10-Q 1 worldwaste_10q-033107.txt WORLD WASTE TECHNOLOGIES, INC. ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended March 31, 2007 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________ to ____________. Commission file number 1-11476 WORLD WASTE TECHOLOGIES, INC. (Exact Name of Registrant as Specified in its Charter) CALIFORNIA 95-3977501 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 13500 EVENING CREEK DRIVE, SUITE 440, SAN DIEGO, CALIFORNIA 92128 (Address of Principal Executive Offices) (858) 391-3400 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non- accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer |_| Accelerated Filer |_| Non-accelerated Filer |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes |_| No |X| State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 26,255,662 shares issued and outstanding as of March 31, 2007. ================================================================================
WORLD WASTE TECHNOLOGIES, INC. FORM 10-Q TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION Item 1 Financial Statements: Consolidated Balance Sheets F-1 Consolidated Statements of Operations F-2 Consolidated Statements of Stockholders' Equity (Deficit) F-3 Consolidated Statements of Cash Flow F-5 Notes to Consolidated Financial Statements F-6 PART II OTHER INFORMATION Item 1A Risk Factors 1 Item 2 Management's Discussion and Analysis of Financial Condition and Results of 1 Operations Item 3 Quantitative and Qualitative Disclosures About Market Risks 9 Item 4 Controls and Procedures 9 Item 6 Exhibits 10 SIGNATURES 11 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS WORLD WASTE TECHNOLOGIES, INC. AND SUBSIDIARIES (FORMERLY WORLD WASTE OF AMERICA, INC.) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED BALANCE SHEETS March 31, December 31, 2007 2006 ---------------------------------- ASSETS: (UNAUDITED) Current Assets: Cash $ 13,033,032 $ 14,330,840 Accounts receivable - 12,517 Prepaid expenses 144,044 174,589 ---------------------------------- Total Current Assets 13,177,076 14,517,946 ---------------------------------- Fixed Assets: Machinery, equipment net of accumulated depreciation of $894,643 on 3/31/07 and $673,201on 12/31/06. 6,107,193 6,187,065 Construction in Progress - 114,238 Leasehold Improvements net of accumulated depreciation of $361,718 on 3/31/07 and $271,164 on 12/31/06. 2,970,549 2,966,424 ---------------------------------- Total Fixed Assets 9,077,742 9,267,727 Other Assets: Deposit L/T 36,518 36,519 Patent license, net of accumulated amortization of $107,896 on 3/31/07 1,237,432 1,266,014 And $88,591 on 12/31/06 ---------------------------------- TOTAL ASSETS $ 23,528,768 $ 25,088,206 ================================== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT): LIABILITIES: Current Liabilities: Accounts payable $ 405,288 $ 503,752 Accrued salaries payable 85,197 136,635 Capital lease S/T 46,563 45,615 Accrued liabilities 192,106 222,803 Other liabilities 10,000 23,183 ---------------------------------- Total Current Liabilities 739,154 931,988 ---------------------------------- Long Term Liabilities: Capital lease L/T 68,349 80,351 ---------------------------------- Total Long Term Liabilities 68,349 80,351 ---------------------------------- TOTAL LIABILITIES 807,503 1,012,339 ---------------------------------- Redeemable preferred stock (See Note 5) 16,347,912 14,506,849 ---------------------------------- Commitments and Contingencies (See Note 7) STOCKHOLDERS' EQUITY (DEFICIT): Common Stock - $.001 par value: 100,000,000 shares authorized, 26,257,122 and 25,412,662 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively. 26,256 25,412 Additional paid-in-capital 53,485,811 51,179,469 Deficit Accumulated during development stage (47,138,714) (41,635,863) ---------------------------------- TOTAL STOCKHOLDERS' EQUITY 6,373,353 9,569,018 ---------------------------------- TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY $ 23,528,768 $ 25,088,206 ================================== SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS F-1 WORLD WASTE TECHNOLOGIES, INC. AND SUBSIDIARIES (FORMERLY WORLD WASTE OF AMERICA, INC.) (A DEVELOPMENT STAGE COMPANY) UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS For the Quarter For the Quarter June 18, 2002 Ending Ending Inception to March 31, 2007 March 31, 2006 March 31, 2007* ----------------------------------------------------- GROSS REVENUE: $ 93,784 Disposal of rejects (65,526) Plant operation cost (2,720,922) Depreciation (1,843,615) ----------------------------------------------------- Total cost of goods sold (4,630,063) ----------------------------------------------------- Gross Margin (4,536,279) G&A Expense Research and development $ (918,934) $ (60,000) (1,960,214) General and administrative (983,491) (968,668) (11,740,890) ----------------------------------------------------- Loss from operations (1,902,425) (1,028,668) (18,237,383) ----------------------------------------------------- Interest income 130,490 15,575 160,492 Financing transaction expense - (1,647,250) (7,442,426) Asset impairment (9,764,267) Other income (expense) (27,276) (120,154) 1,788,780 ----------------------------------------------------- Net loss before provision for income tax (1,799,211) (2,780,497) (33,494,804) ----------------------------------------------------- Income taxes - - - ----------------------------------------------------- Net loss $ (1,799,211) $ (2,780,497) $ (33,494,804) ----------------------------------------------------- Preferred stock dividend and amortization of beneficial conversion feature, warrant discount and offering costs (3,703,640) (540,486) (13,576,484) ----------------------------------------------------- Net loss attributable to common shareholders $ (5,502,851) $ (3,320,983) $ (47,071,288) ===================================================== BASIC AND DILUTED NET LOSS PER SHARE $ (0.21) $ (0.13) $ (2.58) ===================================================== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING USED IN CALCULATION 25,830,809 24,724,833 18,212,936 ===================================================== *APPROXIMATELY $67,526 IN CONSULTING AND TRAVEL EXPENSES INCURRED PRIOR TO INCEPTION OF THE BUSINESS ON JUNE 18, 2002 ARE NOT INCLUDED. SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. F-2 WORLD WASTE TECHNOLOGIES, INC. AND SUBSIDIARIES (FORMERLY WORLD WASTE OF AMERICA, INC.) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) Additional Common Stock Accumulated Shares Dollars Paid in Capital Subscription Deficit * Total ------------------------------------------------------------------------------------- $ $ $ $ $ Preformation expenses (67,526) (67,526) Formation - June 18, 2002 9,100,000 100 73,036 73,136 Net Loss - 2002 (359,363) (359,363) ------------------------------------------------------------------------------------- December 31, 2002 9,100,000 100 73,036 (426,889) (353,753) ===================================================================================== Additional paid in capital 100 100 Common stock subscribed 125,000 125,000 Net Loss - 2003 (804,605) (804,605) ------------------------------------------------------------------------------------- December 31, 2003 9,100,000 100 73,136 125,000 (1,231,494) (1,033,258) ===================================================================================== Merger with Waste Solutions, Inc. 7,100,000 63 2,137 2,200 Common stock subscriptions 125,000 1 124,999 (125,000) - Common stock and warrants net of offering cost prior to VPTI merger 3,045,206 31 3,952,321 3,952,352 Shares cancelled (500,000) (5) 5 - Warrants issued 281,171 281,171 Merger with VPTI 1,200,817 21,062 (21,062) - Conversion of promissory notes 1,193,500 12 1,193,488 1,193,500 Accrued Interest on notes forgiven 135,327 135,327 Common stock and warrants net of offering cost 1,460,667 1,461 2,865,462 2,866,923 Amortization of stock options and warrants to employees and consultants 217,827 217,827 Net loss - 2004 (2,496,188) (2,496,188) ------------------------------------------------------------------------------------- December 31, 2004 22,725,190 22,725 8,824,811 0 (3,727,682) 5,119,854 ===================================================================================== Common stock and warrants net of offering cost 1,961,040 1,961 3,072,116 3,074,077 Amortization of stock options and warrants to employees and consultants 654,220 654,220 Dividend redeemable (Preferred Stock) 106,645 (671,769) (565,124) Warrants issued 861,853 861,853 Bridge financing warrants 1,114,105 1,114,105 Beneficial conversion feature on redeemable preferred stock 1,328,066 1,328,066 Amortization of beneficial conversion feature, warrant discount and offering costs on redeemable preferred stock (562,704) (562,704) Net loss - December 2005 (3,078,917) (3,078,917) ------------------------------------------------------------------------------------- December 31, 2005 24,686,230 24,686 15,961,816 0 (8,041,072) 7,945,430 ===================================================================================== F-3 Additional Common Stock Accumulated Shares Dollars Paid in Capital Subscription Deficit * Total ------------------------------------------------------------------------------------- Common stock and warrants net of offering cost 262,851 263 9,561 9,824 Amortization of stock options and warrants to employees and consultants 989,252 989,252 Dividend (Preferred Stock) 386,954 (2,920,893) (2,533,939) Warrants issued preferred stock 1,647,250 1,647,250 Bridge financing warrants 787,500 787,500 Beneficial conversion feature - Series B 18,207,102 18,207,102 Conversion of Series B preferred stock 296,581 296 840,716 841,012 Series B Investor & placement warrants 7,922,663 7,922,663 Series A Investor warrants 3,065,931 3,065,931 Elimination of warrant liabilities 674,420 674,420 UAH stock for purchase of patent 167,000 167 697,833 698,000 Registration filing fees (11,529) (11,529) Amortization of beneficial conversion feature, warrant discount and offering costs on redeemable preferred stock (5,717,378) (5,717,378) Net loss - 2006 (24,956,520) (24,956,520) ------------------------------------------------------------------------------------- December 31, 2006 25,412,662 25,412 51,179,469 0 (41,635,863) 9,569,018 ===================================================================================== Common stock for services 103,340 103 259,397 259,500 Amortization of stock options and warrants to employees and consultants 185,108 185,108 Dividend (Preferred Stock) (810,842) (810,842) Conversion of Series B preferred stock 741,120 741 1,861,837 1,862,578 Amortization of beneficial conversion feature, warrant discount and offering costs on redeemable preferred stock (2,892,798) (2,892,798) Net loss - March 2007 (Unaudited) (1,799,211) (1,799,211) ------------------------------------------------------------------------------------- March 31, 2007 (Unaudited) 26,257,122 $ 26,256 $ 53,485,811 $ 0 ($47,138,714) $6,373,353 ===================================================================================== * During 2002, the Company issued $67,526 of Convertible Promissory Notes payable for preformation funds received and expended prior to Inception. SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. F-4 WORLD WASTE TECHNOLOGIES, INC. AND SUBSIDIARIES (FORMERLY WORLD WASTE OF AMERICA, INC.) (A DEVELOPMENT STAGE COMPANY) UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOW June 18, 2002 Quarter ended Quarter ended (Inception) to March 31,2007 March 31, 2006 March 31, 2007 ----------------------------------------------------------- Cash Flow from operating activities: $ $ $ Net loss (1,799,211) (2,780,497) (33,494,804) Adjustments to reconcile net loss to net cash used in operating activities: Impairment of assets 9,737,344 Depreciation and amortization 340,579 3,455 2,308,779 Interest forgiveness 135,327 Warrant and common stock Issued for consulting 84,566 Amortization of warrants & options to employees 185,108 289,164 2,046,406 Fair value adjustment warrant liability 120,154 (1,789,134) Financial transaction expense 1,647,250 7,442,426 Amortization of offering cost 252,277 Changes in operating assets and liabilities: Accounts receivable 12,517 - Prepaid expenses/Emp. receivable 30,545 72,713 (144,044) Accounts payable (98,463) (1,861) 405,288 Accrued salaries (51,438) 15,554 85,197 Accrued other liabilities 215,620 (40,479) 461,606 ----------------------------------------------------------- Net Cash used in operating activities (1,164,743) (674,547) (12,468,766) ----------------------------------------------------------- Cash flows from investing activities: Construction in progress (4,043,205) Leasehold improvements (94,679) (3,332,267) Deposits on equipment (5,231,636) Purchase machinery & equipment (38,386) (2,301,511) (7,794,612) Patient license (440,890) Deposits 4,719 (36,519) ----------------------------------------------------------- (133,065) (2,296,792) (20,879,129) ----------------------------------------------------------- Cash flows from financing activities: Redeemable preferred stock 32,071,719 Senior secured debt 2,000,000 6,265,000 Senior secured debt offering cost (122,425) (420,523) Payment of senior secured debt (2,785,000) Warrants, common stock and Additional paid in capital 8,208 11,249,731 ----------------------------------------------------------- 0 1,885,783 46,380,927 ----------------------------------------------------------- Net increase in cash (1,297,808) (1,085,556) 13,033,032 Beginning cash 14,330,840 2,864,377 ----------------------------------------------------------- Ending cash 13,033,032 1,778,821 13,033,032 =========================================================== Non-cash investing and financing activities: Interest (Paid) Received $ 130,490 $ 15,575 $ 160,492 Income Taxes Paid -- -- -- *During 2002, the Company issued $67,526 of Convertible Promissory Notes payable for preformation funds received and expended prior to Inception. *The company issued warrants to purchase 315,354 shares of common stock to the placement agent for services rendered in connection with the fund raising effort. *The Company issued warrants to purchase 50,000 shares of common stock for consulting services in 2004 and 100,000 shares of common stock upon the exercise of a warrant in exchange for services rendered. *The Company issued 1,193,500 shares of common stock upon conversion of the Convertible Promissory notes payable and accrued interest of $135,327. *The Company issued warrants to purchase 250,000 shares of its common stock for a modification to the technology license agreement. *During the quarter ended March 31, 2006, upon completion of the plant in Anaheim, CA. all construction in progress was transferred to leasehold improvements and all deposits on equipment was transferred to machinery and equipment. *During the quarter ended March 31, 2007, the Company issued 103,340 shares in exchange for services rendered in 2006. SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS F-5
WORLD WASTE TECHNOLOGIES, INC. AND SUBSIDIARIES (FORMERLY WORLD WASTE OF AMERICA, INC.) (A DEVELOPMENT STAGE COMPANY) NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2007 AND 2006 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The Company is a new enterprise in the development stage as defined by Statement No. 7 of the Financial Accounting Standards Board, since it has not derived substantial revenues from its activities to date. INTERIM FINANCIAL STATEMENTS The accompanying consolidated financial statements include all adjustments (consisting of only normal recurring accruals), which are, in the opinion of management, necessary for a fair presentation. Operating results for the quarter ended March 31, 2007 are not necessarily indicative of the results to be expected for a full year. The consolidated financial statements should be read in conjunction with the Company's amended consolidated financial statements for the year ended December 31, 2006. USE OF ESTIMATES The preparation of consolidated 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 the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATION Certain amounts for the year ended December 31, 2006 have been reclassified to conform with the presentation of the March 31, 2007 amounts. These reclassifications had no effect on reported net loss. REVENUE RECOGNITION Revenue for receiving Municipal Solid Waste (MSW) is recognized when the MSW is delivered. Revenue for products sold, such as unbleached fiber, metals and aluminum, are recognized when the product is delivered to the customer. All shipping and handling costs are accounted for as cost of goods sold. RESEARCH AND DEVELOPMENT Research and development costs are charged to operations when incurred. INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." In accordance with SFAS No. 109, the Company records a valuation allowance against net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and when temporary differences become deductible. The Company considers, among other available information, uncertainties surrounding the recoverability of deferred tax assets, scheduled reversals of deferred tax liabilities, projected future taxable income, and other matters in making this assessment. The Company adopted FIN 48 on January 1, 2007. There was no material impact on the Company's financial statements as a result of the adoption. F-6 CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased, which are not securing any corporate obligations, to be cash equivalents. The Company had no cash equivalents at March 31, 2007. CONCENTRATION OF CREDIT RISK The Company maintains its cash balances in a financial institution. Cash balances at the institution are insured by the Federal Deposit Insurance Corporation up to $100,000. The Company has not experienced any losses in connection with such accounts. FIXED ASSETS Machinery and Equipment is stated at cost. Depreciation is computed on the straight-line method over the estimated useful asset lives or for leasehold improvements or equipment installed in the Anaheim plant, over the remaining life of the lease, whichever is shorter. Due to the fact that at the time the assets were placed into service the lease had 8 years and two months remaining, all assets and leasehold improvements at the Anaheim facility are being depreciated over a maximum of 8 years and two months on a straight line basis. Maintenance and repairs are expensed as incurred. The Company completed the construction of its initial plant in Anaheim, California early in the second quarter of 2006. The Company placed into service and began depreciating the assets related to this facility in the second quarter of 2006. The assets at the Anaheim plant are comprised of two basic technologies; the front half of the plant consists of assets related to the Company's core patented technology related to "steam classification" and material separation and the back half of the plant consist of assets related to screening and cleaning of the cellulose biomass material to prepare it for sale to paper mills. During the plant start up phase, we confronted several issues, including an unexpected high level of biological oxygen demand from organic waste in the wastewater from the pulp screening and cleaning process. The Company decided not to make the capital improvements necessary to the Anaheim plant's wetlap process, or "back half" which the Company considers necessary in order to recover the carrying amount of the wetlap plant assets through projected future undiscounted cash flow from its operation. Consequently, the Company recorded a charge of $9,737,344 in 2006 which represented the net carrying value of the wetlap process (or "back half") equipment. The charge was equal to the carry cost of the assets of the wetlap process, net of accumulated depreciation. The Company did not record an impairment charge for the steam classification equipment (or "front half") of the plant because the Company intends to use that equipment in research and development activities as part of its development of alternative back end processes such as, but not limited to, gasification and acid hydrolysis and because it also believes that by making certain improvements to the plant, such as adding equipment for energy co-generation, and changing the use of the cellulose biomass mass from the wetlap process to another application, such as its use as a form of fuel, the future undiscounted cash flow from its operations might cover the capitalized cost. During 2007, the Company plans to continue to operate primarily in the research and development mode. Consequently, depreciation of the "steam classification" equipment may be charged to research and development under FASB 2, "Accounting for Research and Development Costs." The Company capitalizes leases in accordance with FASB 13, "Accounting for Leases." F-7 INTANGIBLES Intangible assets are recorded at cost. On May 1, 2006, pursuant to a Patent Assignment Agreement and a Patent Assignment, both dated as of May 1, 2006 (the "Patent Assignment Agreement and a Patent Assignment"), the Company completed the purchase of all right, title and interest in United States Patent No. 6,306,248 (the "Patent") and related intellectual property, subject to existing licenses, from the University of Alabama in Huntsville for $100,000 and 167,000 shares of the Company's unregistered common stock valued at approximately $698,000, based on the market price of the stock on the date issued, May 1, 2006. The Company continues to exploit the technology covered by the Patent through a sublicense from the original licensee, Bio-Products, International, Inc. (BPI). By virtue of the acquisition of the Patent, the Company now owns all rights, title and interest in the Patent, subject to BPI's existing license, which in turn continues to sublicense the technology to the Company. Prior to the purchase of the Patent, the Company's only intangible asset was the sub-license from BPI for the patented technology and other related intellectual property. The Company began amortizing its intangible assets during the second quarter of 2006 upon completion of its first facility, on a straight-line basis over the remaining life of the intellectual property. The Patent expires in 2017 and the license expires in 2022. The Company's policy regarding intangible assets is to review such intangible assets for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. If the review indicates that intangible assets are not recoverable (i.e. the carrying amounts are more than the future projected undiscounted cash flows), their carrying amounts would be reduced to fair value. In April 2007, the Company filed a lawsuit against BPI alleging, among other things, breach of contract and negligence with respect to the construction of the vessels. See Note 3 and 8. The Company does not believe that this lawsuit affects the carrying value of the patent or sub-license. Therefore, the Company had no material impairment to its intangible assets during the quarter ended March 31, 2007 and the year ended December 31, 2006. REDEEMABLE CONVERTIBLE PREFERRED STOCK Convertible Preferred Stock which may be redeemable for cash at the determination of the holder is classified as mezzanine equity, in accordance with FAS 150 "Accounting for Certain Financial Instruments with Characteristics of Both Debt and Equity," EITF Topic D 98 and ASR 268, and is shown net of discounts for offering costs, warrant values and beneficial conversion features. STOCK-BASED COMPENSATION As of March 31, 2007, the Company had one share-based compensation plan, which is described below. The compensation cost that has been charged against income for the plan was $185,108, $463,406 and $1,617,096 for the quarters ended March 31, 2007 and 2006 and for the period from inception to March 31, 2007, respectively. Because the Company is in a net loss position, no income tax benefit has been recognized in the income statement for share-based compensation arrangements. As of March 31, 2007 and 2006, no share-based compensation cost had been capitalized as part of inventory or fixed assets. The Company's 2004 Incentive Stock Option Plan (the Plan), which is shareholder-approved, provides for the issuance by the Company of a total of up to 2.0 million shares of common stock and options to acquire common stock to the Company's employees, directors and consultants. The Company believes that such awards better align the interests of its employees with those of its shareholders. Option awards are generally granted with an exercise price equal to the market price of the Company's stock at the date of grant; those option awards generally vest based on 2 to 4 years of continuous service and have 10-year contractual terms. The Company granted 475,000 options during the quarter ended March 31, 2007 to employees, members of the board of directors and consultants. At March 31, 2007, there were 1,987,000 options outstanding under the Plan. There were no grants made during the quarter ended March 31, 2006. Certain option awards provide for accelerated vesting if there is a change in control (as defined in the Plan). The Company plans to adopt a new incentive stock plan in 2007. F-8 The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the table below. Expected volatilities are based on the historical volatility of the Company's common stock from August 24, 2004 through the date of the respective grant. The Company uses historical data to estimate option exercise and employee terminations within the valuation model. The expected term of options granted was estimated using the simple method which the Company believes provides a reasonable estimation of the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the LIBOR rate at the time of grant. QUARTER ENDED YEAR ENDED MARCH 31, 2007 DECEMBER 31, 2006 ------------------- ------------------- Expected volatility 77 % 70 % Expected dividends 0 % 0 % Expected term (in years) 5.5 - 10.0 4 Risk-free rate 4.64% - 5.07 % 4.64 % A summary of option activity under the Plan as of March 31, 2007, and changes during the quarter then ended is presented below:
AVERAGE REMAINING AGGREGATE WEIGHTED-AVERAGE CONTRACTUAL INTRINSIC OPTIONS SHARES EXERCISE PRICE TERM VALUE -------------------------------------- ------------ ------------------ ------------- ------------ Outstanding at January 1, 2007 1,587,000 $ 2.44 $ 26,250 Granted 475,000 1.29 -- Exercised -- -- -- Forfeited or expired 75,000 $ 1.50 -- Outstanding at March 31, 2007 1,987,000 $ 2.16 8.65 -- Exercisable at March 31, 2007 824,500 $ 1.76 8.64 $ --
The aggregate intrinsic value represents the total pretax intrinsic value, based on options with an exercise price less than the Company's closing stock price of $1.11 as of March 31, 2007 which would have been received by the option holders had those option holders exercised their options as of that date. The weighted-average grant-date fair value of options granted during the three months ended March 31, 2007 was $0.82. There were no options granted during the three months ended March 31, 2006. There have been no options exercised since inception. When options are exercised, the Company will issue new shares to the recipient. F-9
WEIGHTED-AVERAGE NON-VESTED STOCK OPTIONS OPTIONS GRANT DATE FAIR VALUE ----------------------- ----------------------- Non-vested at beginning of period 912,500 1.56 Granted 475,000 0.82 Vested 218,750 0.83 Forfeited -- -- Non-vested at end of period 1,168,750 1.40
As of March 31, 2007, there was approximately $1.31 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 1.87 years. Non employment stock warrants outstanding:
WEIGHTED- WEIGHTED AVERAGE AVERAGE GRANT NUMBER EXERCISE PRICE DATE FAIR VALUE ----------------------------------------- ------------- ------------------ ----------------- Outstanding at December 31, 2006 7,003,147 $ 2.19 $ 2.31 Exercisable at December 31, 2006 7,003,147 $ 2.19 $ 2.31 Granted during the period 0 $ - $ - Vested during the period 0 $ - $ - Exercised during the period 0 $ - $ - Cancelled 0 $ - $ - Outstanding at March 31, 2007 7,003,147 $ 2.19 $ 2.31 Exercisable at March 31, 2007 7,003,147 $ 2.19 $ 2.31
EARNINGS PER SHARE The Company has adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128). SFAS No. 128 provides for the calculation of basic and diluted earnings per share. Basic earnings per share includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities that could share in the earnings of an entity, such as stock options, warrants or convertible securities. Due to their anti-dilutive effect, common stock equivalents of 25,981,222, consisting of employee options of 1,987,000, investor warrants of 7,003,147, Preferred Series A of 5,663,842 and Preferred Series B of 11,327,234, were not included in the calculation of diluted earnings per share at March 31, 2007 and common stock equivalents of 8,809,752 were not included in the calculation of diluted earnings per share at March 31, 2006. NOTE 2. GOING CONCERN The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company had a net loss for the quarter ended March 31, 2007 of $1,799,211 and an accumulated deficit of $47,138,714 at March 31, 2007. The Company expects to incur substantial additional losses and costs and capital expenditures before it can operate profitably. The ability to operate profitably is subject to resolving significant operating issues or developing other products. The Company's ability to accomplish this is dependent on successful research and development, engineering and obtaining of additional funding. If the Company is unsuccessful, it may be unable to continue as a going concern for a reasonable period of time. These issues raise substantial doubt about the Company's ability to continue as a going concern. F-10 There can be no assurance that the Company's research and development and engineering activities or any future efforts to raise additional debt and/or equity financing will be successful. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing, and ultimately to attain successful operations. NOTE 3. LICENSE AGREEMENT On June 21, 2002, the Company entered into a U.S. technology sub-license agreement with Bio-Products International, Inc. (BPI), an Alabama corporation with respect to certain intellectual property and patented methods and processes. This agreement was amended on June 21, 2004 and again on August 19, 2005. The technology was designed to provide for the processing and separation of material contained in Municipal Solid Waste (MSW). This unique process treats MSW with a combination of time, temperature and steam pressure. Temperatures of several hundred degrees cook the material, and the pressure and agitation causes a pulping action. This combination is designed to result in a significant volume reduction, yielding high-density, cellulose biomass product that is ready for processing and/or market. The most recent patent includes the capturing of all Volatile Organic Compounds and was granted by the United States Patent and Trademark Office in October 2001. Through April 30, 2006, the University of Alabama in Huntsville ("UAH") owned the patent for this technology. On May 1, 2006, the Company acquired the patent from UAH for $100,000 and 167,000 shares of the Company's unregistered common stock valued at its fair value on the date of issuance of approximately $698,000. The patent reverts to UAH in the event of bankruptcy of the Company. This patent is licensed to BPI. The license to the patent in the United States was assigned to the Company. BPI is required to continue to make certain payments to the Company, as the patent owner, to maintain exclusivity to the patent for the technology. The Company does not expect royalty income from BPI to be material for the foreseeable future. The Company continues to exploit the technology covered by the Patent through the sublicense from the original licensee, BPI. By virtue of the acquisition of the Patent, the Company now own all rights, title and interest in the Patent, subject to BPI's existing license, which in turn continues to sublicense the technology to the Company. The sub-license extends for a period of 20 years from the effective date of the agreement. The agreement is subject to automatic extension until the expiration date of the last patent issued to BPI. For the sub-license, the Company agreed to pay a one-time fee of $350,000. The license is being amortized over the remaining life of the license beginning when the Company's plant first became operational. In addition, the Company is obligated to pay a royalty for every ton of waste processed using the licensed technology as follows: RATE TONS PROCESSED PER DAY ------------- ----------------------------- $0.50 1 - 2,000 $1.00 2,001 - 10,000 $1.50 10,001 and up The Company is also obligated to pay a bonus to BPI of two and one half percent (2.5%) of the gross sales price in excess of ten dollars ($10.00) per ton for the cellulose biomass product produced from MSW, utilizing the technology. F-11 As additional consideration and for their experience and know-how regarding the technology, the Company agreed to pay BPI a monthly payment for technical services of $10,000 per month from January 2003 to April 2004 and $20,000 per month until the first plant processes or is able to process waste equal to or in excess of the facility's design capacity, and then $15,000 per month for five years thereafter. Due to the proprietary nature of the vessel design utilized in the process, the Company granted BPI the exclusive right of vessel manufacture, and agreed to purchase all required process vessels exclusively from BPI at a fixed purchase price of the quoted cost plus 15%. During the start-up phase of the initial plant in Anaheim, California, the Company became aware of design issues related to the steam classification vessels that the Company intends to use in its operations. The steam vessels were designed and fabricated on the Company's behalf by BPI pursuant to a contract entered into with BPI in July 2004 and the sub-license agreement discussed above. The agreement also provides the Company with the rights to certain technology used in its process. The Company has been dissatisfied with the remediation of these issues by BPI and has proceeded to resolve them itself. Consequently, in April, 2007, the Company filed a lawsuit against BPI in the Superior Court of the State of California alleging, among other things, breach of contract and negligence with respect to the construction of the vessels. The Company is seeking monetary damages, among other relief sought. NOTE 4. INCOME TAXES On July 13, 2006, FASB Interpretation (FIN) No. 48, was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. (FAS) 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken "or expected to be taken in a tax return. The new FASB standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We adopted FIN 48 effective January 1, 2007. As defined by Fin 48, unrecognized tax benefits related to expenses that are recognized for determining income for financial statement purposes but have not been included as expenses in the Company's tax provision, as the Company believes these expenses will be disallowed for tax purposes. As of the date of adoption, the Company had a total amount of unrecognized tax benefits of $8,626,344. Virtually all of this balance related to Federal net operating losses the Company acquired in connection with its merger with Voice Powered Technology International, Inc. These losses are subject to significant limitations under Internal Revenue Code Section 382 that will impact the Company's ability to utilize the net operating losses before they expire. As we provided for a 100% reserve against our deferred tax asset, the adoption of FIN 48 did not have a material effect on the financial statements. We have always excluded these net operating losses from the total available net operating losses we disclosed in our tax footnote. As of January 1, 2007, the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $2,165. The recognition of this amount would be offset by a corresponding tax provision adjustment for an increase to the valuation allowance for deferred taxes related to net operating losses. We have historically classified interest and penalties on income tax liabilities as additional income tax expense and will continue to do so after the adoption of FIN 48. As of January 1, 2007, our statement of financial position did not include any accrued interest or penalties. As of January 1, 2007, it was reasonably possible that the total amount of our unrecognized tax benefits would decrease by approximately $500,000 to $600,000 within the following twelve months. This would result from the expiration of a Federal net operating loss carryforward from the 1994 tax year. This net operating loss carryforward is subject to the limitations mentioned above. F-12 As of January 1, 2007, we were not under examination by any major tax jurisdiction. NOTE 5. REDEEMABLE CONVERTIBLE PREFERRED STOCK The Company has outstanding two classes of Preferred Stock, Series A and Series B. Holders of both series of preferred stock are entitled to receive cumulative dividends, payable quarterly in additional shares of preferred stock, at the rate of 8% per annum. The holders of a majority of reach class of preferred shares have the option to require the Company to redeem all outstanding shares on April 28, 2010. In the event the holders do not exercise this redemption right, all shares of Series A will automatically convert into shares of Common Stock on such date. The warrant values, offering costs and beneficial conversion features of both classes of preferred stock have been treated as discounts to the carrying value of the preferred stock, and are being accreted through their redemption date under an acceptable method in accordance with EITF Topic D-98. For the Series B Preferred Stock the Company deemed the straight-line method was a preferable method, giving rise to a more appropriate distribution of the dividend recognition over the accretion period. The amortization costs are treated consistent with the treatment of preferred stock dividends. THE SUMMARY FOR THE SERIES A AND B IS AS FOLLOWS:
SERIES A SERIES B TOTAL --------------- --------------- --------------- Gross proceeds $ 10,189,000 $ 28,488,800 $ 38,677,800 Cumulative in kind dividends 1,846,665 2,066,457 3,913,122 Converted to common stock -- (2,703,590) (2,703,590) --------------- --------------- --------------- Total outstanding 12,035,665 27,851,667 39,887,332 Unamortized beneficial conversion feature (898,585) (13,191,041) (14,089,626) Unamortized offering costs (1,058,326) (3,321,062) (4,379,388) Unamortized warrant value (898,585) (4,171,821) (5,070,406) --------------- --------------- --------------- Balance at March 31, 2007 $ 9,180,169 $ 7,167,743 $ 16,347,912 =============== =============== ===============
NOTE 6. CAPITAL LEASE OBLIGATION Capital Lease obligation is comprised as follows:
MARCH 31, 2007 DECEMBER 31, 2006 -------------------- -------------------- Capital Lease for Front End Loader, 31 monthly $114,912 $125,966 installments of $4,526, 31 payments were remaining at March 31, 2007, interest was imputed at 8.25% Less: Current portion 46,563 45,615 -------------------- -------------------- $68,349 $80,351 ==================== ====================
NOTE 7. COMMITMENT AND CONTINGENCIES The Company is obligated to pay BPI for technical services $20,000 per month until the first plant processes or is able to process waste equal to or in excess of the facility's design capacity and then $15,000 per month for five years. Due to contract disputes with BPI, the Company suspended payments in January 2007 to BPI until the disputes are resolved. The Company has operating lease obligations for plant and office space of approximately: Less than 1 year $253,000 more than 1 less than 3 $441,000 more than 3 less than 5 $402,000 after 5 years $519,000 F-13 As of March 31, 2007, the Company had in place one employment agreement, pursuant to which, the total annual salary was $224,000. The officer is entitled to receive 12 months salary and continuation of benefits in the event the Company terminates his agreement for other than "good cause" or the officer resigns from the Company for "good reason" (as such terms are defined in the agreements). In addition, the officer is entitled to 12 months salary and continuation of benefits in the event of disability or death during the term of his agreement. Also at March 31, 2007, the Company had in place one employment agreement in which the employee has announced his retirement effective May 2007 at which time the agreement will terminate with no additional obligations to the Company. The Company's CEO is not under an employment contract. NOTE 8. SUBSEQUENT EVENTS During the start-up phase of the initial plant in Anaheim, California, the Company became aware of design issues related to the steam classification vessels that the Company intends to use in its operations. The steam vessels were designed and fabricated on the Company's behalf by BPI pursuant to a contract entered into with BPI in July 2004 and the sub-license agreement discussed above. The agreement also provides the Company with the rights to certain technology used in its process. The Company has been dissatisfied with the remediation of these issues by BPI and has proceeded to resolve them itself. Consequently, in April, 2007, the Company filed a lawsuit against BPI in the Superior Court of the State of California alleging, among other things, breach of contract and negligence with respect to the construction of the vessels. The Company is seeking monetary damages, among other relief sought. F-14 PART II ITEM 1A. THERE HAVE BEEN NO MATERIAL CHANGES TO THE RISK FACTORS FROM THOSE FILED IN THE COMPANY'S FORM 10-K/A FILED MAY 3, 2007. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The following discussion, as well as information contained elsewhere in this report, contain "forward-looking statements." These statements include statements regarding the intent, belief or current expectations of us, our directors or our officers with respect to, among other things: anticipated financial or operating results, financial projections, business prospects, future product performance and other matters that are not historical facts. The success of our business operations is dependent on factors such as the impact of competitive products, product development, commercialization and technology difficulties, the results of financing efforts and the effectiveness of our marketing strategies, and general competitive and economic conditions. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors, including those described under "Item 1A - Risk Factors" in our annual report on Form 10-K/A for the year ended December 31, 2006. COMPANY OVERVIEW We are a development stage company formed to develop technologies designed to profitably transform municipal solid waste (MSW) into usable commodities and products such as ethanol, electricity and paper pulp, and to design, build, own and operate facilities that utilize such technologies. We recently completed construction of our first facility in Anaheim, California, located on the campus of the regional transfer facility and Material Recovery Facility (MRF) of Taormina Industries, a wholly owned subsidiary of Republic Services, Inc. Our Anaheim facility has been in a limited startup phase and has successfully transformed MSW to produce small test quantities of paper pulp, which we have sold to paper manufacturer. We are now utilizing the facility to continue improving our pulp technology and for research and development on additional technologies to create renewable energy products such as ethanol and electricity. We anticipate that our technologies generally will position us to generate three distinct revenue streams: (a) "tipping" fees charged to the entities that supply us with MSW, (b) recycling revenue from the sale of commodity recyclables (such as aluminum, tin, steel, and plastics) that our process recovers and which otherwise would be interned in landfills, and (c) revenue from the sale of our end product, anticipated to be either ethanol, electricity, or paper pulp, depending on which technology is employed, which in turn will depend upon a number of factors including local market demand. We believe that the fact that we are able to receive fees from the entities that provide us with "feedstock" (i.e. waste) is an important and beneficial characteristic of our process and our design, build, own and operate business model. MARKET OVERVIEW According to information currently posted on the National Solid Waste Management Association's website (the most recent publicly available information on this topic that we are aware of), the MSW industry in the United States, the primary market that we plan to serve, accounts for approximately $43 billion in spending. We believe that our existing and future technologies will potentially offer benefits to a number of different constituencies, including solid waste companies (by reducing transportation costs and increasing diversion of waste from landfills), communities and regulators (by increasing recycling rates, lengthening landfill life, gaining a renewable energy source, and reducing traffic), utilities and ethanol distributors (by increasing renewable content in energy production and diversifying ethanol supply away from corn-based production), and environmentally conscious consumers (by decreasing reliance on hydrocarbon-based power, reducing greenhouse gases from landfill methane and truck traffic, and creating ethanol from non-grain sources). We believe that our process will compliment the existing investment made by communities to create and expand curbside recycling programs by targeting the MSW that is still going to the landfill (the "residual MSW", or "RMSW"). RMSW may have already been processed by an MRF, and often contains material that has historically been the most difficult portion of MSW to recycle. 1 Several companies are producing ethanol from cellulosic sources such as corn. We believe that MSW is superior to corn as a feedstock for ethanol production for numerous reasons. For instance, (a) corn must be grown, harvested, and delivered, all of which add cost, (b) ethanol diverts corn from food use, which may raise the cost of other foods, (c) significant energy in the form of planting, harvesting, and transportation must be expended to grow corn, and (d) growing corn requires significant other resources, such as water, fertilizer and gasoline. By contrast, we believe utilizing MSW to produce ethanol can be beneficial for numerous reasons including (a) MSW is comparatively inexpensive because we would be paid a tip fee to accept it, (b) utilizing MSW achieves landfill diversion goals, (c) MSW is located in areas where ethanol is in demand, and (d) MSW has a strong positive energy balance. OUR ANAHEIM FACILITY At our Anaheim facility, we use a rotating pressure vessel to combine steam, heat, pressure and agitation to change the waste's physical composition. The process converts paper, cardboard, and paper packaging found in RMSW into a cellulose biomass fiber-containing material. The cellulose biomass can be screened and cleaned using conventional and non-conventional pulp recycling equipment, and the resulting unbleached fiber, known as "wetlap" pulp, can be used as a raw material for making new lower grade paper stocks such as linerboard, corrugating medium, and packaging. We have entered into a long-term contract with Taormina to supply us with RMSW. We began processing RMSW at our Anaheim facility on a limited start-up basis during the second quarter of 2006, and since then have processed over 2,500 tons of RMSW through the facility and the resulting cellulose biomass has been refined into over 400 tons of wetlap pulp. This wetlap product has been supplied to several cardboard and paper manufacturers with operations in Southern California. We have also sold a limited amount of the other inorganic, recyclable materials captured by our process including aluminum, steel, tin and plastics, into various commodity markets. Although our customers have provided positive feedback on the pulp quality and specifications and have requested continued shipments, we recently became aware of several issues with our process, including its creation of an unexpectedly high level of biological oxygen demand (BOD) from organic wastes in the wastewater from the pulp screening and cleaning process, and design issues related to the steam classification vessels. These issues would require a significant level of reengineering and repairs to put us in a position to potentially conduct sustained and profitable operations on a commercial level at our current facility. Due to, among other factors, the significant costs of additional capital improvements required at our Anaheim plant that would be necessary in order to address the BOD issue, we recently decided not to make these improvements for the pulp process or to actively pursue the creation or sale of wetlap pulp generated at this plant. Rather, we plan to run the plant on an intermittent basis for process improvement trials, technology demonstration, product development and other research and development initiatives, including as relates to the production of ethanol and electricity. We expect to continue to use the steam classification assets at the Anaheim facility in a research mode in an effort to develop ethanol, electricity and pulp opportunities until such time, if ever, as we can develop or acquire the technology to enable us to operate the plant profitably. 2 Based on our research and development, including our accumulated experience from operating the Anaheim plant, we believe the necessary characteristics for the successful development of additional wetlap-based MSW conversion facilities include: a relatively high volume of MSW, larger physical plant enabling a larger scale operation, a desire by the community to increase recycling rates to minimize the amount of this waste disposed of in landfills, feedstock composition which includes a higher amount of paper products, a fully scoped on-site water treatment facility, and higher landfill tipping fees than we currently receive in Anaheim, California. We plan to continue to conduct business development discussions with various paper and solid waste companies and government agencies to determine where the proper combination of operating characteristics can be achieved to pursue a larger scale wetlap production facility in future locations. ETHANOL AND ELECTRICITY OPPORTUNITIES We recently began pursuing the development of various energy products which can be produced from MSW. One process which we believe has potential for successful commercialization involves using gasification technologies to produce a synthetic gas (or "syngas") from wetlap or intermediate products in our process. This syngas can be used to produce energy to drive a turbine or passed through a catalyst environment to produce fuel grade alcohols, primarily ethanol. We believe this same basic process can also be used to produce hydrogen for industrial applications and fuel cells. In this area we recently filed a provisional patent covering a process and certain conditions, which we believe may maximize the yield of these alcohols. A by-product of the catalyst process is a residual producer gas that can be used for the beneficial co-generation of renewable electricity. The syngas can be used to fire either a boiler driving a steam turbine, or a gas-fired turbine, and thereby produce energy to reduce our utility costs. Also in the ethanol area, in addition to the above process for producing fuel alcohols through gasification, we are investigating alternative pathways for transforming our cellulose biomass product into ethanol using various acid and enzymatic hydrolysis processes. We have produced small quantities of ethanol through an intermediate acid hydrolysis process in the early trials and are currently performing additional testing and engineering studies to determine the economic feasibility of a commercial size plant based on the insights from our research. In addition, we recently entered into a memorandum of understanding with Ensyn Corporation relating to a proposed technology development agreement under which the companies would collaborate to develop technologies for production of energy products and bio-fuels from MSW cellulose biomass. We recently established a Technical Advisory Board to assist us in advancing our business of creating usable commodity products from MSW, particularly as it pertains to developing our ethanol and electricity technologies. STRATEGY Our goal is to profitably transform residual MSW into usable commodity products, such as ethanol, electricity, and paper pulp and to build, own and operate facilities to accomplish this goal. Our strategies to achieve our goal include the following: PRELIMINARY COMMERCIALIZATION AND FURTHER RESEARCH AND DEVELOPMENT Technical feasibility and process characterization of our RMSW to pulp process has been achieved at our facility in Anaheim. We are now utilizing the facility to collect further detailed operating data in anticipation of developing a potential full-scale plant. We are also using the facility to perform research and development on alternative energy technologies for processing RMSW, such as gasification for the production of electricity and ethanol, and acid hydrolysis for the production of ethanol. We are investigating the installation of a small-scale gasification unit in Anaheim or elsewhere, with the intention of collecting detailed operating data on ethanol and electricity production. In addition we anticipate constructing a small-scale hydrolysis facility to generate ethanol from MSW. We anticipate that this phase of our strategy will continue through at least the remainder of 2007. 3 FULL SCALE FACILITY AND COMMERCIALIZATION We are in the early stages of identifying potential sites for our next facility, which we anticipate will be a full-scale facility. We are identifying high priority sites and targeting locations with advantageous MSW tip fees and volume. REPLICATION AND ROLLOUT We anticipate that our technologies will be configured to meet the needs of the local market, and we will seek to develop additional facilities, implementing the most profitable end product platforms on a site by site basis. We will seek to develop facilities in the most favorable locations within the United States, and we anticipate exploring licensing opportunities to accelerate the rollout. We plan to leverage experienced engineering and construction partners for the most effective utilization of our resources. POTENTIAL ACQUISITIONS In addition, as part of the implementation of our strategy, we may investigate potential acquisitions. In general, we may seek acquisition candidates with characteristics that included: (a) established and growing revenue, (b) positive cash flow, or (c) technology or strategy that complements our focus. Our ability to implement our strategy will be dependent upon our ability to raise significant amounts of additional capital, of which there can be no assurance. TRENDS IN OUR BUSINESS The Resource Conservation and Recovery Act of 1991 requires landfills to install expensive liners and other equipment to control leaching toxics. Due to the increased costs and expertise required to run landfills under this Act, many small, local landfills closed during the 1990's. Larger regional landfills were built requiring increased logistics costs for the waste haulers. In addition, state and federal governments have continued to increase the pressure on the industry to improve their recycling percentages. California currently mandates one of the highest standards in the United States by requiring 50% of all incoming MSW to be diverted from landfills. We believe that the trend in state law throughout the U.S. is to migrate toward this California standard. We expect that the resale price of our products, including wetlap pulp, aluminum, steel, plastic, glass and tin will be tied to commodity markets. The resale and market demand for these materials can be volatile, which can significantly impact our results of operations. Due in part to increasing demands for packaging material from China and India, the demand is expected to increase in the future. High prices for hydrocarbon-based fuels have led to increasing market interest in renewable fuel sources such as ethanol. Investment into corn-based ethanol production facilities is increasing in the U.S. Research and development investment spending is also increasing for technologies and processes which can convert cellulose biomass into ethanol and other fuels. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's discussion and analysis of our financial condition and plan of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, bad debts, impairment of long-lived assets, including finite lived intangible assets, accrued liabilities and certain expenses. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. 4 Our significant accounting policies are summarized in Note 1 to our audited financial statements for the year ended December 31, 2006 and our unaudited financial statements dated March 31, 2007. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: BASIS OF PRESENTATION The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The Company is a new enterprise in the development stage as defined by Statement No. 7 of the Financial Accounting Standards Board, since it has not derived substantial revenues from its activities to date. INTERIM FINANCIAL STATEMENTS The accompanying consolidated financial statements include all adjustments (consisting of only normal recurring accruals), which are, in the opinion of management, necessary for a fair presentation. Operating results for the quarter ended March 31, 2007 are not necessarily indicative of the results to be expected for a full year. The consolidated financial statements should be read in conjunction with the Company's amended consolidated financial statements for the year ended December 31, 2006. USE OF ESTIMATES The preparation of consolidated 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 the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. FIXED ASSETS Machinery and Equipment is stated at cost. Depreciation is computed on the straight-line method over the estimated useful asset lives or for leasehold improvements or equipment installed in the Anaheim plant, over the remaining life of the lease, whichever is shorter. Due to the fact that at the time the assets were placed into service the lease had 8 years and two months remaining, all assets and leasehold improvements at the Anaheim facility are being depreciated over a maximum of 8 years and two months on a straight line basis. Maintenance and repairs are expensed as incurred. The Company completed the construction of its initial plant in Anaheim, California early in the second quarter of 2006. The Company placed into service and began depreciating the assets related to this facility in the second quarter of 2006. The assets at the Anaheim plant are comprised of two basic technologies, the front half of the plant consists of assets related to the Company's core patented technology related to "steam classification" and material separation and the back half of the plant consist of assets related to screening and cleaning of the cellulose biomass material to prepare it for sale to paper mills. During the plant start up phase, we confronted several issues, including 5 an unexpected high level of biological oxygen demand from organic waste in the wastewater from the pulp screening and cleaning process. The Company decided not to make the capital improvements necessary to the Anaheim plant's wetlap process or back half which the Company considers necessary in order to recover the carrying amount of the wetlap plant assets through projected future undiscounted cash flow from its operation. Consequently, the Company recorded a charge of $9,737,344 which represented the net carrying value of the wetlap process (or "back half") equipment. The charge was equal to the carry cost of the assets of the wetlap process, net of accumulated depreciation. The Company did not record an impairment charge for the steam classification equipment (or "front half") of the plant because the Company intends to use that equipment in research and development activities as part of its development of alternative back end processes such as, but not limited to, gasification and acid hydrolysis and it also believes that by making certain improvements to the plant, such as adding equipment for energy co-generation, and changing the use of the cellulose biomass from the wetlap process to another application, such as its use as a form of fuel, the future undiscounted cash flow from its operations might cover the capitalized cost. During 2007, the Company plans to operate primarily in the research and development mode. Consequently, depreciation of the "steam classification" equipment may be charged to research and development under FASB 2, "Accounting for Research and Development Costs." The Company capitalizes leases in accordance with FASB 13, "Accounting for Leases." INTANGIBLES Intangible assets are recorded at cost. On May 1, 2006, pursuant to a Patent Assignment Agreement and a Patent Assignment, both dated as of May 1, 2006 (the "Patent Assignment Agreement and a Patent Assignment"), the Company completed the purchase of all right, title and interest in United States Patent No. 6,306,248 (the "Patent") and related intellectual property, subject to existing licenses, from the University of Alabama in Huntsville for $100,000 and 167,000 shares of the Company's unregistered common stock valued at approximately $698,000, based on the market price of the stock on the date issued, May 1, 2006. We continue to exploit the technology covered by the Patent through a sublicense from the original licensee, Bio-Products, International, Inc. (BPI). By virtue of our acquisition of the Patent, we now own all rights, title and interest in the Patent, subject to BPI's existing license, which in turn continues to sublicense the technology to us. Prior to the purchase of the Patent, the Company's only intangible asset was the sub-license from BPI for the patented technology and other related intellectual property. The Company began amortizing its intangible assets during the second quarter of 2006 upon completion of its first facility, on a straight-line basis over the remaining life of the intellectual property. The Patent expires in 2017 and the license expires in 2022. The Company's policy regarding intangible assets is to review such intangible assets for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. If the review indicates that intangible assets are not recoverable (i.e. the carrying amounts are more than the future projected undiscounted cash flows), their carrying amounts would be reduced to fair value. In April 2007, the Company filed a lawsuit against BPI alleging, among other things, breach of contract and negligence with respect to the construction of the vessels. See Note 3 to the accompanying notes to consolidated financial statements. The Company does not believe that this lawsuit affects the carrying value of the patent or sub-license. Therefore, the Company had no material impairment to its intangible assets during the period ended March 31, 2007 and December 31, 2006. 6 REVENUE RECOGNITION Revenue for receiving Municipal Solid Waste (MSW) is recognized when the MSW is delivered. Revenue for products sold, such as unbleached fiber, metals and aluminum, are recognized when the product is delivered to the customer. All shipping and handling costs are accounted for as cost of goods sold. In January of 2007, the Company changed its plan of operation to focus entirely on research and development projects and consequently recognized no revenue during the first quarter of 2007. All cash received for tip fees and the sale of recyclables was netted against disposal costs. RESEARCH AND DEVELOPMENT Research and development costs are charged to operations when incurred. INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." In accordance with SFAS No. 109, the Company records a valuation allowance against net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and when temporary differences become deductible. The Company considers, among other available information, uncertainties surrounding the recoverability of deferred tax assets, scheduled reversals of deferred tax liabilities, projected future taxable income, and other matters in making this assessment. The Company adopted FIN 48 on January 1, 2007. There was no material impact on the Company's financial statements as a result of the adoption. REDEEMABLE CONVERTIBLE PREFERRED STOCK Convertible preferred Stock which may be redeemable for cash at the determination of the holder is classified as mezzanine equity, in accordance with FAS 150 "Accounting for Certain Financial Instruments with Characteristics of Both Debt and Equity, EITF Topic D 98 and ASR 268, and is shown net of discounts for offering costs, warrant values and beneficial conversion features. RECLASSIFICATION Certain amounts for the year ended December 31, 2006 have been reclassified to conform with the presentation of the March 31, 2007 amounts. These reclassifications had no effect on reported net loss. STOCK-BASED COMPENSATION During the fourth quarter of 2004, we adopted SFAS No. 123 entitled, "Accounting for Stock-Based Compensation" retroactively to our inception. Accordingly, we have expensed the compensation cost for the options and warrants issued based on their fair value at their grant dates. During the quarter ended March 31, 2006, we adopted SFAS No. 123R, "Share Based Payments." The adoption had no material effect on our financial statements. 7 RESULTS OF OPERATIONS COMPARISON OF QUARTERS ENDED MARCH 31, 2007 AND 2006 REVENUES AND COST OF GOODS SOLD During the plant start up phase of our Anaheim plant, we confronted several issues, including an unexpected high level of biological oxygen demand from organic waste in the wastewater from the pulp screening and cleaning process. In January 2007, we decided not to make the capital improvements necessary to the Anaheim plant's wetlap process which the Company considers necessary to operate the plant with the expectation of being profitable. Therefore, beginning in January 2007, we began to operate the plant only as part of research and development projects including but not limited to the development of alternative back end processes such as gasification and acid hydrolysis for the production of ethanol. Consequently, we did not recognize any revenue during the first quarter of 2007. All cash received for tip fees and the sale of recyclables was netted against disposal costs. We also did not recognize any revenue during the first quarter of 2006 because the plant did not start operations until the second quarter of 2006. EXPENSES Research and development expense increased from $60,000 during the quarter ended March 31, 2006 to $918,934 during the comparable quarter in 2007. This was primarily due to the cost of operating the Anaheim plant of $497,380 and plant depreciation of $309,948 in the 2007 period being classified as research and development expense due to the current nature and intent of the plant operations. As part of its shift from operations to research and development, the Company reduced expenditures at the plant by approximately $500,000 for the fourth quarter of 2006 to the first quarter of 2007. The plant was not operational during the comparable quarter in 2006. General and administrative expense increase from $968,668 during the quarter ended March 31, 2006 to $983,491. This $14,823 increase was primarily the result of an increase in professional and consulting fees of approximately $275,000 offset by the allocation of payroll costs to the plant upon completion of construction. Finance expense in 2006 represents the value of warrants issued to the holder of the Series A Preferred Stock for their consent to our issuance of additional senior secured debt and agreement to waive certain of their veto rights and contractual rights to facilitate the Company's next round of financing. Preferred stock dividend and amortization of beneficial conversion feature, warrant discount and offering costs increased to $3,953,403 in the quarter ended March 31, 2007 from $540,486 during the comparable period in 2006 due to the issuance of the Series B Preferred Stock in the second quarter of 2006. See Note 5 to the accompanying unaudited consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES At March 31, 2007, we had cash on hand of approximately $13.0 million, a decrease of approximately $1.3 million from December 31, 2006. During the first quarter of 2007, we used cash primarily for research and development activities of approximately $600,000 net of non cash items primarily depreciation, general and administrative expenses of approximately $600,000 net of non cash items primarily the amortization of employee options and warrants and accrued expenses for consulting, and the purchase of equipment of approximately $100,000. We estimate that our cash will sustain operations through approximately December 2008, based on our current expected burn rate, exclusive of any significant costs to make substantial changes to our initial facility or construct additional facilities, if we choose to do so. 8 As of March 31, 2007, the only long-term debt obligations, capital lease obligations, operating lease obligations, purchase obligations, or other similar long-term liabilities, were the Taormina agreement described in "Business" above, the monthly payment due BPI as part of the license agreement, and the one capital lease described in Note 6 to the unaudited consolidated financial statements. Due to contract disputes, the Company suspended payments to BPI in January 2007. We are not a party to any off-balance sheet arrangements, and we do not engage in trading activities involving non-exchange traded contracts. In addition, we have no financial guarantees, debt or lease agreements or other arrangements that could trigger a requirement for an early payment or that could change the value of our assets. We do not believe that inflation has had a material impact on our business or operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary objective of our investment activities is to preserve our capital to fund operations. We also seek to maximize income from our investments without assuming significant risk. To achieve our objectives, we maintain a portfolio of cash equivalents and investments in a variety of securities of high credit quality. As of March 31, 2007, we had cash and short term investments of $13.0 million. A portion of our investments may be subject to interest rate risk and could fall in value if market interest rates increase. However, because our investments are short-term in duration, we believe our exposure to interest rate risk is not significant and a 1% movement in market interest rates would not have a significant impact on the total value of out portfolio. We actively monitor changes in interest rates. We did not have any financial instruments sensitive to changes in interest rates at March 31, 2007 or December 31, 2006. We currently do not conduct any business outside of the United States and therefore are not subject to risks from changes in foreign currency exchange rates. If and when we begin to generate substantive revenues from our operations, we anticipate that we will be exposed to price changes in the commodity goods we sell in the ordinary course of our business, which changes could have a significant impact on our results of operations. We may in the future use financial instruments to manage our exposure to changes in commodity prices. ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, the Company's Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There was no change in the Company's internal control over financial reporting during the quarter that ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 9 PART II-- OTHER INFORMATION ITEM 6. EXHIBITS Exhibits 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act. 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act 32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act 10 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: May 15, 2007 WORLD WASTE TECHNOLOGIES, INC. (Registrant) By: /s/ David Rane ------------------------------ David Rane Chief Financial Officer 11 INDEX TO EXHIBITS Exhibit Number Description ------ ----------- 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act. 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act 32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act 12