
Inc. Our name change was effected with NASDAQ on December 13, 2006 and our
ticker symbol on the OTC Bulletin Board was changed to “CETH”.
California-based
Convergence Ethanol, Inc. is comprised of three wholly owned subsidiaries,
California MEMS USA, Inc., (“CA MEMS”) a California Corporation, Bott Equipment
Company, Inc. (“Bott”), Gulfgate Equipment, Inc. (“Gulfgate”) and a fourth
majority-owned subsidiary, Hearst Ethanol One, Inc., a Federal Canadian
Corporation (“HEO”).
The
following discussion should be read in conjunction with the consolidated
financial statements and notes thereto. The years 2006 and 2005 represent the
fiscal years ended September 30, 2006 and 2005, respectively, and are used
throughout the document.
Ethanol
from Woodwaste
HEO-
Our
Hearst Ethanol One Inc. (HEO) subsidiary is working on plans for a
woodwaste-to-ethanol refinery to be built in Hearst Ontario Canada. The company
owns 87% of HEO. We intend that the refinery will use modern catalytic
processing, as used in oil refineries, to synthetically convert cellulosic
woodwaste into ethanol. Given the high and rising price of corn, we believe
that
the conversion of low-cost woodwaste will be important in future ethanol
production. Our plan of operation is to focus in an area which offers abundant
supplies of cellulosic woodwaste, superior transportation infrastructure,
expedited permitting processes, high local demand for Ethanol and favorable
local, provincial and federal tax incentives.
The
Company's ability to complete this project is wholly dependent, however, on
the
successful fulfillment of several conditions, including receipt of all necessary
environmental and other permits and the acquisition of capital for the
development and construction of the plant.
Delivery
of Intelligent Filtration System
(IFS)
- a $1.6 million contract
On
December 1, 2006 the Company delivered of its first Intelligent Filtration
System (IFS™) to a major Los Angeles-area oil refinery. This advanced filtration
system enables the production of cleaner-burning, reduced-sulfur motor fuel,
supporting refinery environmental improvement goals.
The
IFS™
integrates previously separate units into a dynamic filtration system.
Engineered for ease of operation and maintenance, it gives the refinery
exceptional and coordinated control. Direct ecological benefits of the
energy-efficient design include reduced greenhouse emissions and a dramatic
reduction in the volume of hazardous waste.
This
IFS
system has been delivered on budget and before scheduled
installation.
Basis
of Presentation
The
accompanying condensed consolidated financial statements, included elsewhere
in
this Annual Report on Form 10-KSB, have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplate continuation as a going concern. From inception through September
30, 2006, we incurred a cumulative net loss of $16,473,023 which included
non-cash asset impairment charges of $10,900,000. We expect to continue
incurring operating losses until we are able to derive meaningful revenues
from
our proposed business relating to ethanol production, energy generation and
supply and increase sales of our filtration equipment, industrial pumps,
compressors, flow meters, valves and instrumentation for the oil and power
industries.. These conditions raise substantial doubt as to our ability to
continue as a going concern. The condensed consolidated financial statements
do
not include any adjustments that might result from the outcome of this
uncertainty.
Comparison
of Operations
Net
sales
for the twelve-month periods ended September 30, 2006 and 2005 were $9,210,755
and $8,828,157, respectively. The sales increase for the twelve months (4.3%)
ended September 30, 2006 as compared to the prior year were due primarily to
strong customer demand for our industrial pumps, equipment rentals and repairs
services.
The
Company computes gross profit as net sales less cost of sales. The gross profit
margin is the gross profit divided by net sales, expressed as a percentage.
Gross profit margin for the twelve-month periods ended September 30, 2006 and
2005 were 19.8% and 24.4% respectively. This decrease of 4.6% was primarily
due
to lower margins on commercial aviation refueling systems shipments and cost
over-runs on two large international orders for our Vacuum Industrial Oil
purifier Systems. Also impacting the margins were higher physical inventory
adjustments and material costs as compared to the prior year. Margins for this
segment of the business reflect the significant competitive pressures
encountered on bidding and winning this business.
Selling,
general and administrative (SG&A) expenses were $5,125,048 and $4,570,066
for the twelve months ended September 30, 2006 and 2005, respectively. The
increase in SG&A spending for the twelve months ended September 30, 2006 as
compared to the prior year were due primarily to legal costs (See Part I, Item
3, Legal Proceedings), consulting fees and commissions.
We
expect
that over the near term, our selling, general and administration expenses will
increase as a result of, among other things, increased accounting fees
associated with increased corporate governance activities in response to the
Sarbanes-Oxley Act of 2002, recently adopted rules and regulations of the
Securities and Exchange Commission, the filing of a registration statement
with
the Securities and Exchange Commission to register for resale the shares of
common stock and shares of common stock underlying warrants issued in various
private offerings, increased employee costs associated with planned staffing
increases (replacements), increased sales and marketing expenses, increased
activities related to the design, engineering and construction of the Hearst
Ethanol One, Inc. ethanol production facility and increased activity in
searching for and analyzing potential acquisitions.
For
the
year ended September 30, 2006, shareholder’s equity was $577,844 as compared to
equity of $428,632 for the prior year period ended September 30, 2005. The
increase in shareholder equity is primarily attributable to the acquisition
of
HEO.
Other
expense (income), net for the twelve-month periods ended September 30, 2006
and
2005 were $71,364 and $4,704, respectively. The increase in other expense is
attributable to the interest payments made pursuant to the terms of the credit
lines of Bott and Gulfgate and the “Put Option” (See note 13) with Mr.
Trumble.
Loss
from
operations for the twelve-month periods ended September 30, 2006 and 2005 were
$3,371,350 and $2,424,798, respectively.
The
Company has addressed the low margin performance by launching a profit
improvement - cost savings initiative in the second half of 2006. The initiative
is significantly improving operations efficiency, increasing competitiveness
and
improving business profitability. The cost savings initiative includes:
administrative workforce reduction, phase out of low margin products, tighter
control of travel costs and a decrease in external costs across the company.
The
initiative is expected to deliver over $1,200,000 in annualized savings, for
only a one-time $200,000 related pre-tax charge. On an annualized basis, the
company expects to increase profitability by more than $2,000,000 as a combined
result of cost savings and business growth.
This
initiative reflects our ongoing commitment to improve our rate of return on
invested capital and deliver stronger bottom-line performance. Senior management
is focused on ensuring that our cost structure is competitive and that it is
aligned with the company’s strategic market opportunities, such as our
development of a woodwaste-to-ethanol refinery in Ontario, Canada.”
Workforce
reductions were made in non-revenue generating areas, with the greatest
reductions in corporate headquarters administrative jobs and outside consulting.
The company has not reduced sales, marketing, engineering, manufacturing,
finance or audit capabilities.
Liquidity
and Capital Resources
Our
plan
of operations over the next 12 months includes the continued pursuit of our
goal
to design, engineer, build and operate one or more ethanol plants. In that
regard we are dependent upon Hearst Ethanol One, Inc.’s efforts to raise the
necessary capital. We also intend to continue to develop our sensor technology.
We believe that our working capital as of the date of this report will not
be
sufficient to satisfy our estimated working capital requirements at our current
level of operations for the next twelve months. Our cash and cash equivalents
were $130,150 as of September 30, 2006, compared to cash and cash equivalents
of
$828,153 as of September 30, 2005
At
our
current cash “burn rate”, we will need to raise additional cash through debt or
equity financings during 2007 in order to fund our continued development and
marketing of our IFS™ product line and to finance possible future losses from
operations as we expand our business lines and reach a profitable level of
operations. Before considering Hearst Ethanol One, Inc., we believe that we
require a minimum of $1,800,000 in order to fund our planned operations over
the
next 12 months, in addition to the capital required for the establishment of
any
ethanol production facilities. We plan to obtain the additional working capital
through private placement sales of our equity securities. As of the date of
this
report the Company has no firm commitment for additional funds. In the absence
of this commitment there is no assurance that such funds will be available
on
commercially reasonable terms, if at all. Should we be unable to raise the
required funds, our ability to finance our continued operations will be
materially adversely affected.
Off-Balance
Sheet Arrangements:
We
do not
have any off-balance sheet financing arrangements.
Recent
Accounting Pronouncements:
In
December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based
Payment”. Statement 123(R) will provide investors and other users of financial
statements with more complete and neutral financial information by requiring
that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the
fair
value of the equity or liability instruments issued. Statement 123(R) covers
a
wide range of share-based compensation arrangements including share options,
restricted share plans, performance based awards, share appreciation rights,
and
employee share purchase plans. Statement 123(R) replaces FASB Statement No.
123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. Statement 123, as originally issued
in
1995, established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in APB Opinion
25, as long as the footnotes to financial statements disclosed what net income
would have been had the preferable fair-value- based method been used. Public
entities (other than those filing as small business issuers) will be required
to
apply Statement 123(R) as of the first quarter of the fiscal year beginning
after June 15, 2005. For small business (S-B) filers, the effective date is
fiscal year beginning after December 15, 2005. The Company has evaluated the
impact of the adoption of SFAS 123(R), and believes the impact will be
significant.
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.”
This statement applies to all voluntary changes in accounting principles and
requires retrospective application to prior periods’ financial statements of
changes in accounting principle, unless such would be impracticable. This
statement also makes a distinction between “retrospective application” of an
accounting principle and the “restatement” of financial statements to reflect
the correction of an error. This statement is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005. The Company does not expect the adoption of SFAS No. 154 to have a
material impact on its financial position or results of operation.
In
February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments”. SFAS No. 155 amends SFAS No 133, “Accounting for
Derivative Instruments and Hedging Activities”, and SFAS No. 140, “Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities”. SFAS No. 155, permits fair value re-measurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. This statement is effective for all financial instruments acquired
or issued after the beginning of the Company’s first fiscal year that begins
after September 15, 2006. Management believes that this statement will not
have
a significant impact on the financial statements.
In
March
2006 FASB issued SFAS 156 Accounting for Servicing of Financial Assets, this
Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities,
with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement requires:
| 1.
|
An
entity to recognize a servicing asset or servicing liability each
time it
undertakes an obligation to service a financial asset by entering
into a
servicing contract.
|
| 2.
|
All
separately recognized servicing assets and servicing liabilities
to be
initially measured at fair value, if practicable.
|
| 3.
|
Permits
an entity to choose Amortization method or Fair Value Measurement
method for each class of separately recognized servicing assets and
servicing liabilities:
|
| 4.
|
At
its initial adoption, permits a one-time reclassification of
available-for-sale securities to trading securities by entities with
recognized servicing rights, without calling into question the treatment
of other available-for-sale securities under Statement 115, provided
that
the available-for-sale securities are identified in some manner as
offsetting the entity’s exposure to changes in fair value of servicing
assets or servicing liabilities that a servicing company elects to
subsequently measure at fair value.
|
| 5.
|
Separate
presentation of servicing assets and servicing liabilities subsequently
measured at fair value in the statement of financial position and
additional disclosures for all separately recognized servicing assets
and
servicing liabilities.
|
This
Statement is effective for fiscal year beginning after September 15, 2006.
Management has not determined the effect if any, the adoption of this statement
will have on the financial statements.
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
This statement clarifies the definition of fair value, establishes a framework
for measuring fair value, and expands the disclosures on fair value
measurements. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007. Management has not determined the effect if any, the
adoption of this statement will have on the financial statements.
In
September 2006, FASB issued SFAS 158 Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
88, 106, and 132(R). This Statement improves financial reporting by requiring
an
employer to recognize the over-funded or under-funded status of a defined
benefit postretirement plan (other than a multiemployer plan) as an asset or
liability in its statement of financial position and to recognize changes in
that funded status in the year in which the changes occur through comprehensive
income of a business entity or changes in unrestricted net assets of a
not-for-profit organization. This Statement also improves financial reporting
by
requiring an employer to measure the funded status of a plan as of the date
of
its year-end statement of financial position, with limited exceptions. An
employer with publicly traded equity securities is required to initially
recognize the funded status of a defined benefit postretirement plan and to
provide the required disclosures as of the end of the fiscal year ending after
December 15, 2006. An employer without publicly traded equity securities is
required to recognize the funded status of a defined benefit postretirement
plan
and to provide the required disclosures as of the end of the fiscal year ending
after June 15, 2007. However, an employer without publicly traded equity
securities is required to disclose the following information in the notes to
financial statements for a fiscal year ending after December 15, 2006, but
before June 16, 2007, unless it has applied the recognition provisions of this
Statement in preparing those financial statements. The disclosures include
a
brief description of the provisions of this Statement; the date that adoption
is
required; and the date the employer plans to adopt the recognition provisions
of
this Statement, if earlier.
This
statement is effective for fiscal year ending after December 15, 2008.
Management
has not determined the effect if any, the adoption of this statement will have
on the financial statements.
Item
7. Financial Statements
INDEX
TO FINANCIAL STATEMENTS
| Report of Independent Certified Public
Accountants |
19
|
| Consolidated Balance Sheet at September
30,
2006 |
20
|
| Consolidated Statements of Operations
for the
years ended September 30, 2006 and 2005 |
21
|
| Consolidated Statements of Stockholders’
Equity for the years ended September
30, 2006 and 2005 |
22
|
| Consolidated Statements of Cash Flows
for the
years ended September 30, 2006 and 2005 |
23
|
| Notes to Consolidated Financial
Statements |
24
|
REPORT
OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors of:
CONVERGENCE
ETHANOL, INC.
Westlake
Village, California
We
have
audited the accompanying consolidated balance sheet of Convergence Ethanol,
Inc.
and subsidiaries as of September 30, 2006, and the related consolidated
statements of operations, stockholders’ equity and cash flows for the years
ended September 30, 2006 and 2005. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a
reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Convergence Ethanol, Inc.
and subsidiaries as of September 30, 2006 and the results of their operations
and their cash flows for the years ended September 30, 2006 and 2005 in
conformity with accounting principles generally accepted in the United States
of
America.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as a going concern. As discussed in the Note 1 to
the
consolidated financial statements, the Company has incurred recurring losses
from operations and has accumulated deficit of $16,473,023 as of September
30,
2006 that raise substantial doubt about its ability to continue as a going
concern. Management's plans regarding those matters also are described in Note
1
to the consolidated financial statements. The consolidated financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
/s/
Kabani & Company, Inc.
CERTIFIED
PUBLIC ACCOUNTANTS
Los
Angeles, California
January
12, 2007
CONVERGENCE
ETHANOL, INC. (fka Mems USA, Inc.)
Consolidated
Balance Sheet
September
30, 2006
ASSETS
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalent
|
|
$
|
130,550
|
|
|
Accounts
receivable, net allowance for uncollectible of $83,081
|
|
|
1,281,998
|
|
|
Inventories,
net of provision for slow moving items of $25,000
|
|
|
2,039,688
|
|
|
Other
current assets
|
|
|
630,881
|
|
|
Total
current assets
|
|
|
4,083,117
|
|
|
Plant,
property and equipment, net
|
|
|
2,575,027
|
|
|
Other
assets
|
|
|
58,473
|
|
|
Total
assets
|
|
$
|
6,716,617
|
|
| |
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
3,381,466
|
|
|
Lines
of credits
|
|
|
325,114
|
|
|
Notes
payable
|
|
|
343,302
|
|
|
Current
portion of long-term debt
|
|
|
51,904
|
|
|
Other
liabilities
|
|
|
78,884
|
|
|
Loans
from shareholders
|
|
|
167,408
|
|
|
Convertible
loan payable
|
|
|
150,000
|
|
|
Liability
due to a legal settlement
|
|
|
307,000
|
|
|
Liability
to be satisfied through the issuance of shares
|
|
|
1,194,376
|
|
|
Total
current liabilities
|
|
|
5,999,454
|
|
|
Other
payables
|
|
|
35,389
|
|
|
Total
liabilities
|
|
|
6,034,843
|
|
|
Minority
interests
|
|
|
103,930
|
|
|
Stockholders'
equity:
|
|
|
|
|
|
Common
stock, $0.001 par value; 100,000,000 shares authorized; 20,186,938
shares
issued and outstanding
|
|
|
20,187
|
|
|
Additional
paid in capital
|
|
|
21,061,314
|
|
|
Receivables
in shares of common stock
|
|
|
(231,076
|
)
|
|
Accumulated
deficit
|
|
|
(16,473,023
|
)
|
|
Treasury
stock (2,699,684 shares)
|
|
|
(3,799,558
|
)
|
|
Total
stockholders' equity
|
|
|
577,844
|
|
|
Total
liabilities and stockholders' equity
|
|
$
|
6,716,617
|
|
The
accompanying notes are an integral part of these financial
statements.
CONVERGENCE
ETHANOL, INC. (fka Mems USA, Inc.)
Consolidated
Statement of Operations
Years
ended September 30 2006 and 2005
| |
|
|
2006
|
|
|
2005
|
|
|
Revenues
|
|
$
|
9,210,755
|
|
$
|
8,828,157
|
|
|
Cost
of revenues
|
|
|
7,385,693
|
|
|
6,678,185
|
|
|
Gross
profit
|
|
|
1,825,062
|
|
|
2,149,972
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
5,125,048
|
|
|
4,570,066
|
|
|
Other
operating expense
|
|
|
71,364
|
|
|
4,704
|
|
|
Total
operating expenses
|
|
|
5,196,412
|
|
|
4,574,770
|
|
|
Loss
from operations
|
|
|
(3,371,350
|
)
|
|
(2,424,798
|
)
|
|
Income
due to legal settlement
|
|
|
3,703,634
|
|
|
-
|
|
|
Impairment
of investment in CanAm
|
|
|
(71,765
|
)
|
|
-
|
|
|
Impairment
of construction in progress of airplane
|
|
|
(289,740
|
)
|
|
-
|
|
|
Impairment
of goodwill
|
|
|
(915,434
|
)
|
|
-
|
|
|
Biomass
inventory write off
|
|
|
(11,461,362
|
)
|
|
|
|
|
Loss
attributable to minority interest
|
|
|
1,478,450
|
|
|
-
|
|
|
Net
loss
|
|
$
|
(10,927,567
|
)
|
$
|
(2,424,798
|
)
|
| |
|
|
|
|
|
|
|
|
Net
loss per share, basic and diluted:
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding, basic and diluted
|
|
|
19,489,977
|
|
|
16,950,966
|
|
|
Net
loss per share, basic and diluted
|
|
$
|
(0.56
|
)
|
$
|
(0.14
|
)
|
The
accompanying notes are an integral part of these financial
statements.
CONVERGENCE
ETHANOL, INC. (fka Mems USA, Inc.)
Consolidated
Statement of Stokholders’ Equity
For
the
years ended September 30, 2006 and 2005
| |
|
Common
stock
|
|
Subscrip-tions
receivable
|
|
Additional
paid in capital
|
|
Treasury
Stock
|
|
Accumulated
deficit
|
|
Stockholders'
equity
|
|
|
Balance
as of September 30, 2004
|
|
$
|
15,092
|
|
$
|
(2,050
|
)
|
$
|
3,422,911
|
|
|
|
|
$
|
(3,120,655
|
)
|
$
|
315,298
|
|
|
Payment
on subscriptions receivable
|
|
|
|
|
|
1,800
|
|
|
|
|
|
|
|
|
|
|
|
1,800
|
|
|
Common
stock issued to acquired Bott & Gulfgate
|
|
|
1,310
|
|
|
|
|
|
890,625
|
|
|
|
|
|
|
|
|
891,935
|
|
|
Common
stock issued for cash
|
|
|
964
|
|
|
|
|
|
1,613,940
|
|
|
|
|
|
|
|
|
1,614,904
|
|
|
Common
stock issued for service
|
|
|
38
|
|
|
|
|
|
65,416
|
|
|
|
|
|
|
|
|
65,454
|
|
|
Other
adjustments
|
|
|
|
|
|
|
|
|
(35,960
|
)
|
|
|
|
|
(1
|
)
|
|
(35,961
|
)
|
|
Net
loss for the year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,424,798
|
)
|
|
(2,424,798
|
)
|
|
Balance
as of September 30, 2005
|
|
|
17,404
|
|
|
(250
|
)
|
|
5,956,932
|
|
|
-
|
|
|
(5,545,454
|
)
|
|
28,632
|
|
|
Common
stock issued for service
|
|
|
269
|
|
|
|
|
|
378,388
|
|
|
|
|
|
|
|
|
378,657
|
|
|
Common
stock issued for cash received in prior year
|
|
|
129
|
|
|
|
|
|
105,871
|
|
|
|
|
|
|
|
|
106,000
|
|
|
Common
stock issued for cash received
|
|
|
2,014
|
|
|
|
|
|
1,541,949
|
|
|
|
|
|
|
|
|
1,543,963
|
|
|
Receivables
in shares of common stock
|
|
|
|
|
|
|
|
|
(231,076
|
)
|
|
|
|
|
|
|
|
(231,076
|
)
|
|
Common
stock issued pursuant to terms of acquisition
|
|
|
371
|
|
|
|
|
|
809,595
|
|
|
|
|
|
|
|
|
809,966
|
|
|
Subscription
receivable deemed uncollectible
|
|
|
|
|
|
250
|
|
|
|
|
|
|
|
|
|
|
|
250
|
|
|
Canceled
put option related to acquisition of Texas subsidiaries
|
|
|
|
|
|
|
|
|
1,400,000
|
|
|
|
|
|
|
|
|
1,400,000
|
|
|
Investment
in HEO
|
|
|
|
|
|
|
|
|
10,868,579
|
|
|
|
|
|
|
|
|
10,868,579
|
|
|
Treasury
stock from legal settlement
|
|
|
|
|
|
|
|
|
|
|
|
(3,799,558
|
)
|
|
|
|
|
(3,799,558
|
)
|
|
Net
loss for the year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,927,569
|
)
|
|
(10,927,569
|
)
|
|
Balance
as of September 30, 2006
|
|
$
|
20,187
|
|
$
|
-
|
|
$
|
20,830,238
|
|
$
|
(3,799,558
|
)
|
$
|
(16,473,023
|
)
|
$
|
577,844
|
|
The
accompanying notes are an integral part of these financial
statements.
|
|
|
|
CONSOLIDATED
STATEMENT OF CASH FLOWS
|
|
|
For
the years ended September 30, 2006 and 2005
|
|
| |
|
|
|
|
|
| |
|
2006
|
|
2005
|
|
|
Cash
flows used in operating activities:
|
|
|
|
|
Net loss
|
|
$
|
(10,927,567
|
)
|
$
|
(2,424,798
|
)
|
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
233,445
|
|
|
242,367
|
|
|
Bad
debt expense
|
|
|
37,135
|
|
|
-
|
|
|
Common
stock issued for services
|
|
|
388,033
|
|
|
65,450
|
|
|
Loss
on investment in CanAm One
|
|
|
71,765
|
|
|
-
|
|
|
Loss
attributable to minority interest
|
|
|
(1,478,450
|
)
|
|
|
|
|
Loss
due to write off of biomass inventory
|
|
|
11,461,362
|
|
|
|
|
|
Impairment
of goodwill
|
|
|
915,434
|
|
|
-
|
|
|
Impairment
of construction in progress - airplane
|
|
|
289,740
|
|
|
|
|
|
Income
due to legal settlement
|
|
|
(3,703,634
|
)
|
|
-
|
|
|
(Gain)
on sale or disposal of equipment
|
|
|
-
|
|
|
(44,743
|
)
|
|
Change
in assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(562,043
|
)
|
|
214,547
|
|
|
Inventories
|
|
|
(494,879
|
)
|
|
(236,662
|
)
|
|
Other
current assets
|
|
|
(414,851
|
)
|
|
(24,232
|
)
|
|
Accounts
payable and accrued expenses
|
|
|
1,986,201
|
|
|
321,789
|
|
|
Other
current liabilities
|
|
|
78,884
|
|
|
-
|
|
|
Total
adjustments
|
|
|
8,808,142
|
|
|
538,516
|
|
|
Net
cash used in operating activities
|
|
|
(2,119,425
|
)
|
|
(1,886,282
|
)
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(126,455
|
)
|
|
(55,408
|
)
|
|
Net
proceeds from sale of equipment
|
|
|
|
|
|
87,600
|
|
|
Cash
balance net of payments for purchase of Bott and Gulfgate
|
|
|
-
|
|
|
55,712
|
|
|
Investment
in CanAm One
|
|
|
|
|
|
(71,765
|
)
|
|
Other
assets
|
|
|
-
|
|
|
(44,340
|
)
|
|
Stock
subscription receivable
|
|
|
-
|
|
|
1,800
|
|
|
Net
cash used in for investing activities
|
|
|
(126,455
|
) |
|
(26,401
|
)
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Lines
of credit
|
|
|
(52,297
|
)
|
|
-
|
|
|
Notes
payable
|
|
|
(30,031
|
)
|
|
(105,655
|
)
|
|
Current
portion of long-term debt
|
|
|
(22,612
|
)
|
|
(21,158
|
)
|
|
Loan
from shareholders
|
|
|
(24,192
|
)
|
|
191,600
|
|
|
Payment
on long term liabilities
|
|
|
(26,553
|
)
|
|
(76,294
|
)
|
|
Purchase
of shares pursuant to acquisition of subsidiaries
|
|
|
(20,000
|
)
|
|
-
|
|
|
Underwriting
related to issuance of shares
|
|
|
|
|
|
(386,143
|
)
|
|
Cash
received for shares to be issued
|
|
|
180,000
|
|
|
1,111,000
|
|
|
Common
stock issued for cash
|
|
|
1,652,878
|
|
|
2,001,047
|
|
|
Net
cash provided (used) by financing activities
|
|
|
1,548,278
|
|
|
2,714,397
|
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
(697,603
|
)
|
|
801,714
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
828,153
|
|
|
26,439
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
130,550
|
|
$
|
828,153
|
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
Income
taxes paid
|
|
$
|
26,125
|
|
$
|
27,515
|
|
|
Interest
paid
|
|
$
|
178,814
|
|
$
|
84,361
|
|
|
Supplemental
disclosure of non-cash financing activities:
|
|
|
|
|
Common
stock (including $1,400,000 of shares subject to mandatory redemption
factor as of September 30, 2005) issued for acquisition of Bott and
Gulfgate
|
|
$
|
-
0 -
|
|
$
|
2,291,935
|
|
|
Assets
acquired by HEO through issuance of shares
|
|
$
|
12,474,497
|
|
|
-
|
|
The
accompanying notes are an integral part of these financial
statements.
CONVERGENCE
ETHANOL, INC. (fka Mems USA, Inc.)
Notes
to consolidated financial statements:
1)
Organization
and Summary of Significant Accounting
Policies:
Organization
Convergence
Ethanol, Inc. formerly known as MEMS USA, Inc. (the “Company” or “we”) has been
incorporated in November, 2002; The
Company changed its name to Convergence Ethanol, Inc. in November
2006.
The Company’s mission is to support the energy industry in producing cleaner
burning fuels. Each of our subsidiaries has a specific eco-energy focus:
(1)
development of a woodwaste to bio-renewable fuel-grade alcohol/ethanol project
(HEO); (2) selling engineered products (Bott); and (3) engineering, fabrication
and sale of eco-focused energy systems (Gulfgate).
Subsidiaries:
The
Company is comprised of three wholly owned subsidiaries, California MEMS USA,
Inc., a California Corporation (“CA MEMS”), Bott Equipment Company, Inc.
(“Bott”), a Texas Corporation, and Gulfgate Equipment, Inc. (“Gulfgate”) a Texas
Corporation, and a majority interest (87%) of Hearst Ethanol One, Inc., a
Federal Canadian Corporation (“HEO”).
CA
Mems
CA
MEMS
engineers, designs and oversees the construction of “Intelligent Filtration
Systems” (“IFS™”) for the gas and oil industry. The Company’s IFS™ systems are
fully integrated and are composed of a “Smart Backflush Filtration System” with
an integral electronic decanting system, a carbon bed filter and an ion-exchange
resin bed system.
Bott
Bott
is a
stocking distributor for premier lines of industrial pumps, valves and
instrumentation. Bott specializes in the construction of aviation refueling
systems for helicopter refueling on oil rigs throughout the world. Bott
and Gulfgate have a combined direct sales force as well as commissioned sales
representatives that sell their products.
Gulfgate
Gulfgate
engineers, designs, fabricates and commissions eco-focused energy systems
including particulate filtration equipment for the oil and power
industries. Gulfgate also makes and sells vacuum dehydration and
coalescing systems that remove water from hydrocarbon oils. Gulfgate
maintains and operates a rental fleet of filtration and dehydration
systems.
HEO
- Hearst Ethanol One
In
December 2005, the Company incorporated Hearst Ethanol One, Inc., a Federal
Canadian Corporation (“HEO”). Since that time, HEO has acquired 720 acres in
Hearst, Ontario, Canada together with approximately 1.3 million cubic meters
of
woodwaste. The property was purchased to provide the site and the biomass
material to produce bio-renewable fuel-grade alcohol/ethanol from
woodwaste.
HEO has
obtained construction and zoning permits. The Company currently owns 87% of
HEO.
Fair
Value of Financial Instruments:
The
Company measures its financial assets and liabilities in
accordance with accounting principles generally accepted in the United
States of America. For certain of the Company's financial instruments,
including accounts receivable (trade and related party), notes receivable
and accounts payable (trade and related party), and
accrued expenses, the carrying amounts approximate fair
value due to their short maturities.
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 and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Concentration
of Credit Risk:
The
Company's financial instruments that are exposed to concentrations of credit
risk consist primarily of cash and accounts receivable. The Company maintains
cash with various major financial institutions and performs evaluations of
the
relative credit standing of these financial institutions in order to limit
the
amount of credit exposure with any institution. The Company extends credit
to
customers based upon an evaluation of the customer's financial condition and
credit history and generally requires no collateral. The Company's customers
are
principally located throughout North America, and their ability to pay amounts
due to the Company may be dependent on the prevailing economic conditions of
their geographic region. Management performs regular evaluations concerning
the
ability of its customers to satisfy their obligations and records a provision
for doubtful accounts based on these evaluations. The Company's credit losses
for the periods presented are insignificant and have not significantly exceeded
management's estimates.
Cash
and Cash Equivalents:
All
highly liquid investments maturing in three months or less when purchased are
considered as cash equivalents.
Accounts
Receivable:
In
the
normal course of business, the Company provides credit to customers. We monitor
our customers’ payment history, and perform credit evaluation of their financial
condition. We maintain adequate reserves for potential credit losses based
on
the age of the receivable and specific customer circumstance.
Inventories:
Inventories
are valued at the lower of cost (first-in, first-out) or market value and have
been reduced by an allowance for excess, slow-moving and obsolete inventories.
The estimated allowance is based on Management's review of inventories on hand
compared to historical usage and estimated future usage and sales. Inventories
under long-term contracts reflect accumulated production costs, factory
overhead, initial tooling and other related costs less the portion of such
costs
charged to cost of sales and any un-liquidated progress payments. In accordance
with industry practice, costs incurred on contracts in progress include amounts
relating to programs having production cycles longer than one year, and a
portion thereof may not be realized within one year.
Property
and Equipment:
Property
and equipment are stated at cost. Depreciation of equipment is provided for
by
the straight-line method over their estimated useful lives ranging from three
to
ten years for equipment and 28 to 30 years for plants.
Impairment
of Long-Lived Assets
The
Company adopted Statement of Financial AccountingStandards No. 144, "Accounting
for the Impairment or Disposal of Long-LivedAssets" ("SFAS 144"), which
addresses financial accounting and reporting for the impairment or disposal
of
long-lived assets and supersedes SFAS No. 121,"Accounting for the Impairment
of
Long-Lived Assets and for Long-Lived Assets tobe Disposed Of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations for a Disposal of a Segment of a Business." The Company
periodically evaluates the carrying value of long-lived assets to be held and
used in accordance with SFAS 144. SFAS 144 requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amounts. In that event, a loss is
recognized based on the amount by which the carrying amount exceeds the fair
market value of the long-lived assets. Loss on long-lived assets to be disposed
of is determined in a similar manner, except that fair market values are reduced
for the cost of disposal. For the year ended September 30, 2006, impairment
loss
on investment in CAN AM of $71,765 (See note 8) and impairment loss on
Construction in Progress (airplane) of 289,740 (See note 6) was
recorded.
Accounts
Payable and accrued expenses:
Accounts
payable and accrued expenses includes trade accounts payable of $1,577,310
and
$879,733 for years ended September 30, 2006 and 2005 and accrued expenses of
$1,804,156 and $515,532 respectively.
Revenue
Recognition:
The
Company’s revenue recognition policies are in compliance with Staff accounting
bulletin (SAB) 104. Sales revenue is recognized at the date of shipment to
customers when a formal arrangement exists, the price is fixed or determinable,
the delivery is completed, no other significant obligations of the Company
exist
and collectibility is reasonably assured. Payments received before all of the
relevant criteria for revenue recognition are satisfied are recorded as unearned
revenue.
Advertising
Costs:
The
Company expenses the cost of advertising as incurred. The advertising expense
charged against operations for September 30, 2006 and 2005 were $10,000 and
$17,472 respectively.
Income
Taxes:
Provisions
for federal and state income taxes are calculated on reported financial
statement income based on the current tax law. Such provisions differ from
the
amounts currently payable because certain items of income and expense, known
as
temporary differences, are recognized in different tax periods for financial
reporting purposes than for income tax purposes. Deferred income taxes are
the
result of the recognition of tax benefits that management expects to realize
from the utilization of net operating loss carry-forwards. The amounts recorded
are net of valuation allowance and represent management's estimate of the
amount
that is more likely than not to be realized.
Earnings
Per Share:
Basic
earnings (loss) per share are computed by dividing net income (loss)
attributable to common stockholders by the weighted average number of common
shares outstanding. Diluted earnings (loss) per share is computed similar
to
basic earnings (loss) per share except that the denominator is increased
to
include the number of additional shares of common stock that would have been
outstanding if the potential shares of common stock equivalents had been
exercised and issued and if the additional common shares were dilutive. Diluted
earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company. There were 1,431,456
shares and 5,849,572 shares of common stock equivalents for the year ended
September 30, 2006 and 2005, respectively which were excluded because they
are
not dilutive. Common stock equivalents includes, but is not limited to warrants,
stock options, convertible debentures, etc.
Stock
Based Compensation:
Pro
forma
information regarding net loss and loss per share, pursuant to the requirements
of SFAS 123, for the years ended September 30, 2006 and 2005 are as follows:
| |
|
2006
|
|
2005
|
|
|
Net
income (loss), as reported
|
|
$
|
(10,927,567
|
)
|
$
|
(2,424,798
|
)
|
|
Deduct:
|
|
|
|
|
|
|
|
|
Total
stock-based employee compensation expenses determined under the
fair value
Black-Scholes method with a 145% and 80% volatility and 6% and
3% risk
free rate of return assumption at September 30, 2006 and 2005 respectively
|
|
|
(1,036,510
|
)
|
|
(1,444,684
|
)
|
|
Pro
forma net income (loss)
|
|
$
|
(11,964,077
|
)
|
$
|
(3,869,482
|
)
|
|
Income
(loss) per share:
|
|
|
|
|
|
|
|
|
Weighted
average shares, basic and diluted
|
|
|
19,489,977
|
|
|
16,950,966
|
|
|
Basic,
pro forma, per share
|
|
$
|
(
0.61
|
)
|
$
|
(0.23
|
)
|
Going
Concern:
The
accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America,
which
contemplates the Company as a going concern. However, the Company has sustained
net losses of $10,927,567 and has used substantial amounts of working capital
in
its operations. Realization
of a major portion of the assets reflected on the accompanying balance sheet
is
dependent upon continued operations of the Company which, in turn, is dependent
upon the Company's ability to meet its financing requirements and succeed
in its
future operations. Management believes that actions presently being taken
to
revise the Company's operating and financial requirements provide them with
the
opportunity for the Company to continue as a going concern. We will continue
to
raise additional cash through debt or equity financings in 2007 in order
to meet
our working capital requirements.
Reclassifications
Certain
reclassifications have been made to prior year amounts to conform to the
current
year
presentation. These changes had no effect on reported financial positions
or
results of operations.
Recent
Accounting Pronouncements:
In
December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based
Payment”. Statement 123(R) will provide investors and other users of financial
statements with more complete and neutral financial information by requiring
that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the
fair
value of the equity or liability instruments issued. Statement 123(R) covers
a
wide range of share-based compensation arrangements including share options,
restricted share plans, performance based awards, share appreciation rights,
and
employee share purchase plans. Statement 123(R) replaces FASB Statement No.
123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. Statement 123, as originally issued
in
1995, established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in APB
Opinion
25, as long as the footnotes to financial statements disclosed what net income
would have been had the preferable fair-value- based method been used. Public
entities (other than those filing as small business issuers) will be required
to
apply Statement 123(R) as of the first quarter of the fiscal year beginning
after June 15, 2005. For small business (S-B) filers, the effective date
is
fiscal year beginning after December 15, 2005. The Company has evaluated
the
impact of the adoption of SFAS 123(R), and believes the impact will be
significant.
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.”
This statement applies to all voluntary changes in accounting principles
and
requires retrospective application to prior periods’ financial statements of
changes in accounting principle, unless such would be impracticable. This
statement also makes a distinction between “retrospective application” of an
accounting principle and the “restatement” of financial statements to reflect
the correction of an error. This statement is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005. The Company does not expect the adoption of SFAS No. 154 to have a
material impact on its financial position or results of operation.
In
February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments”. SFAS No. 155 amends SFAS No 133, “Accounting for
Derivative Instruments and Hedging Activities”, and SFAS No. 140, “Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities”. SFAS No. 155, permits fair value re-measurement for any hybrid
financial instrument that contains an embedded derivative that otherwise
would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. This statement is effective for all financial instruments acquired
or issued after the beginning of the Company’s first fiscal year that begins
after September 15, 2006. Management believes that this statement will not
have
a significant impact on the financial statements.
In
March
2006 FASB issued SFAS 156 Accounting for Servicing of Financial Assets, this
Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities,
with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement requires:
An
entity
to recognize a servicing asset or servicing liability each time it undertakes
an
obligation to service a financial asset by entering into a servicing contract.
All
separately recognized servicing assets and servicing liabilities to be initially
measured at fair value, if practicable.
Permits
an entity to choose Amortization method or Fair Value Measurement method
for each class of separately recognized servicing assets and servicing
liabilities:
At
its
initial adoption, permits a one-time reclassification of available-for-sale
securities to trading securities by entities with recognized servicing rights,
without calling into question the treatment of other available-for-sale
securities under Statement 115, provided that the available-for-sale securities
are identified in some manner as offsetting the entity’s exposure to changes in
fair value of servicing assets or servicing liabilities that a servicing
company
elects to subsequently measure at fair value.
Separate
presentation of servicing assets and servicing liabilities subsequently measured
at fair value in the statement of financial position and additional disclosures
for all separately recognized servicing assets and servicing liabilities.
This
Statement is effective for fiscal year beginning after September 15, 2006.
Management
has not determined the effect if any, the adoption of this statement will
have
on the financial statements.
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
This statement clarifies the definition of fair value, establishes a framework
for measuring fair value, and expands the disclosures on fair value
measurements. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007. Management has not determined the effect if any, the
adoption of this statement will have on the financial statements.
In
September 2006, FASB issued SFAS 158 Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
88, 106, and 132(R). This Statement improves financial reporting by requiring
an
employer to recognize the over-funded or under-funded status of a defined
benefit postretirement plan (other than a multiemployer plan) as an asset
or
liability in its statement of financial position and to recognize changes
in
that funded status in the year in which the changes occur through comprehensive
income of a business entity or changes in unrestricted net assets of a
not-for-profit organization. This Statement also improves financial reporting
by
requiring an employer to measure the funded status of a plan as of the date
of
its year-end statement of financial position, with limited exceptions. An
employer with publicly traded equity securities is required to initially
recognize the funded status of a defined benefit postretirement plan and
to
provide the required disclosures as of the end of the fiscal year ending
after
December 15, 2006. An employer without publicly traded equity securities
is
required to recognize the funded status of a defined benefit postretirement
plan
and to provide the required disclosures as of the end of the fiscal year
ending
after June 15, 2007. However, an employer without publicly traded equity
securities is required to disclose the following information in the notes
to
financial statements for a fiscal year ending after December 15, 2006, but
before June 16, 2007, unless it has applied the recognition provisions of
this
Statement in preparing those financial statements. The disclosures include
a
brief description of the provisions of this Statement; the date that adoption
is
required; and the date the employer plans to adopt the recognition provisions
of
this Statement, if earlier.
This
statement is effective for fiscal year ending after December 15, 2008.
Management
has not determined the effect if any, the adoption of this statement will
have
on the financial statements.
(2)
Investments
in Hearst Ethanol One, Inc.:
Hearst
Ethanol One Inc. Agreement:
In
December 2005, the Company incorporated Hearst Ethanol One, Inc., a Federal
Canadian Corporation (“HEO”). On April 21, 2006 the Company completed the
acquisition of 720 acres of real property, together with all biomass material
located thereon. The site is located in the Township of Kendall, District
of
Cochrane, Canada, The property was purchased from C. Villeneuve Construction
Co.
LTD., a Canadian Corporation to provide the site and the biomass material
for
the construction and operation of bio-renewable woodwaste-to-fuel-grade
alcohol/ethanol refinery to be owned by HEO.
Pursuant
to the provisions of the Agreement, HEO issued ten point five percent (10.5%)
of
HEO’s common shares to Villeneuve as consideration for the transfer of the
Property. At the close of the transaction, the Company owned 87% of the common
stock of HEO.
Pursuant
to a Memorandum of Understanding entered into on April 20, 2006 between HEO
and
Villeneuve to clarify the Agreement, Villeneuve shall be entitled to appoint
one
member of HEO’s board of directors for so long as Villeneuve is at least a ten
percent (10%) shareholder of HEO. As of the date of this report HEO has incurred
$180,000 for legal, market survey consulting, permits, and travel
expenses.
Hearst
Ethanol One Inc. Valuation:
The
valuation based on the residual property valuation
of the land is $253,070, building $88,574, raw material (mature timber) of
$647,953 and Forest Waste Disposal license Bond $67,780. Also included in
the
valuation was the residual value of the biomass on the HEO site of
US$11,461,362.
The
other
tangible and intangible assets owned by HEO include: a small rock quarry
(and
associated mineral rights) on the property, as well as a landfill license
and
permits as issued by the Government of Ontario Ministry of the Environment
(“MOE”).
Writing
off Inventory:
During
the fourth quarter of this year the company has written off the value of
HEO’s
inventory to a nominal amount. After conducting an asset evaluation review
it
was determined that no known market for the materials other than utilization
in
the Company’s planned manufacturing facility currently exists.
At
September 30, 2006, HEO’s inventory with a gross value of US $11,461,362 was
fully written off.
(3)
Business
Acquisition:
On
October 26, 2004 (“Closing Date”), effective October 1, 2004, the Company
purchased 100% of the outstanding shares of two Texas corporations, Bott
Equipment Company, Inc. (“Bott”) and Gulfgate Equipment, Inc. (“Gulfgate”) from
their president and sole shareholder, Mr. Mark Trumble.
Under
the
terms of the stock purchase agreement, the Company acquired 100% of the shares
of Bott and Gulfgate from Mr. Trumble for $50,000 in cash and 1,309,677 shares
of the Company’s newly issued common stock.
The
Company also agreed, to raise $2,000,000 in gross equity funding within 120
days
of the Closing Date. The Company failed to achieve this milestone and issued
Trumble an additional 123,659 shares of its restricted stock
During
the first quarter of fiscal year 2005, the Company, in order to avoid the
issuance of 61,829 penalty shares, paid $75,000 directly to Mr. Trumble.
As of
the date of this report the Company has received approximately $39,000 of
the
$75,000 from Mr. Weisdorn Sr. The Company has recorded this payment as a
reduction to additional paid-in capital.
On
December 15, 2005, the Company assumed Weisdorn Sr.’s obligation to purchase
165,054 shares from Mr. Trumble at $1.86 per share.
First
amended stock purchase agreement with Mark Trumble
Effective
May 8, 2006, the Company and its officers entered into a First Amended Stock
Purchase Agreement and Release (“Agreement”) with Mark Trumble, amending that
certain Stock Purchase Agreement dated September 1, 2004 (the “SPA”), pursuant
to which the parties agreed to, among other things, Trumble agreed to release
the Company from its obligations under the put, including any obligation
to make
the interest payment or to pay interest on any sum whatsoever, and release
any
security interest he claims in the real estate owned by Gulfgate and/or Bott,
and the Company, within 60 days, shall secure a funding commitment in which
Trumble shall be paid the sum of $307,000 at the time of the closing of the
funding. This sum shall be used to purchase 165,053 shares of the common
stock
of the Company from Trumble at the price of $1.86 per share. The Company
shall
also pay from the funding all amounts of bank or other indebtedness owed
by the
Company, Bott or Gulfgate, which is personally guaranteed by Trumble. The
Company shall issue Trumble, upon closing of the funding, 60,000 shares of
the
Company’s common stock. This additional issuance of shares of the common stock
of the Company shall be in full and final satisfaction of all claims that
Trumble has or may have to additional shares of the Company’s common stock as a
result of any breach of, or failure to meet a milestone under, the
SPA.
(4)
Accounts
Receivable:
Accounts
receivable has been reduced by an allowance for amounts that may become
uncollectible. This estimated allowance is based primarily on Management's
evaluation of the financial condition of the customer and historical bad
debt
experience. The Company has provided reserves for doubtful accounts as of
September 30, 2006 in the amount of $83,081 that the Company believes
are adequate.
(5)
Inventories:
Inventories
consist of finished goods of $647,823, raw material of mature timber of
$647,953, and work in process in the amount of $768,912 at September 30,
2006.
(6)
Plant,
Property and Equipment:
A
summary
at September 30, 2006 and 2005 are as follows:
| |
|
2006
|
|
|
Land
|
|
$
|
778,608
|
|
|
Buildings
and improvements
|
|
|
1,244,453
|
|
|
Furniture,
Machinery and equipment
|
|
|
1,025,414
|
|
|
Automobiles
and trucks
|
|
|
47,508
|
|
| |
|
|
3,095,983
|
|
|
Less
accumulated depreciation
|
|
|
(520,956
|
)
|
| |
|
$
|
2,575,027
|
|
Depreciation
expense charged to operations totaled $238,569 and $242,367 respectively,
for
the years ended September 30, 2006 and 2005.
The
Company had construction in progress amounting $289,740. The Company determined
that the completion of the asset is uncertain due to lack of resources and
impaired the full amount of construction in progress as of September 30,
2006.
(7)
Goodwill
Impairment
The
Company evaluates intangible assets and other long-lived assets for impairment,
at a minimum, on an annual basis and whenever events or changes in circumstances
indicate that the carrying value may not be recoverable from its estimated
future cash flows. Recoverability of intangible assets, other long-lived
assets
and goodwill is measured by comparing their net book value to the related
projected undiscounted cash flows from these assets, considering a number
of
factors including past operating results, budgets, economic projections,
market
trends and product development cycles. If the net book value of the asset
exceeds the related undiscounted cash flows, the asset is considered impaired,
and a second test is performed to measure the amount of impairment loss.
The
Company assessed the carrying value of goodwill in accordance with the
requirements of SFAS #142 "Goodwill and Other Intangible Assets". Based on
its assessment, the Company determined that $915,434 of goodwill relating
to its
acquisition of BOTT & Gulfgate is impaired at September 30, 2006
(8)
Investments
in Can Am Ethanol One, Inc.:
Can
Am
was created to manufacture, own and operate one ethanol production facility
in
British Columbia, Canada in November 2004. In June 2005, the Company made
CN$75,000 at risk deposit to open escrow toward purchase of 2,150 acres of
land
intended to serve as a plant site in British Columbia, Canada (“Purchase
Agreement”). This
project was discontinued. As
of
September 30, 2006 the Company impaired
this investment deposit.
(9)
Business
Lines of Credits - Bott:
Bott
previously maintained three lines of credits with a bank in Houston, Texas.
The
credit lines were evidenced by three promissory notes, a Business Loan Agreement
and certain commercial guarantees issued in favor of the bank. The material
terms of these agreements follow:
In
May
2004, Bott entered into a promissory note with a bank whereby Bott could
borrow
up to $250,000 over a three year term. The note required monthly payments
of one
thirty-sixth (1/36) of the outstanding principal balance plus accrued interest
at the Bank's prime rate plus 1.0 percent.
In
June
2004, Bott executed a promissory note ("Note") with a bank whereby Bott could
borrow
up
to $600,000, at an interest rate equal to the bank's prime rate. The Note
provided for monthly payments of all accrued unpaid interest due as of the
date
of each payment. The Note further provided for a balloon payment of all
principal and interest outstanding on the Note's one year anniversary. The
Company informed the bank that it would not renew the line of credit and
negotiated a long-term promissory note.
This
replacement promissory note was finalized in December 2005, for $372,012
at a
variable interest rate equal to the bank's prime rate. The note provides
for
five monthly principal payments of $3,092 and a final payment of the remaining
principal and interest in June 2006.
The
Agreements and Notes are secured by the inventory, chattel paper, accounts
receivable and general intangibles. The Agreements and Notes are also secured
by
the personal performance guarantees of certain executives of the
Company (Commercial Guarantees). All amounts related to Bott’s outstanding
promissory notes totaled $496,877 on September 30, 2006.
(10)
Business
Line of Credit - Gulfgate:
In
June
2002, Gulfgate executed a promissory note (“Note”) with a bank that allowed
Gulfgate to borrow up to $200,000 at an interest rate equal to the bank’s prime
rate, or a minimum interest rate of 5.00% per annum, whichever was greater.
The
Note provided for monthly payments of all accrued unpaid interest due as
of the
date of each payment. The Note remains in force and effect until the bank
provides notice to Gulfgate that no additional withdrawals are permitted
(Final
Availability Date). Thereafter, payments equal to either $250 or the outstanding
interest plus one percent of the outstanding principal as of the Final
Availability Date are due monthly until the Note is repaid in full. The Note
allows for prepayment of all or part of the outstanding principal or interest
without penalty. The Note is secured by Gulfgate’s accounts with the bank, and
by Gulfgate’s inventory, chattel paper, accounts receivable, and general
intangibles. The Agreement is also secured by the performance guarantees
of Mr.
Mark Trumble, Mr. Lawrence Weisdorn and the Company. Amounts outstanding
at
September 30, 2006 totaled $171,539.
(11)
Liability
to be satisfied through the issuance of shares
In
September, 2006, the Company incurred a liability for stock subscribed in
the
amount of $1,194,376. The Company sold 670,000 shares of its common stock
for $1,005,000 via a private placement offering through SW Bach & Company, a
New York securities dealer. The Company anticipates satisfying its private
placement obligations through issuance of common stock to shareholders as
soon
as the Company completes its SB-2 registration with the Securities &
Exchange Commission.
The
Company sold 277,978 shares of its common stock for $180,000 via another
private
placement offering from June through August 2006. The remainder $9,376 for
6,298
shares are for services rendered during the fiscal year. The Company intends
to
satisfy its obligations through issuance of common stock to shareholders
in
January 2007.
(12) Long-Term
Debts:
Promissory
Notes:
In
May
2003, Bott executed a promissory note with a bank in the amount of $26,398
at an
interest rate equals to four point fifty five percent (4.55%) for a vehicle
purchase. The term of the note is for fifty-nine (59) months at $494 per
month.
Balance outstanding at September 30, 2006 was $10,143.
Mortgage:
On
May
31, 2002, Gulfgate entered into a $140,000 promissory note (“Note”) with a bank
in connection with the refinancing of Gulfgate’s real estate. The
Note bears a fixed interest rate of seven percent (7.00%) per annum.
The Loan provided for fifty-nine monthly payments of $1,267 due beginning
July
2002 and ending June 2007. The Note may be prepaid without fee or penalty
and is secured by a deed of trust on Gulfgate’s realty. Balance
outstanding at September 30, 2006 was $19,724.
Loans
from shareholders:
In
September 2005, Daniel K. Moscaritolo, COO and Director, and James A. Latty,
CEO
and Chairman, (“Lenders”) each loaned the Company, $95,800 (collectively,
$191,600). The transactions are evidenced by two notes dated November 1,
2005
(hereinafter, “Notes”). The terms of the Notes require repayment of the
principal and interest, which accrues at a rate of ten percent (10%) per
annum
on May 1, 2006. The Notes are accompanied by Security Agreements that grant
the
Lenders a security interest in all personal property belonging to the Company,
as well as granting an undivided ½ security interest in all of the Company’s
right title and interest to any trademarks, trade names, contract rights,
and
leasehold interests. Balance outstanding at September 30, 2006 was $147,163.
The
interest recorded was $17,563 for the year ended September 30,
2006.
Financing
Lease Agreements:
In
September 2002, Gulfgate entered into a non-cancelable debt financing agreement
(“Agreement”) with the bank’s leasing corporation for the financing of certain
equipment and a paint booth. The Agreement calls for the payment of forty-eight
(48) monthly installment payments of $1,556 beginning September 2002 at the
interest rate of 6.90 percent per annum. Balance was paid at September 30,
2006.
Convertible
Loan Payable:
In
September 2004, the Company entered into a convertible loan with an investor.
The principal amount of the convertible loan payable is $150,000 at an interest
rate of 8% per annum paid quarterly. The loan is convertible into common
stock
at any time within two (2) years (24 months) starting September 3, 2004 at
the
conversion price of $2.20 or 68,182 shares. Each share converted entitles
the
holder to purchase one additional share of stock at an exercise price of
$3.30
within the ensuing 12 months.
At
the
end of September 30, 2006 the loan has not been converted into common stock,
the
principal amount became due and payable.
Summary
of long-term notes payable and financing lease are as follow:
|
Promissory
notes for automobile
|
|
$ |
10,143 |
|
| Mortgage
payable |
|
|
19,724 |
|
| Convertible
loan |
|
|
150,000 |
|
| Less
current portion |
|
|
179,867
|
|
|
Long-term
|
|
|
168,267 |
|
| |
|
$ |
11,600 |
|
(13)
Income
Taxes:
The
Company accounts for income taxes under the provisions of Statement of Financial
Accounting Standards No. 109 ("SFAS 109"). Under SFAS 109,
deferred income tax assets or liabilities are computed based on the temporary
difference between the financial statement and income tax bases of assets
and
liabilities using the currently enacted marginal income tax rate. Deferred
income tax expenses or credits are based on the changes in the deferred income
tax assets or liabilities from period to period. Deferred
tax
assets may be recognized for temporary differences that will result in
deductible amounts in future periods and for loss carry forwards. A valuation
allowance is recognized if, based on the weight of available evidence, it
is
more likely than not that some portion or all of the deferred tax asset will
not
be realized.
There
is
no provision for income taxes for the periods presented. Net operating loss
carry forwards have been offset in their entirety by a valuation allowance.
The
reconciliation of the effective income tax rate to the Federal statutory
rate is
as follows:
| |
|
2006
|
|
2005
|
|
|
Federal
income tax rate
|
|
|
35.0% |
|
|
35.0% |
|
|
State
income tax rate
|
|
|
6.0% |
|
|
6.0% |
|
|
Current
year losses: loss for which no current benefit is provided
|
|
|
(41.0) |
|
|
(41.0) |
|
|
Effective
Income Tax Rate
|
|
|
0% |
|
|
0% |
|
The
deferred tax asset results from net operating loss carry forwards of
approximately $9.2 million of which $0.2 million expires in 2017; $0.7 million
expires in 2018; $2.3 million expires in 2019; $2.3 million expires in 2020,
and
$3.6 million expires in 2021. The resulting tax benefit of approximately
$2.3
million is completely offset by a valuation allowance because of uncertainties
as to its realization.
(14)
Commitments:
The
Company leases one facility for its operations under a lease agreement expiring
December 31, 2008. The following is a schedule by years of future minimum
base
rental payments, excluding operating expenses, required under operating lease,
which represents non-cancelable lease terms in excess of one year as of
September 30, 2006:
On
April
30, 2005, the Company entered into a vehicle lease agreement. The agreement
provided for a $25,000 down payment and thirty-eight (38) monthly payments
of
$2,884 due on the 1st
of each
month.
| Facility
and vehicle leases: |
|
|
|
| 2007 |
|
$ |
182,777 |
|
| 2008 |
|
|
174,124 |
|
| 2009 |
|
|
37,041 |
|
| |
|
$ |
393,942 |
|
Lease
expenses amounted to $151,275 and $151,275 for the years ended September
30,
2006 and 2005 respectively.
The
Company has employment agreements with certain key executives through 2007
providing aggregate annual compensation of approximately $713,000.
(15) Warrants
and Employee Stock Options:
|
Warrants
outstanding
|
|
|
|
| |
|
Number
|
|
Average
Exercise
Price
|
|
|
Outstanding
at beginning of the year
|
|
|
910,183
|
|
$
|
2.65
|
|
|
Granted
during the year
|
|
|
2,230,182
|
|
|
2.26
|
|
|
Outstanding
at end of the year
|
|
|
2,440,365
|
|
|
2.52
|
|
|
Exercisable
at end of the year
|
|
|
380,000
|
|
|
2.26
|
|
|
Exercised
during the year
|
|
|
0
|
|
|
-
|
|
|
Cancelled
during the year
|
|
|
700,000
|
|
|
2.65
|
|
| |
|
|
Aggregate
Intrinsic
Value
|
|
|
Number
of
Warrants
|
|
|
Outstanding
at September 30, 2005
|
|
$ |
2,411,985
|
|
|
910,183
|
|
|
Granted
|
|
|
921,250
|
|
|
2,230,182
|
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
|
Cancelled
|
|
|
-
|
|
|
700,000
|
|
|
Outstanding
at September 30, 2006
|
|
$
|
6,145,653
|
|
|
2,440,365
|
|
Significant
Assumptions Used to Estimate Fair Value
The
weighted-average assumptions used in estimating the fair value of warrants
granted during the period, along with the weighted-average grant date
fair
values, were as follows: Expected volatility: 145%; average expected
life in
years: 3; average risk free interest rate: 6% and dividend yield:
0%
Employee
Stock Options:
In
connection with the employment agreements, the Company has granted options
to
certain key employees to acquire common stock of the Company
(“Options”).
The
number of weighted average exercise prices of all options granted for
the years
ended September 30, 2006 are as follows:
| |
|
Number
|
|
Average
Exercise
Price
|
|
|
Outstanding
at beginning of the year
|
|
|
4,428,044
|
|
$
|
3.00
|
|
|
Granted
during the year
|
|
|
300,000
|
|
|
1.65
|
|
|
Outstanding
at end of the year
|
|
|
4,443,044
|
|
|
1.81
|
|
|
Exercisable
at end of the year
|
|
|
3,893,720
|
|
|
1.81
|
|
|
Exercised
during the year
|
|
|
10,000
|
|
|
1.00
|
|
|
Cancelled
during the year
|
|
|
275,000
|
|
|
1.83
|
|
| |
|
|
|
|
|
|
|
|
Total
options outstanding
|
|
|
4,443,044
|
|
|
Exercise
prices
|
|
|
$
3.35
|
|
|
Weighted
average remaining life (years)
|
|
|
3
|
|
(16)
Stockholders’
Equity
On
October 26, 2004 the Company issued 1,309,667 shares of its common stock
to Mr.
Mark Trumble in consideration for the purchase of 100% of the shares of Bott
Equipment Company, Inc. and Gulfgate Equipment, Inc. in accordance with the
Stock Purchase Agreement (“Agreement”) entered into by the Company and Mr.
Trumble. The Agreement contains covenants in favor of Mr. Trumble that are
secured with our promise to issue up to a total of 1,236,591 additional shares
of our stock to Mr. Trumble in the event we fail to satisfy those covenants.
Effective
May 8, 2006 the Company and Mr. Trumble amended the original Stock Purchase
Agreement dated October 26, 2004 and agreed to, among other things, to issue
60,000 shares to Mr. Trumble in full and final satisfaction of all claims
that
Trumble has or may have to additional shares of the Company’s common stock as a
result of any breach of, or failure to meet a milestone under the SPA.
As
of the
date of this report, the Company is obligated to issue 60,000 additional
shares
to Mr. Trumble. Additionally, certain outstanding covenants may require us
to
issue up to 370,977 additional penalty shares in the event that we fail to
satisfy those covenants.
In
its
stock purchase agreement with Mr. Trumble, respecting the purchase of Gulfgate
and Bott, the Company recognized that Trumble would sell 326,344 shares of
its
stock at a purchase price of approximately $607,000 to private parties,
including a related party Lawrence Weisdorn, Sr., the CEO’s father and a
shareholder and/or Weisdorn Sr.’s assignees pursuant to a written agreement
between Trumble and Weisdorn Sr.. As part of the Company’s agreement with Mr.
Trumble, the Company agreed that if Mr. Trumble failed to recognize $607,000,
portions of which were due on specific dates following the closing date of
the
transaction, the Company agreed to issue up to 494,636 shares of restricted
stock to Trumble.
In
December 2004 the Company paid $75,000 to Mr. Mark Trumble in order to avoid
the
issuance of 61,829 Penalty Shares to Mr. Trumble. In January 2005, the Company
paid Mr. Trumble $158,000 to avoid the issuance of 123,659 Penalty Shares
to Mr.
Trumble. Although the Company had no obligation to make these payments under
its
agreement with Mr. Trumble, it did have an obligation to issue penalty shares
to
Mr. Trumble if Mr. Trumble did not recognize these monies through the sale
of
stock. When the Company learned that the primary obligor, Mr. Lawrence Weisdorn
Sr., was then unable to fulfill his contractual obligations to Mr. Trumble,
the
Company believed that it was in the shareholder’s best interests to avoid
dilution by making these payments and seeking to recoup the monies paid by
the
Company from Mr. Weisdorn Sr. at a later date. As of this date the company
has
received $185,000 from Lawrence Weisdorn Sr. The Company believes that it
will
recover some or all of the remaining balance, $48,000, before the close of
the
next quarter. The Company is obligated to issue to Mr. Trumble 247,318 Penalty
Shares because Mr. Trumble did not recognize $307,000 within 60 days of the
close of the acquisition. Finally, the Company is obligated to issue to Mr.
Trumble an additional 123,659 Penalty Shares since the Company did not receive
$2,000,000 in gross equity funding within 120 days of the Closing Date. In
summary, the Company’s obligation to issue penalty shares totaling 370,977
valued at $810,000 to Mr. Trumble has significantly increased
goodwill.
On
November 10, 2005, the Company entered into a stock purchase agreement with
Mercatus & Partners, Limited, a private limited company of the United
Kingdom (“Mercatus Limited”), for the sale of 1,530,000 shares of the Company’s
common stock for a minimum purchase price of $0.73 per share (the “SICAV One
Agreement), and another stock purchase agreement with Mercatus Limited also
for
the sale of 1,530,000 shares of the Company’s common stock for a minimum
purchase price of $0.73 per share (the “SICAV Two Agreement” and together with
the SICAV One Agreement, the “SICAV Agreements”). The shares offered and sold
under the SICAV Agreements were offered and sold pursuant to a private placement
that is exempt from the registration provisions of the Securities Act under
Section 4(2) of the Securities Act pursuant to Mercatus Limited’s exemption from
registration afforded by Regulation S. Pursuant to the terms of the SICAV
Agreements, the Company issued and delivered an aggregate number of 3,060,000
shares of the Company’s common stock within five days of the execution of the
respective SICAV Agreements to a custodial lock box on behalf of Mercatus
Limited for placement into two European SICAV funds. The SICAV Agreements
provided Mercatus Limited with up to 30 days after the delivery of the shares
of
the Company’s common stock to issue payment to the Company. If payment for the
shares was not received by the Company within 30 days of the delivery of
the
shares, the Company had the right to demand the issued shares be
returned.
On
November 12, 2005, the Company also entered into another private stock purchase
agreement with Mercatus & Partners, Limited, a private limited company of
the United Kingdom (“Mercatus Limited”) for the sale of 170,000 shares of the
Company’s common stock for a minimum purchase price of $0.82 per share (the
“Private SICAV One Agreement”) and another private stock purchase agreement with
Mercatus LP also for the sale 170,000 shares of the Company’s common stock for a
minimum purchase price of $0.82 per share (the “Private SICAV Two Agreement” and
with the Private SICAV One Agreement, the “Private SICAV Agreements”). The
shares offered and sold under the SICAV Agreements were offered and sold
pursuant to a private placement that is exempt from the registration provisions
of the Securities Act under Section 4(2) of the Securities Act pursuant to
Mercatus Limited’s exemption from registration afforded by Regulation S.
Pursuant to the terms of the Private SICAV Agreements, the Company issued
and
delivered an aggregate amount of 340,000 shares of the Company’s common stock
within five days of the execution of the respective Private SICAV Agreements
to
a custodial lock box on behalf of Mercatus Limited for placement into a European
bank SICAV fund. Subject to a valuation of the shares, Mercatus LP had up
to 30
days after the delivery of the shares of the Company’s common stock to issue
payment to the Company. If payment was not received by the Company within
45
days of the issuance of the shares to Mercatus Limited, the Company had the
right to demand the issued shares be returned.
In
a
letter to Mercatus dated April 13, 2006 the Company declared Mercatus to
be in
material breach of the above Private Purchase Agreements due to non-payment,
terminated the Agreements in their entirety and exercised its right to demand
the return of all the shares. All 3,400,000 shares were returned to the
Company’s treasury in August 2006.
On
December 13, 2005 the Company issued and delivered 129,054 shares of the
Company’s common stock for $106,000.
During
the month of December 2005, the Company issued and delivered an aggregate
amount
of 8,254 shares of the Company’s common stock to three consultants for services
valued at approximately $16,000.
The
Company sold 2,013,510 shares of its common stock for $1,534,963 via another
private placement offering from February through June 2006,
net of
underwriting fees of $108,915.
The
Company satisfied its obligations through issuance of common stock to
shareholders in June 2006.
The
company issued warrants to the underwriters to purchase 310,000 shares of
its
common stock at a price of $1.60 per share. The proceeds from the issuance
of
the 2,013,510 shares were recorded net of the fair value of the warrants
and the
underwriter’s fees. The fair value of the warrants, $419,639 was calculated
using the Black Scholes option pricing model using the following assumptions:
risk free rate of return of 6%, volatility of 145%, dividend yield of 0%
and
expected life of 3 years.
(17)
Resignation
of Executive Officer and Board Member:
On
October 17, 2005, the Company and its officers filed a complaint against
Lawrence Weisdorn, Jr. (“Weisdorn), the Company’s former Chief Executive Officer
and Chairman of the Board of Directors, Lawrence Weisdorn, Sr. (“Weisdorn Sr.”
and together with Weisdorn, the “Weisdorn Parties”), Nathan Drage (“Drage”) and
Drage related parties in the Superior Court of the State of California for
Los
Angeles County, alleging claims for, among other things, breaches of Nevada
and
federal law and breach of fiduciary duty (the “Action”). The Company’s claims
were based in substantial part on allegations of the unauthorized issuance
of
shares of the Company’s predecessor’s common stock in December 2003, prior to
the reverse acquisition and merger with CA MEMS, which was finalized in February
2004. The Company sought an injunction preventing the Weisdorn Parties and
Drage
and his related parties from selling or transferring any of the shares of
the
Company’s common stock issued in December 2003, the return of the shares to the
Company for cancellation and monetary damages.
On
November 3, 2005, the Weisdorn Parties filed a cross-complaint against the
Company and its officers, alleging claims for, among other things, breach
of
employment agreement, libel and indemnification (the “Weisdorn Counterclaim”).
The Weisdorn Parties’ claims were based in part on assertions by Weisdorn that
he was improperly terminated without cause from his positions with the Company
in June 2005, and that he was entitled to indemnification pursuant to Nevada
corporations law in connection with the Action. The Weisdorn Parties sought
monetary damages.
On
December 15, 2005, the Company and its officers entered into a Settlement
Agreement and Release with the Weisdorn Parties and other Weisdorn related
parties, effective as of July 1, 2005 (the “Settlement Agreement”), pursuant to
which the parties agreed to, among other things, dismiss the Action as it
related to the Weisdorn Parties, dismiss the Weisdorn Counterclaim, mutually
release all claims and mutually indemnify the other parties from certain
claims.
Weisdorn also agreed to deliver a letter of resignation to the Company,
confirming his resignation as Chief Executive Officer and Chairman of the
Board
of Directors of the Company as of June 25, 2005 and clarifying and confirming
the terms of his separation from the Company. The Weisdorn Parties and other
Weisdorn related parties further agreed to deliver to the Company all shares
or
rights to shares of the Company’s common stock owned by such parties. The net
stock returned to the Company by the Weisdorn parties was 2,699,684 shares,
not
including 670,000 shares of the Company’s common stock to be held by the Company
in an account for the benefit of the Weisdorn Parties (the “Retained Stock”),
which Retained Stock will be sold for the benefit of the Weisdorn Parties
pursuant to the terms set forth in the Settlement Agreement. The Company
has the
option to purchase any portion of the Retained Stock at a price determined
according to the terms of the Settlement Agreement. The Company also agreed
to
assume the obligations of the Weisdorn Parties to purchase certain shares
of the
Company’s common stock from Mark Trumble, and the Weisdorn Parties assigned to
the Company their interests in their rights, if any, purchase such shares
(the
Trumble Claims).
The
Settlement Agreement did not in any way affect claims brought in the Action
by the Company and its officers against Drage and the
Drage-related entities. However, on January 13, 2006, Drage and
Adrian Wilson verbally agreed to a settlement in principle with the Company,
which the parties have memorialized. In connection with the verbal
agreement to a settlement, the Company and its officers filed a Request for
Dismissal without prejudice of all claims against Drage and the
Drage-related entities on January 13, 2006.
(18) Legal
settlement:
On
December 15, 2005, the Company and its officers entered into a Settlement
Agreement and Release with the Weisdorn Parties and other Weisdorn related
parties, effective as of July 1, 2005 (the “Settlement Agreement”), pursuant to
which the Weisdorn Parties and other Weisdorn related Parties agreed to deliver
to the Company all shares or rights to shares of the Company’s common stock
owned by such parties. The net common stock returned to the Company by the
Weisdorn parties and other Weisdorn related parties was 2,699,684 shares.
The
fair
value of 2,669,684 shares of the Company’s common stock at December 15, 2005 was
$3,779,558. The per share closing price of the Company’s stock at December 15,
2005 was $1.40.
(19)
Assignment
of the Trumble Claims:
The
Company and the Weisdorn Parties further agreed the Weisdorn Parties, and
each
of them; assigned to the Company any and all rights or interest they, or
any of
them, have in or to the Trumble Claims. On December 15, 2005, the Company
assumed Weisdorn Sr.’s obligation to purchase 165,054 shares from Mr. Trumble at
$1.86 per share for a total liability of $307,000. The fair value of this
obligation at December 15, 2005 is $231,076 (165,054 shares at $1.40 per
share)
with the difference charged to other income ($75,924).
(20)
Contingencies
and Subsequent Events:
A.
Appointment of Director
Effective
October 18, 2006, Mr. Steven Newsom was appointed to the Board of Directors
of
the Company. As of November 15, 2006, the Board of Directors is comprised
of two
members, Mr. Newsom and James A. Latty.
Pursuant
to his appointment, Mr. Newsom and the Company entered into a Consulting
Agreement. Pursuant to the Consulting Agreement, Mr. Newsom shall receive
the
following: (i) the sum of $20,000, (ii) the sum of $4,000 per month payable
on
the first day of each month during his tenure as a member of the Company's
Board of Directors, (iii) an additional $2,000 per trip, if Mr. Newsom makes
more than three trips (per quarter) to attend meetings on Company's
business, (iv) $250 per hour for work performed for the Company over and
above time spent on trips to attend meetings on Company's business, (v)
travel expenses for trips to attend meetings on Company's business, and
(vi) options for the purchase of up to 300,000 shares of common stock of
the Company at an exercise price of $0.51 per share. The option period
shall be 60 months from October 18, 2006.
B.
Securities
Purchase Agreement with GCA
Strategic Investment Fund Limited:
On
October 31, 2006, the Company closed its Securities Purchase Agreement (the
“Agreement”) with GCA Strategic Investment Fund Limited (“Purchaser”). The
Company issued a $3,530,000 Convertible Note due October 31, 2009 (the “Note”),
and the purchase price of the Note was $3,177,000 (ninety per cent of the
principal amount of the Note). The Note does not bear interest except upon
an
event of default, at which time interest shall accrue at the rate of 18%
per
annum.
Security-The
Note is secured by a first security position in all assets of the Company
and
its subsidiaries, Bott Equipment Company, Inc., a Texas corporation, and
Gulfgate Equipment, Inc., in their inventory, equipment, furniture and fixtures,
rental fleet equipment and any other of their assets wherever located except
accounts receivable and assets solely attributable to their alternative fuel
projects.
Registration
Rights-The Company agreed to use its best efforts to file a registration
statement to register the resale of the common shares issuable upon the
conversion of the Note and exercise of the warrants (the “Conversion Shares”) by
December 31, 2006. The Company will also use its best efforts to cause the
registration statement to become effective within by January 31, 2007. If
the
registration statement is not timely filed, the Company owes Purchaser
liquidated damages in the amount of 1% of the principal amount of the then
outstanding balance due under the Note for each 60-day period, prorated,
until
the registration statement is filed. If the registration statement is not
declared effective within such 90 day period, the Company will owe Purchaser
liquidated damages in the amount of 2% of the principal amount of the then
outstanding balance of the Note for each 30-day period, prorated, until the
registration statement is declared effective.
Conversion
Price: The Note may be converted into Company's common shares. The conversion
price will be 85% of the trading volume weighted average price, as reported
by
Bloomberg LP (the “VWAP”), for the five trading days immediately prior to the
date of notice of conversion. During the first 30 days after the registration
statement is effective registration the conversion price will not be less
than
$0.47 (the “Floor Conversion Price”), nor greater than $0.61 (the “Ceiling
Conversion Price”). For the ninety (90) day period following the Initial Pricing
Period and each successive ninety (90) day period thereafter (each a “Reset
Period”), the Floor Conversion Price shall be reduced by an amount equal to 40%
of the lesser of (i) the Floor Conversion Price or (ii) the Closing Bid Price
as
reported by Bloomberg on the trading day immediately following the Initial
Pricing Period or Reset Period, as the case may be, and the Ceiling Conversion
Price shall be increased by an amount equal to 40% of the lesser of (y) the
current Ceiling Conversion Price or (z) the closing bid price as reported
by
Bloomberg on the trading day immediately following the Initial Pricing Period
or
Reset Period as the case may be.
Prepayment-For
so long as Company is not in default and Company is not in receipt of
a notice of conversion from the holder of the Note, Company may, at its
option, prepay, in whole or in part, this Convertible Note for a pre-payment
price (the “Prepayment Price”) equal to the greater of (i) 110% of the
outstanding principal amount of the Note plus all accrued and unpaid interest
if
any, and any outstanding liquidated damages, if any, or (ii) (x) the number
of Company's common shares into which the Notes is then convertible, times
(y) the average VWAP of Company's common shares for the five (5) trading
days immediately prior to the date that the Note is called for redemption,
plus
accrued and unpaid interest.
Redemption-The
Company may be required under certain circumstances to redeem any
outstanding balance of the Note and the warrants. The redemption price under
these circumstances of the outstanding balance due under the Note is equal
to
the greater of: (i) the Prepayment Price or (ii) (x) the number of Company's
common shares into which the unpaid balance due under the Note is then
convertible, times (y) the five (5) day VWAP price of Company's common shares
for the five trading days immediately prior to the date that the unpaid balance
due under the Note is called for redemption, plus accrued and unpaid interest,
if any.
Warrant-The
Company issued warrants to purchase 1,000,000 shares of its common stock.
These
warrants are callable if the common stock trades at a price equal to 200%
of the
strike price of the warrants based on any consecutive five day trading average
VWAP value. The warrants have a term of five years and an exercise price
of
$0.66 (120% of the average five day VWAP price for Company's common stock
for the five trading days immediately prior to October 31, 2006).
Company paid
an application fee to Global Capital Advisors, LLC (“Adviser”), Purchaser's
adviser, from the proceeds of the funding in an amount equal to one percent
of
the funding, excluding warrants. Additionally, Company issued to Adviser on
warrant to purchase 500,000 shares of Company's common stock. These
warrants have a term of five years and have an initial fixed exercise price
of $0.66 (120% of the five day VWAP for the five trading days immediately
prior
to October 31, 2006).
The
proceed received from this agreement were used to pay off all notes payable
to
third party listed under Footnotes 9, 10 and 12. Major disbursements included
three notes payable to a bank (Notes 9 and 10) totaling $668,030; auto and
property loans totaling $40,561; convertible loan $150,000; and $307,000
related
to the First
amended stock purchase agreement with Mark Trumble (Note
3),
and Daniel Moscaritolo (see section F)
C.
Amendments to Articles of Incorporation and Bylaws
On
December 5, 2006, the Company filed Articles of Merger with the Secretary
of
State of Nevada in order to effectuate a merger whereby the Company (as MEMS
USA, Inc.) would merge with a newly formed wholly-owned subsidiary, Convergence
Ethanol, Inc., as a parent/ subsidiary merger with the Company as the surviving
corporation. This merger, which became effective as of December 5, 2006,
was
completed pursuant to Section 92A.180 of the Nevada Revised Statutes.
Shareholder approval to this merger was not required under Section 92A.180.
The
purpose of this merger was to change the Company's name to "Convergence Ethanol,
Inc."
D.
Resignation and termination of Daniel Moscaritolo as a director and officer:
On
December 14, 2006, the Company filed a lawsuit in the United States District
Court, Central District of California, Western Division (Case No.: CV06-07971)
against Daniel Moscaritolo for violations of the Securities
Exchange Act
of
1934, declaratory relief, breach of fiduciary duty, intentional interference
with contract, and conversion arising out of Mr. Moscaritolo's improper actions
to wrest control of the Company by soliciting proxies for a shareholder vote
to
take over the Company.
On
December 15, 2006, Mr. Moscaritolo and Mr. Hemingway, individually, and
purporting to act derivatively on behalf of the shareholders of the Company,
filed a lawsuit in Nevada State Court, County of Washoe (Case No.: CV0603002)
against Dr. Latty and Mr. York for injunctive relief, declaratory relief,
receivership, and accounting relating to the failed effort to remove them
from
the Board of Directors of the Company and seeking a court order approving
their
removal (the “Moscaritolo Action”). The Moscaritolo action has been dismissed,
but on January 9, 2007 he filed a second lawsuit in Nevada State Court against
the Company, Dr. Latty, and Mr. Newsom for injuctive relief to hold Annual
Shareholders Meeting.
The
Company intends to pursue the claims set forth in the Company Action and
to
oppose the claims set forth in the Second Moscaritolo Action.
On
October 31, 2006 Mr. Daniel Moscaritolo demanded repayment of the remainder
balance of his loans to the Company. He was paid a sum of $54,358 of which
$8,558 was for accrued interest.
Item
8.
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
None.
Item
8A. Controls and Procedures
Our
disclosure controls and procedures are designed to ensure that information
required to be disclosed in reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within
the
time periods specified in the rules and forms of the Securities and Exchange
Commission and that such information is accumulated and communicated to our
management, as appropriate, to allow timely decisions regarding required
disclosure. Our Chief Executive Officer and Chief Financial Officer have
reviewed the effectiveness of our disclosure controls and procedures and
have
concluded that the disclosure controls and procedures, overall, are effective
as
of the end of the period covered by this report. There has been no change
in the
Company’s internal control over financial reporting (as defined in Rule
13a-15(f) under the Exchange Act) during the period covered by this report
that
have materially affected, or are reasonably likely to materially affected,
the
Company’s internal control over financial reporting.
Item
8B. Other Information
None
Part
III
Item
9. Directors,
Executive Officers, Promoters and Control Persons; Compliance with Section
16(a)
of the Exchange Act.
Set
forth
below are our directors and officers.
|
Name
|
Age
|
Position
|
|
Dr.
James A. Latty
|
|
60
|
|
Chief
Executive Officer, President and Chairman of the Board of
Directors
|
|
Steve
Newsom
|
|
47
|
|
Director
|
|
Richard
W. York
|
|
58
|
|
Chief
Financial Officer
|
James
A.
Latty, Ph.D., PE was appointed Chief Executive Officer and Chairman of the
Board
on July 1, 2005, in addition to the position of President, which Dr. Latty
has
held since September of 2004. Since 1992, Dr. Latty has been president of
JAL
Engineering, an engineering services provider wholly-owned by Dr. Latty
specializing in power and petro-chemical process technologies. >From April
2000 to September 2004, Dr. Latty was a director of business development
for
Rockwell Scientific, Inc.
Mr.
Newsom joined us a director and consultant in October 2006. He received his
undergraduate degree in Maritime Systems Engineering from Texas A&M
University, a Master's of Business Administration from the University of
Houston
at Clear Lake, and a Juris Doctrate from the University of Houston. Mr. Newsom
has been an attorney in Houston, Texas since June 19, 1997. His practice
consists of general civil practice and real estate transactions.
On
November 14, 2006, Danny Moscaritolo submitted a letter of resignation to
resign
as a member of the Board of Directors of the Company.
On
November 17, 2006, Daniel Moscaritolo was terminated from his position as
Chief
Operating Officer.
On
December 13, 2006, Mr. Moscaritolo presented management with a purported
action
by written consent of the shareholders of the Company indicating that the
shareholders had elected to remove the current board of directors and elect
Daniel Moscaritolo and Thomas Hemingway as directors. Mr. Moscaritolo also
presented management with two separate purported actions by written consent
of
the new purported board of directors indicating that the Company's current
officers, James A. Latty and Richard W. York, were terminated and that Mr.
Moscaritolo was elected to serve as Secretary of the Company and Mr. Hemingway
was elected to serve as President and Chief Executive Officer of the Company.
The Company rejected the purported shareholder action on the grounds that,
on
its face, the purported action showed an insufficient number of votes had
been
obtained to approve the requested action, and on the further grounds that
the
consenting shareholders had violated the proxy rules set forth in Section
14 of
the Securities Exchange Act of 1934, as amended (the “Act”). In light of the
invalidity of the purported shareholder action, the Company also rejected
the
actions of the new purported board of directors terminating and replacing
the
officers of the Company.
Mr.
York
has served as our chief financial officer since November 2004. Mr. York served
as controller of PTI technologies, Inc. from 2000 through October 2004 and
Rantec Microwave & Electronics, Inc. from 1992 through 2000. PTI and Rantec
are both subsidiaries of ESCO Technologies, Inc., a NYSE-listed producer
of
engineered products and systems for industrial and commercial applications.
All
directors serve for a three-year term and until their successors are duly
elected and qualified. All officers serve at the discretion of the Board
of
Directors.
Audit
Committee Financial Expert
We
do not
have an audit committee nor do we have a financial expert.
Code
of Ethics
We
have adopted
a
code of ethics that applies to the principal executive officer and principal
financial and accounting officer. We will provide to any person without charge,
upon request, a copy of our code of ethics. Requests may be directed to our
principal executive offices at 5701 Lindero Canyon Road, Suite 2-100, Westlake
Village, California 91362.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our officers,
directors and persons who beneficially own more than 10% of a registered
class
of our equity securities to file reports of securities ownership and changes
in
such ownership with the Securities and Exchange Commission (the “SEC”).
Officers, directors and greater than 10% beneficial owners are also required
by
rules promulgated by the SEC to furnish us with copies of all Section 16(a)
forms they file.
Our
current officers and directors have filed the reports required by Section
16(a).
All reports were timely except: (1) Form 3 and Form 4 filed by James A. Latty
on
December 6, 2006; (2) Form 3 and Form 4 filed by Richard York on December
7,
2006; and, (3) Form 3 and Form 4 filed by Steven Newsom on December 11, 2006.
We
have requested that all former officers, directors and 10% stockholders file
all
required reports. We have requested that all former officers, directors and
10%
stockholders file all required reports.
Item
10. Executive Compensation.
Cash
Compensation of Executive Officers.
The
following table sets forth the cash compensation paid by us to our executive
officers for services rendered during the fiscal years ended September 30,
2006,
2005 and 2004.
| |
|
Annual
Compensation
|
|
Long-Term
Compensation
|
|
|
|
|
Name
and Position
|
|
Year
|
|
Salary
|
|
Bonus
|
|
Other
Annual
Compensation
|
|
Restricted
Stock
Awards
($)
|
|
Common
Shares Underlying Options Granted
(#
Shares)
|
|
All
Other
Compensation
|
|
|
James
A. Latty,
CEO
|
|
|
2006
|
|
$
|
240,000 |
|
|
--
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
2005
|
|
$
|
240,000
|
|
|
--
|
|
$
|
5,950
|
|
|
|
|
|
1,000,000
|
|
|
|
|
| |
|
|
2004
|
|
$
|
240,000
|
|
|
--
|
|
|
|
|
|
|
|
|
1,284,343
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daniel
K. Moscaritolo,
|
|
|
2006
|
|
$
|
240,000
|
|
|
|
|
$
|
9,350
|
|
|
|
|
|
|
|
|
|
|
|
COO
&
CTO (1)
|
|
|
2005
|
|
$
|
240,000
|
|
|
|
|
$ |
10,200
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
2004
|
|
$
|
240,000
|
|
|
|
|
$
|
94,770
|
|
|
|
|
|
1,284,343
(1
|
)
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard
York, CFO (2)
|
|
|
2006
|
|
$
|
93,000
|
|
|
|
|
|
|
|
|
|
|
|
26,335
|
|
|
|
|
| |
|
|
2005
|
|
$
|
93,000
|
|
|
|
|
|
|
|
|
|
|
|
5,000
|
|
|
|
|
| |
|
|
2004
|
|
$
|
15,500
|
|
|
|
|
|
|
|
|
|
|
|
50,000
|
|
|
|
|
(1) Mr.
Moscaritolo was
removed as our COO and CTO on November 17, 2006.
(2) Effective
November 1,
2006 Mr. Richard W. York’s annual compensation will be $120,000.
No
executive officer received options in fiscal 2006.
Aggregated
Option/SAR Exercises in 2006 Fiscal Year
and
FY-End Option/SAR Values
|
Name
|
|
Shares
Acquired
on
Exercise
(#)
|
|
Value
Realized
($)
|
|
Number
of
Securities
Underlying
Unexercised Options/SARs at
FY-End
(#)Exercisable/
Unexercisable
|
|
Value
of
Unexercised
In-the-Money
Options/SARs at
FY-End
($)
Exercisable/
Unexercisable
|
|
|
James
A. Latty
|
|
|
-
|
|
|
-
|
|
|
1,000,000/0
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daniel
K. Moscaritolo (3)
|
|
|
-
|
|
|
-
|
|
|
0
/ 0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard
York
|
|
|
-
|
|
|
-
|
|
|
35,000/15,000
|
|
|
|
|
(1) Based
on
a closing price of $1.00 per share for our common stock as quoted on the
OTC
Bulletin Board on September 29, 2006.
Compensation
of Directors.
At the
present time, directors receive no compensation for serving as directors
of the
company, however, we may in the future begin to compensate our non-officer
directors. All directors receive reimbursement for out-of-pocket expenses
in
attending board of directors meetings. From time to time, we may engage certain
members of our board of directors to perform services on our behalf and will
compensate such persons for the services that they perform.
Employment
Agreements.
Our
President and CEO, Dr. Latty, has a written employment agreement with us
dated
as of July 1, 2002. We assumed this agreement pursuant to the January 2004
reverse acquisition transaction. It provides for annual compensation of
$240,000. Options were granted with the original agreement which did not
vest.
Our
CFO,
Mr. York, had an employment agreement with us dated as of November 1,
2004. The agreement was for a term of three years and provided for annual
compensation of $93,000. Mr. York was granted an option to purchase 50,000
shares of our common stock at an exercise price of $1.92 per share. These
options shall vest as follows: 10% upon execution of the agreement; and thirty
percent (30%) per annum on each anniversary date.
On
November 1, 2006, Mr. York’s employment agreement was renewed for an additional
three year term for annual compensation of $120,000 per year and a $500 per
month car allowance. Mr. York was granted an option to purchase 300,000
shares of our common stock at $0.45 per share. The options vest as follows:
10%
upon execution of the agreement; and thirty percent (30%) per annum on each
anniversary date. If Mr. York terminates his employment for good reason or
if he
is terminated by us for any reason other than for cause, Mr. York shall be
entitled to a lump sum cash payment equal to 12 months salary, payable no
later
than thirty days following termination of employment.
Pursuant
to his appointment, Mr. Newsom and the Company entered into a Consulting
Agreement. Pursuant to the Consulting Agreement, Mr. Newsom shall receive
the
following: (i) the sum of $20,000, (ii) the sum of $4,000 per month payable
on
the first day of each month during his tenure as a member of the Registrant's
Board of Directors, (iii) an additional $2,000 per trip, if Mr. Newsom makes
more than three trips (per quarter) to attend meetings on Registrant's business,
(iv) $250 per hour for work performed for the Registrant over and above time
spent on trips to attend meetings on Registrant's business, (v) travel expenses
for trips to attend meetings on Registrant's business, and (vi) options for
the
purchase of up to 300,000 shares of common stock of the Registrant at an
exercise price of $0.51 per share. The option period shall be 60 months from
October 18, 2006.
Item
11. Security Ownership of Certain Beneficial Owners and
Management.
The
following table sets forth certain information regarding the beneficial
ownership of the shares of our common stock as of December 14, 2006 by (i)
each
person who is known by us to be the beneficial owner of more than five percent
(5%) of the issued and outstanding shares of our common stock, (ii) each
of our
directors and executive officers and (iii) all directors and executive officers
as a group.
|
Name
and Address (1)
|
|
Number
of Shares
|
|
Percentage
Owned
|
|
|
Dr.
James A. Latty
|
|
|
3,464,468
(2)
|
|
|
18.6%
|
|
|
Steve
Newsom
|
|
|
300,000
(3)
|
|
|
1.7%
|
|
|
Richard
W. York
|
|
|
96,336
(4)
|
|
|
0.5%
|
|
|
Mark
Trumble
|
|
|
1,569,902
|
|
|
8.9%
|
|
|
Daniel
K. Moscaritolo
|
|
|
2,437,605
|
|
|
13.8%
|
|
(1) Address
is 5701 Lindero Canyon Road, Suite 2-100, Westlake Village, California
91362.
(2) Includes
options granted to Dr. Latty to purchase 1,000,000 shares of our common stock
exercisable within 60 days of December 14, 2006.
(3) All
represent options exercisable within 60 days of December 14, 2006.
(4) Includes
65,000 options granted to Mr. York exercisable within 60 days of December
14,
2006.
Equity
Compensation Plans
The
following table sets forth certain information as of September 30, 2006
concerning our equity compensation plans:
|
Plan
Category
|
|
Number
of Common
Shares
to Be Issued Upon
Exercise
of Outstanding
Options
|
|
Weighted-
Average
Exercise
Price of
Outstanding
Options
|
|
Number
of Common
Shares
Remaining
Available
for Issuance
Under
Equity Compensation Plan
|
|
|
Equity
compensation plan approved by shareholders
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
|
Equity
compensation plan not approved by shareholders (1)
|
|
|
2,453,167
|
|
|
$2.53
|
|
|
863,715
|
|
| (1) |
Represents
(a) 1,435,167 shares of common stock issuable upon exercise of
options
granted to officers and employees under our 2004 Stock Incentive
Plan
which has not been approved by shareholders (b) 1,000,000 shares
of common
stock issuable upon exercise of options issued outside the 2004
Plan to
our Chairman Mr. Latty.
|
Item
12. Certain Relationships and Related Transactions.
In
October 2005, our Chairman and CEO James Latty, PhD, PE. loaned the Company
$105,800. The terms of the Note require repayment of the principal and interest,
which accrues at a rate of ten percent (10%) per annum on May 1, 2006. The
Note
is accompanied by Security Agreements that grant the Lenders a security interest
in all personal property belonging to the Company, as well as granting an
undivided ½ security interest in all of the Company’s right title and interest
to any trademarks, trade names, contract rights, and leasehold interests.
Balance outstanding at September 30, 2006 was $93,187.
Daniel
Moscaritolo, our then COO and director loaned the Company $105,800 in October
2005 under the same terms. Balance outstanding at September 30, 2006 was
$53,976. Mr. Moscaritolo’s balance plus interest accrued in October 2006 was
paid in full on October 31, 2006.
Item
13. Exhibits.
(a)
Index
To Exhibits
| 3.1 |
Articles
of Incorporation of the Registrant, as
amended
|
| 3.2 |
Bylaws
of the Registrant
|
| 4.1 |
Registration
Rights Agreement
|
| 10.1
|
Sales
Agency Agreement dated August 22, 2005 between S.W. Bach & Company and
MEMS USA, Inc., a Nevada
corporation
|
| 21.1
|
List
of Subsidiaries
|
| 23.1
|
Consent
of Independent Certified Public Accountants (FY
2004)
|
| 23.2
|
Consent
of Independent Certified Public Accountants (FY
2005)
|
| 31.1
|
Certification
of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley
Act of 2002
|
| 31.2
|
Certification
of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley
Act of 2002
|
| 32 |
Certification
of Chief Executive Officer and Chief Financial Officer pursuant
to
18
U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act
of
2002
|
Item
14. Principal Accountant Fees and Services.
Our
board
of directors has selected Kabani & Company, Inc. as our independent
accountants to audit our consolidated financial statements for the fiscal
year
2006.
Audit
and Non-Audit Fees
Aggregate
fees for professional services rendered to us by Kabani & Company, Inc. for
the years ended September 30, 2006 and Stonefield Josephson, Inc. in 2005
were
as follows:
|
Services
Provided
|
|
2006
|
|
2005
|
|
|
Audit
Fees
|
|
$
|
75,000
|
|
$
|
110,920
|
|
|
Audit
Related Fees
|
|
$
|
22,500
|
|
$
|
-
0 -
|
|
|
Tax
Fees
|
|
$
|
-
0 -
|
|
$
|
-
0 -
|
|
|
All
Other Fees
|
|
$
|
-
0 -
|
|
$
|
-
0 -
|
|
|
Total
|
|
$
|
97,500
|
|
$
|
110,920
|
|
Audit
and Non-Audit Fees
Audit
Fees. The
aggregate fees billed for the years ended September 30, 2006 and 2005 were
for
the audits of our annual financial statements and reports.
Audit
Related Fees. The
aggregate fees billed for the year ended September 30, 2006 were for review
of
our quarterly financial statements.
Tax
Fees. There
were no fees billed for the years ended September 30, 2006 and 2005 for
professional services related to tax compliance, tax advice and tax returns
preparation.
All
Other Fees. There
were no other fees billed for the years ended September 30, 2006 and 2005
for
services other than the services described above.
Pre-Approval
Policies and Procedures
We
have
implemented pre-approval policies and procedures related to the provision
of
audit and non-audit services. Under these procedures, our board of directors
pre-approves all services to be provided by Kabani & Company, Inc. and the
estimated fees related to these services.
Pursuant
to the requirements of Section 13 or 15(d) 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, on this 17th
day of
January 2007.
| |
|
|
| |
CONVERGENCE
ETHANOL, INC.
(Registrant)
|
|
|
|
| |
By: |
/s/ James
A. Latty |
| |
James
A. Latty |
| |
Chief
Executive Officer |
POWER
OF ATTORNEY
KNOW
ALL
THESE PERSONS BY THESE PRESENTS, that each person whose signature appears
below
constitutes and appoints James A. Latty, his attorney-in-fact, with full
power
of substitution, for him in any and all capacities, to sign any and all
amendments to this Report on Form 10-KSB, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
said attorney-in-fact or his substitute or substitutes, may do or cause to
be
done by virtue hereof.
Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report on
Form 10-KSB has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
|
Signature
|
|
Title
|
|
Date
|
| |
|
|
|
|
|
/s/
James A. Latty
|
|
Chief
Executive Officer and Director
|
|
January
17, 2007
|
|
James
A. Latty
|
|
(Principal
Executive Officer)
|
|
|
| |
|
|
|
|
| /s/
Richard W. York |
|
Chief
Financial Officer |
|
January
17, 2007
|
|
Richard
York
|
|
(Principal
Financial Officer)
|
|
|
| |
|
|
|
|
| /s/
Steven Newsome |
|
Director |
|
January
17, 2007
|
| Steven
Newsome |
|
|
|
|
-49-