10QSB 1 v050001_10qsb.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2006 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 TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) California 95-3977501 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 13520 Evening Creek Drive, Suite 130, San Diego, California 92128 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (858) 391-3400 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 |_| Number of shares of World Waste Technologies, Inc. Common Stock, $.001 par value, issued and outstanding as of July 31, 2006: 25,030,230. Transitional Small Business Format (Check One): Yes |_| No |X| 1 WORLD WASTE TECHNOLOGIES, INC. Form 10-QSB Table of Contents Page ---- PART I. FINANCIAL INFORMATION Item 1 Financial Statements (unaudited and restated): Consolidated Balance Sheets 3 Consolidated Statements of Operations for the three months ended June 30, 2006 4 Consolidated Statements of Operations for the six months ended June 30, 2006 5 Consolidated Statements of Stockholders' Equity (Deficit) 6 Consolidated Statements of Cash Flows 7 Notes to Financial Statements 8 Item 2 Management's Discussion and Analysis of Financial Condition or Plan of Operations 23 Item 3 Controls and Procedures 35 PART II. OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K 35 SIGNATURES 36 2 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 Sheet
(Unaudited) June 30 December 31 2006 2005 ------------ ------------ Restated ASSETS: Current Assets: Cash $ 19,350,519 $ 2,864,377 Prepaid Expenses 205,750 181,912 Debt Offering Cost 453,264 ------------ ------------ Total Current Assets 19,556,269 3,499,553 ------------ ------------ Fixed Assets: Machinery and Equipment, net of accumulated depreciation of $633,571 at 6/30/06 and $30,958 at 12/31/05 18,975,430 12,926,284 Construction in Progress 4,094,263 ------------ ------------ Total Fixed Assets 18,975,430 17,020,547 Other Assets: Deposit L/T 47,244 104,839 Patent License 1,323,180 556,605 ------------ ------------ TOTAL ASSETS $ 39,902,123 $ 21,181,544 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY: LIABILITIES: Current Liabilities: Accounts Payable $ 1,022,081 $ 1,292,810 Accrued Salaries Payable 205,382 217,684 Accrued Retention Payable 380,572 Deposit on Senior Secured Debt 250,000 Other Liabilities 123,006 188,039 ------------ ------------ Total Current Liabilities 1,350,469 2,329,105 ------------ ------------ Long Term Liabilities: Senior Secured Debt (See Note 5) 3,191,811 Warrant Liabilities 2,009,937 618,654 ------------ ------------ Total Long Term Liabilities 2,009,937 3,810,465 ------------ ------------ TOTAL LIABILITIES 3,360,406 6,139,570 ------------ ------------ Redeemable Preferred Stock (See Note 6) 8,816,730 7,096,544 STOCKHOLDERS' EQUITY Common Stock - $.001 par value: 100,000,000 shares authorized, 25,030,230 and 24,686,230 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively 25,030 24,686 Additional Paid-in-Capital 49,148,321 15,961,816 Deficit Accumulated during development stage (21,448,364) (8,041,072) ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 27,724,987 7,945,431 ------------ ------------ ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 39,902,123 $ 21,181,544 ============ ============
See accompanying notes to consolidated financial statements. 3 World Waste Technologies, Inc. and Subsidiaries (Formerly World Waste of America, Inc.) (A Development Stage Company) Unaudited Consolidated Statements of Operations
Three Months Three Months Ended Ended June 30, 2006 June 30, 2005 ------------- ------------- Restated GROSS REVENUE: $ 14,327 $ -- Operating expenses: Disposal of rejects (14,247) Plant operating expenses (664,809) Depreciation (595,346) ------------- ------------- Gross Margin (1,260,075) -- Research and Development (60,000) (67,410) General and Administrative: (1,037,451) (910,168) ------------- ------------- Loss from Operations (2,357,526) (977,578) ------------- ------------- Interest Income (Expense) (290,190) 26,168 Financing Expense (see note 2) (5,795,176) Change in fair value of warrant liability (135,642) 390,048 ------------- ------------- Net Loss before Provision for Income Tax (8,578,534) (561,362) ------------- ------------- Income Taxes -- -- ------------- ------------- Net Loss $ (8,578,534) $ (561,362) ------------- ------------- Preferred Stock Dividend, amortization of Discount and Beneficial Conversion Feature (1,507,775) (359,917) ------------- ------------- Net Loss Attributable to Common Shareholders $ (10,086,309) $ (921,278) ============= ============= Basic and diluted Net Loss per share available to common shareholders (0.41) (0.04) ============= ============= Weighted average number of shares outstanding used in calculation (see Note 1) 24,893,023 24,418,745 ============= =============
See accompanying notes to consolidated financial statements. 4 World Waste Technologies, Inc. and Subsidiaries (Formerly World Waste of America, Inc.) (A Development Stage Company) Unaudited Consolidated Statements of Operations
Six Months Six Months June 18, 2002 Ended Ended (Inception) to June 30, 2006 June 30, 2005 June 30, 2006 --------------- ------------- -------------- Restated GROSS REVENUE: $ 14,327 $ 14,327 EXPENSES: Operating expenses: Disposal of rejects (14,247) (14,247) Plant operating expenses (664,809) (664,809) Depreciation (595,346) (595,346) ------------ ------------ Gross Margin (1,260,075) (1,260,075) Research and Development (120,000) $ (129,660) (887,386) General and Administrative: (2,006,117) (1,569,290) (8,609,413) ------------ ------------ ------------ Loss from Operations (3,386,192) (1,698,950) (10,756,874) ------------ ------------ ------------ Interest Income (Expense) (274,616) 25,219 (352,424) Financing Expense (see note 2) (7,442,426) (7,442,426) Change in fair value of warrant liability (255,796) 390,048 453,616 ------------ ------------ ------------ Net Loss before Provision for Income Tax (11,359,030) (1,283,682) (18,098,108) ------------ ------------ ------------ Income Taxes -- -- -- ------------ ------------ ------------ Net Loss $(11,359,030) $ (1,283,682) $(18,098,108) ------------ ------------ ------------ Preferred Stock Dividend, amortization of Discount and Beneficial Conversion Feature (2,048,261) (359,917) (3,282,734) ------------ ------------ ------------ Net Loss Attributable to Common Shareholders $(13,407,291) $ (1,643,599) $(21,380,842) ============ ============ ============ Basic and diluted Net Loss per share available to common shareholders $ (0.54) $ (0.07) $ (1.27) ============ ============ ============ Weighted average number of shares outstanding used in calculation (see Note 1) 24,809,174 23,914,740 16,859,201 ============ ============ ============
* 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 consolidated financial statements. 5 World Waste Technologies, Inc. and Subsidiaries (Formerly World Waste of America, Inc.) (A Development Stage Company) Consolidated Statement of Stockholders' Equity Restated
Additional Paid-in Common Stock Accumulated Shares Dollars 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, Restated 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, Restated 217,827 217,827 Net Loss - 2004, Restated (2,496,188) (2,496,188) ---------- ------- ----------- --------- ------------ ------------ December 31, 2004, Restated 22,725,190 $22,725 $ 8,824,811 $ 0 $ (3,727,682) $ 5,119,854 ========== ======= =========== ========= ============ ============ Common Stock and warrants net of offering cost, Restated 1,961,040 1,961 3,072,116 3,074,077 Amortization of stock options and warrants, Restated 654,220 654,220 Dividend (Preferred Stock) 106,645 (671,768) (565,123) Warrants Issued to placement agents on preferred stock, Restated 861,853 861,853 Senior Secured Debt Warrants to debt holders and placement agent, Restated (See note 5) 1,114,105 1,114,105 Beneficial conversion feature on Redeemable Preferred Stock, Restated 1,328,066 1,328,066 Amortization of Beneficial conversion feature and discount on Redeemable Preferred Stock, Restated (562,704) (562,704) Net Loss - 2005, Restated (3,078,917) (3,078,917) ---------- ------- ----------- --------- ------------ ------------ December 31, 2005, Restated 24,686,230 $24,686 $15,961,816 $ 0 $ (8,041,072) $ 7,945,430 ========== ======= =========== ========= ============ ============ Common Stock and warrants net of offering cost 42,725 42 8,166 8,208 Amortization of employee and consultant stock options and warrants 289,164 289,164 Dividend (Preferred Stock) 87,215 (329,479) (242,264) Warrants Issued as financing expense to Series A Preferred holders (See Note 6) 1,647,250 1,647,250 Senior Secured Debt Warrants (See Note 5) 787,500 787,500 Amortization of Beneficial conversion feature, warrants, and offering costs on Redeemable Preferred Stock (211,007) (211,007) Net Loss - March 2006 (2,780,497) (2,780,497) ---------- ------- ----------- --------- ------------ ------------ March 31, 2006 (Unaudited) 24,728,955 $24,728 $18,781,111 $ 0 $(11,362,055) $ 7,443,784 ========== ======= =========== ========= ============ ============ Common Stock and warrants net of offering cost 134,275 135 1,285 1,420 Amortization of employee and consultant stock options and warrants 231,703 231,703 Dividend (Preferred Stock) 240,860 (690,616) (449,756) Beneficial Conversion Feature on Redeemable Preferred Stock 18,207,102 18,207,102 Warrants issued to placement agents and investors on preferred stock 7,922,663 7,922,663 Reset of series A preferred stock conversion feature 3,065,931 3,065,931 UAH Stock for Purchase of Patent 167,000 167 697,666 697,833 Amortization of Beneficial conversion feature, warrants, and offering costs on Redeemable Preferred Stock (817,159) (817,159) Net Loss - June 2006 (8,578,534) (8,578,534) ---------- ------- ----------- --------- ------------ ------------ June 30, 2006 (Unaudited) 25,030,230 $25,030 $49,148,321 0 $(21,448,364) $ 27,724,987 ========== ======= =========== ========= ============ ============
See accompanying notes to consolidated financial statements. 6 World Waste Technologies, Inc. and Subsidiaries (Formerly World Waste of America, Inc.) (A Development Stage Company) Unaudited Consolidated Statements of Cash Flow
Six Months Six Months June 18, 2002 Ended Ended (Inception) to June 30, 2006 June 30, 2005 June 30, 2006 --------------- ------------- -------------- Restated Restated Cash Flow from Operating Activities: $ $ $ Net Loss (11,359,030) (1,283,682) (18,098,108) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 633,871 7,540 664,829 Interest Forgiveness 135,327 Warrant and Common Stock Issued for consulting 10,000 84,566 Amortization of warrants & options to employees and consultants 520,867 236,515 1,392,913 Change in Fair Value of warrant liabilities 255,796 (390,048) (453,616) Financing expense 7,442,426 7,442,426 Amortization of debt offering costs 252,277 Changes in operating assets and liabilities: Prepaid Expenses (23,837) 40,000 (205,750) Accounts Payable 148,905 (77,029) 328,396 Accrued Salaries (12,302) (36,197) 205,382 Accrued Other Liabilities (53,133) (64,221) 123,006 ------------ ------------ ------------ Net Cash used in Operating Activities (2,194,160) (1,556,981) (8,128,348) ------------ ------------ ------------ Cash flows from investing activities: Purchase Machinery & Equipment (3,109,258) (5,928,263) (18,495,980) Purchase of patent license (20,000) (370,000) Deposits 57,595 4,720 (47,244) ------------ ------------ ------------ Net Cash used in Investing Activities (3,071,663) (5,923,543) (18,913,224) ------------ ------------ ------------ Cash flows from financing activities: Note Payable (22,368) Redeemable Preferred Stock 22,649,764 9,209,328 32,136,465 Senior Secured Debt 2,000,000 6,265,000 Repayment of senior secured debt (2,785,000) (2,785,000) Senior Secured Debt Offering Cost (122,424) (420,523) Warrants, Common Stock and Additional Paid-in Capital 9,627 3,198,487 11,202,797 ------------ ------------ ------------ Net Cash provided by Financing Activities 21,751,967 12,385,447 46,392,091 ------------ ------------ ------------ Net Increase in Cash 16,486,142 4,904,923 19,350,519 Beginning Cash 2,864,377 1,128,502 -- ------------ ------------ ------------ Ending Cash $ 19,350,519 $ 6,033,425 $ 19,350,519 ============ ============ ============ Non-Cash Investing and Financing Activities: Interest (Paid) Received $ (153,964) $ (948) $ (151,220) 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 during 2004 and 2005. * 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 in 2005. * The Company issued 1,193,500 shares of common stock upon conversion of the Convertible Promissory notes payable and accrued interest of $135,327 during 2004. * The Company issued warrants to purchase 250,000 shares of its common stock for a modification to the technology license agreement during 2004. * Accounts Payable of $613,685 at June 30, 2006 related to fixed asset acquisitions. The impact has been adjusted in the six month period ended June 30, 2006 statement of cash flow. * Accounts Payable of $1,266,060 and other liabilities of $ 114,242 at December 31, 2005 related to asset acquisitions. The impact has been adjusted in the six month period ended June 30, 2006 statement of cash flow. * During the quarter ended March 31, 2006, non cash interest expense of $340,343 was capitalized in fixed assets. * During the quarter ended June 30, 2006, $3,480,000 of Senior Secured Debt was exchanged for Series B Preferred Stock. * During the quarter ended June 30, 2006, the Company issued 167,000 shares of common stock for the purchase of the patent from the University of Alabama in Huntsville. See accompanying notes to consolidated financial statements. 7 World Waste Technologies, Inc. and Subsidiaries (Formerly World Waste of America, Inc.) (A Development Stage Company) NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2006 Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Amendment and Restatement On July 7, 2006, the Company filed an amended Annual Report on Form 10-KSB/A, originally filed March 30, 2006, as amended, to restate the financial statements for the years ended December 31, 2005 and 2004 included therein. (see Note 11) 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 derived no 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 June 30, 2006 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 and restated consolidated financial statements for the year ended December 31, 2005 included in Amendment Number 2 to the Company's Annual Report on Form 10-KSB, filed July 7, 2006. See Note 11. 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. Revenue Recognition Revenue for receiving MSW is recognized when the MSW is delivered. Revenue for products sold are recognized when the product is delivered and sold to the customer. 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 remain 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. The Company completed the construction of its initial plant in Anaheim, California at the end of March 2006. The Company capitalized all costs directly associated with developing the plant, including interest and labor, throughout the construction period. The Company placed into service and began depreciating the assets related to this facility in the second quarter of 2006. 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. By virtue of our acquisition of the Patent, we now own all rights, title and interest in the Patent, subject to Bio-Products International, Inc.'s existing license, which in turn continues to sublicense the technology to us. 8 Prior to the purchase of the Patent, the Company's only intangible asset was the license from Bio-Products 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. The Company carried no goodwill on its books at either June 30, 2006 or December 31, 2005. Further, during the quarter and six-month period ended June 30, 2006 and the year ended December 31, 2005, the Company had no material impairment to its intangible asset. Redeemable Convertible Preferred Stock Preferred Stock which may be redeemable for cash at the determination of the holder is classified as mezzanine equity, and is shown net of discounts for offering costs, warrant values and beneficial conversion features. 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. Reclassification Certain amounts for the year ended December 31, 2005 and for the three and six month periods ended June 30, 2005 have been reclassified to conform with the presentation of the June 30, 2006 amounts. These reclassifications had no effect on reported net loss. Stock-Based Compensation During the fourth quarter of 2004, the Company adopted SFAS No. 123 entitled, "Accounting for Stock Based Compensation." Accordingly, the Company has expensed the compensation cost for the options and warrants issued based on the fair value at the warrant grant dates. During the quarter ended March 31, 2006, the Company adopted SFAS No. 123R. Because the Company had already been accounting for it stock-based compensation on an estimated fair value basis, the adoption of SFAS No. 123R did not have a material impact on the financial statements of the Company. As of June 30, 2006, 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 $463,406, $118,289, and $963,662 for the six month periods ended June 30, 2006 and 2005 and from inception to June 30, 2006, 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 June 30, 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 has made no share awards as of June 30, 2006. Certain option awards provide for accelerated vesting if there is a change in control (as defined in the Plan). 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 following table. Expected volatilities are based on the historical volatility of the Company's common stock from August 24, 2004 through March 31, 2005. Although the Company uses historical data to estimate option exercise and employee terminations within the valuation model, because of its limited history, the Company has assumed that all options will be exercised and that there will be no employee terminations. As and when employee terminations occur the Company stops amortizing the expense associated with the options. The expected term of options granted was estimated to be the vesting period of the respective options 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. There were no grants made from the Plan during the six months ended June 30, 2006. 9 Year ended 2005 Year ended 2004 --------------- --------------- Expected volatility 70% 70% Expected dividends 0% 0% Expected term (in years) 2 to 4 4 Risk-free rate 3.7%-4.82% 3.6% A summary of option activity under the Plan as of June 30, 2006, and changes during the quarter then ended is presented below: Weighted- Weighted- Average Aggregate Average Remaining Intrinsic Exercise Contractual Value Options Shares Price Term ($000) ------- --------- --------- ----------- ---------- Outstanding at January 1, 2006 1,587,000 $2.42 9.4 Granted Exercised Forfeited or expired 50,000 $2.70 9.3 Outstanding at June 30, 2006 1,537,000 $2.41 8.9 $1,666,600 Exercisable at June 30, 2006 575,333 $2.37 9.0 $ 648,390 The weighted-average grant-date fair value of options granted during 2005 and 2004, was $1.20 and $1.55, respectively. There were no options granted in the six months ended June 30, 2006. There have been no options exercised since inception. A summary of the status of the Company's nonvested shares as of June 30, 2006, and changes during the six months ended June 30, 2006, is presented below: Weighted- Average Grant-Date Nonvested Shares Shares Fair Value ---------------- --------- ---------- Nonvested at January 1, 2006 1,338,333 $2.46 Granted Vested (326,666) $2.48 Forfeited (50,000) $2.70 --------- Nonvested at June 30, 2006 961,667 $2.44 As of June 30, 2006, there was $736,194 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 2.0 years. The total fair value of shares vested during the six months ended June 30, 2006 and the year ended December 31, 2005 was $810,748 and $280,993. There were no shares vested during 2004. 10 Non employment stock warrants outstanding
Average Exercise Weighted Average Grant Number Price Date Fair Value --------- ---------------- ---------------------- Outstanding at December 31, 2005 2,212,362 $1.83 $1.84 Exercisable at December 31, 2005 2,212,362 $1.83 $1.84 Granted during the period 6,538,340 $2.45 $2.55 Vested during the period 6,538,340 $2.45 $2.55 Exercised during the period 186,125 $0.24 $2.00 Cancelled 407,560 $4.00 $3.26 Outstanding at June 30, 2006 8,157,017 $2.26 $2.26 Exercisable at June 30, 2006 8,157,017 $2.26 $2.26
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 25,364,807 were not included in the calculation of diluted earnings per share at June 30, 2006 and common stock equivalents of 6,677,383 were not included in the calculation of diluted earnings per share at June 30, 2005. New Accounting Pronouncements SFAS No. 156, Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140. The FASB has issued FASB Statement No. 156, Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140. This standard amends the guidance in FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Among other requirements, Statement 156 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. Statement 156 is effective as of the beginning of an entity's first fiscal year that begins after September 15, 2006. Management does not believe that this statement will have a material effect on the financial statements. FIN No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109 Summary - 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. 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. As the Company provides for a 100% reserve against its deferred tax asset, Management does not believe that this statement will have a material effect on the financial statements. 11 Note 2. FINANCING EXPENSE Financing expense during the three and six months ended June 30, 2006 were comprised of the following:
Six months ended Three months ended June 30, 2006 June 30, 2006 ---------------- ------------------ Fair value of warrants issued for consent to issue Senior Secured Debt on February 6, 2006 (see Note 6) $1,647,250 Early extinguishment of Senior Secured Debt - unamortized warrant value and offering costs (see Note 5) 1,593,758 $1,593,758 Change in fair value of Series A Preferred due to modification of conversion ratio and warrants upon issuance of Series B Preferred in accordance with anti-dilusion provisions (see Note 6) 4,201,418 4,201,418 ---------- ---------- Total $7,442,426 $5,795,176 ========== ==========
12 Note 3. LICENSE AGREEMENT On June 21, 2002, the Company entered into a U.S. technology license agreement with Bio-Products International, Inc., 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 large 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. As of June 30, 2006, the Company owed $80,000 of the $100,000. The patent reverts to UAH in the event of bankruptcy of the Company. This patent is licensed to Bio-Products International, Inc. ("Bio-Products"). The license to the patent in the United States was assigned to the Company. Bio-Products 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 Bio Products 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, Bio-Products. By virtue of our acquisition of the Patent, we now own all rights, title and interest in the Patent, subject to Bio-Products' existing license, which in turn continues to sublicense the technology to us. The 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 Bio-Products and/or the University of Alabama in Huntsville covering the technology. For the license, the Company agreed to pay a one-time fee of $350,000, payable in several installments. The Company recorded an intangible asset of $350,000 at December 31, 2003 and recorded a payable for the outstanding balance of $167,500 at December 31, 2003. The final installment of $167,500 was paid in August 2004, two years after the signing of the agreement. The license is being amortized over the remaining life of the license beginning when the Company's plant first became operational. During June 2004, the Company issued warrants to purchase 250,000 shares of its common stock at $1.50 per share to the owners of Bio-Products in consideration for their assistance in obtaining certain modifications and amendments to the license agreement. The fair value of the warrants of $206,605 was estimated at the date of grant using the option valuation model. The value of the warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 3.6%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 4 years. The Company recorded the fair value of the warrants as an increase to the capitalized license. 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 Bio-Products 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. 13 As additional consideration and for their experience and know-how regarding the technology, the Company agreed to pay Bio-Products 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. All amounts due have been paid through June 30, 2006. Due to the proprietary nature of the vessel design utilized in the process, the Company granted Bio-Products the exclusive right of vessel manufacture, and agreed to purchase all required process vessels exclusively from Bio-Products at a fixed purchase price of the quoted cost plus 15%. Note 4. SIGNIFICANT CONTRACT In June 2003, the Company signed a 10-year contract with Taormina Industries, LLC (TI), a wholly owned division of Republic Services, Inc., whereby TI has agreed to deliver residual waste to the Company for processing at its initial facility which is located on the campus of TI in Anaheim, CA and is expected to be capable of processing approximately 500 tons per day. The second phase of the contract calls for the Company to build up to a 2,000 ton per day plant in the Orange County, California-area at a site mutually agreeable to both parties. The Company is investigating the purchase or lease of water treatment equipment for our initial facility. If we decide to purchase the equipment, it may require approximately $3 million to $6 million of additional capital. It is estimated that the second phase will cost the Company approximately $60 million, excluding land and building, and is projected to be completed in 2007 or 2008, if the Company is successful in raising the necessary funds in a timely manner. The agreement also grants TI a right of first refusal for an additional 10 counties throughout California where TI has operations. Under the terms of this contract, TI is obligated to pay a per ton tipping fee to the Company. The initial tipping fee is $30 per ton (payable monthly) of "Net Processed Waste" (defined as the total RMSW delivered to us less the total residual/non-processed waste removed by Taormina for handling and disposal by Taormina). The tipping fee is subject to increase or decrease based upon changes in certain county landfill disposal fees Taormina is required to pay. Our process is also expected to mechanically sort and collect standard recyclable materials such as scrap steel, cans, and aluminum. Although the Company has not concluded on the economic feasibility on a commercial scale, it intends to study the possibility of making other products such as higher value paper products, ethanol, refuse derived fuel and other energy related products, cellulose insulation and building product additives. Under the terms of this first contract it is anticipated that these materials will be collected and sold to Taormina for resale to commodities buyers. The ultimate success of the Company is highly dependent on the ability of both parties to the contract to fulfill their obligations, of which there can be no assurance. The contract provides for three five year extensions. Effective July 26, 2004, the Company entered into a ten-year operating lease agreement, with TI for the site of the Company's initial processing facility. This lease agreement was amended on March 17, 2005 and July 27, 2005. The lease requires monthly rent of $15,900, subject to annual cost-of-living adjustments. The Company paid the lessor $95,400 upon execution of the lease representing prepaid rent of $63,600 and a $31,800 security deposit. Note 5. SENIOR SECURED DEBT On November 1, 2005, the Company sold to accredited investors $4,015,000 aggregate principal amount of Senior Secured Notes and Warrants to purchase up to a total of 529,980 shares of Common Stock. In February 2006, all of the notes were exchanged for a new series of Senior Secured Debt as described below. No material terms of the notes changed other than the maturity date. The Notes were due and payable in full on the earlier to occur of (i) the closing of one or more equity financings generating gross proceeds in an aggregate amount of at least $9.0 million, or (ii) May 1, 2007. The Notes bore interest at an annual rate of 10.00% payable quarterly in arrears, on December 31, March 31, June 30 and September 30 of each year, beginning on December 31, 2005. The Notes were secured by a first-priority lien on substantially all of the Company's assets, and ranked pari passu in right of payment with all existing and future senior indebtedness of the Company, and senior in right of payment to any subordinated indebtedness. If an event of default on the Notes had occurred, the principal amount of the Notes, plus accrued and unpaid interest, if any, could have been declared immediately due and payable, subject to certain conditions set forth in the Notes. These amounts were to automatically become due and payable in the case of certain types of bankruptcy or insolvency events of default involving the Company. As described below, in May 2006 all of these Notes were either repaid or were exchanged for shares of the Company's Series B Preferred Stock. 14 The Warrants are exercisable for a period of five years commencing as of their issuance date, at an exercise price of $0.01 per share. In connection with the sale and issuance of these securities, the Company and the investors entered into a Registration Rights Agreement, dated November 1, 2005, and subsequently amended on February 10, 2006, pursuant to which the Company agreed to use best efforts to include the shares of Common Stock issuable upon exercise of the Warrants on a registration statement filed by the Company with the Securities and Exchange Commission. The fair value of the Warrants was $1,187,422. The value of the Warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 4.82%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of one and a half years. In accordance with APB Opinion 14, the fair value of the warrant issued to the investors of $1,187,422 is shown as a discount to the face value of the Senior Secured Notes on the balance sheet at the relative fair value of $923,450 and is also being amortized over 18 months, the term of the notes. Chadbourn Securities, Inc. served as the Company's placement agent in connection with the offering in certain states in which Chadbourn is registered with the NASD as a broker/dealer (the "Chadbourn States"), and, for serving as such, received a cash fee from the Company of $307,340, and was issued warrants to acquire up to 134,600 shares of Common Stock at an exercise price of $2.50 per share and otherwise on the same terms as the Warrants sold to the investors. The Company also agreed to reimburse Chadbourn for its reasonable expenses incurred in connection with the offering. Chadbourn in turn has re-allowed a portion of these fees ($267,550 in cash and warrants to acquire up to 79,300 shares of Common Stock) to Northeast Securities, Inc., an NASD registered broker/dealer ("NES"), in connection with NES acting as a selling agent for the offering. NES also received a cash fee from the Company equal to 8.0% of the principal amount of Notes sold in all non-Chadbourn States (for a total cash fee of $4,000) and warrants to acquire up to 2,000 shares of Common Stock. The Company also agreed to reimburse NES for its reasonable expenses incurred in connection with the offering. In addition to the fees referred to above, the Company paid $10,000 in cash and issued Warrants to acquire up to 24,000 shares of Common Stock to third party finders. The fair value of all of the 160,600 placement Warrants was $193,594. The value of the Warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 4.82%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of four years. The debt offering cost of $514,934, consisting of cash of $321,340 and warrant value of $193,594, is shown as a current asset and is being amortized over 18 months. The Company's chief executive officer, works with Cagan McAfee Capital Partners, LLC ("CMCP"); Laird Cagan, a Managing Director of CMCP, acted as a registered representative of Chadbourn in connection with this offering. On February 10, 2006, the Company issued and sold $2,250,000 aggregate principal amount of its 10% Senior Secured Notes and Warrants to purchase up to an aggregate of 297,000 shares of the Company's Common Stock, to three accredited investors. The Warrants are exercisable for a period of five years commencing as of their issuance date and have an exercise price of $0.01 per share. The fair value of the Warrants was $1,200,085. The value of the Warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 4.82%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of one and a half years. The Notes were due and payable in full on the earlier to occur of (i) the closing of one or more equity financings generating gross proceeds in an aggregate amount of at least $9.0 million, or (ii) August 10, 2007. The Notes bore interest at an annual rate of 10.00% payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year. The Notes were secured by a first-priority lien on substantially all of the Company's assets, and ranked pari passu in right of payment with all existing and future senior indebtedness of the Company, and senior in right of payment to any subordinated indebtedness. As described below, in May 2006 all of these Notes were either repaid or were exchanged for shares of the Company's Series B Preferred Stock. In connection with the issuance of the Notes, the Company entered into a Registration Rights Agreement on February 10, 2006, pursuant to which the Company agreed to use best efforts to include the shares of Common Stock issuable upon exercise of the Warrants on a registration statement filed by the Company with the Securities and Exchange Commission. Chadbourn Securities, Inc. served as the Company's placement agent in connection with the offering, and, for serving as such, received a cash fee from the Company of $27,500. The Company also agreed to reimburse Chadbourn for its reasonable expenses incurred in connection with the offering. 15 In addition to the fees referred to above, the Company paid $5,000 in cash to third party finders. The debt offering costs of $122,424, consisting of placement agent fees, finders fees, and legal and administrative fees is shown as a current asset and was being amortized over 18 months. In accordance with APB Opinion 14, the fair value of the warrants issued to the investors was shown as a discount to the face value of the Notes on the balance sheet at its relative fair value of $787,500 and was also being amortized over 18 months, the term of the notes. Upon repayment, all unamortized placement fees and warrant value was expensed as Financing Transaction Expense (see Note 2). In connection with the Febuary 6, 2006 transaction, the holders of the Company's 10% Senior Secured Notes issued November 1, 2005 described above exchanged their notes for debentures on a dollar-for-dollar basis. Therefore, at the conclusion of the transaction the Company had a total of $6,265,000 of Senior Secured Debt outstanding. During the quarter ended March 31, 2006, the interest expense of $131,625 and the amortization of the offering costs of $78,266 and amortization of the warrants issued to the investors of $241,408 were capitalized as construction cost on the Anaheim facility. As the facility was considered completed at the end of March, 2006, interest expense and the amortization of the offering costs were expensed during the quarter ended June 30, 2006. On May 30, 2006, the Company completed the placement of Series B Cumulative Redeemable Convertible Participating Preferred Stock (Series B). Consistent with their contractual rights of participation, certain holders of the Senior Secured Debt elected to exchange their debt and accrued interest, or a portion there of, into shares of Series B. The principal and accrued interest of the Senior Debt exchanged was $3,480,000 and $8,800, respectively. As required by the terms of the Notes, the balance of the Senior Debt and accrued interest thereon was repaid in full on May 30, 2006 with a portion of the proceeds of the sale of the Series B. As a consequence, all unamortized debt discount and offering costs were expensed (see Note 2). As of June 30, 2006, no Senior Debt remained outstanding. Note 6. CUMULATIVE REDEEMABLE CONVERTIBLE PARTICIPATING PREFERRED STOCK Series A On April 28, 2005, the Company issued and sold 4,000,000 shares of its newly created 8% Series A Cumulative Redeemable Convertible Participating Preferred Stock (the "Series A") and warrants (the "Warrants," and, together with the Series A Preferred, the "Securities") to purchase up to 400,000 shares of common stock of the Company. On May 9, 2005, the Company entered into a Securities Purchase Agreement whereby the Company issued and sold an additional 75,600 shares of Series A Preferred and Warrants to purchase up to 7,560 shares of common stock of the Company. The gross aggregate proceeds to the Company from the sale of the Securities was $10,189,000. The certificate of determination governing the terms of the Series A provides for the Series A to convert into shares of common stock at a conversion rate of one-for one. In February 2006, however, the Company contractually agreed with the holders of the Series A to provide for an increase in this conversion rate upon subsequent issuances of shares of common stock (subject to specified exceptions) at a price less than 115% of the conversion rate in effect at the time of issuance. As a result of this agreement, on May 25, 2006 (the date the Company first issued shares of its Series B Preferred, as described below), the conversion rate was adjusted to approximately 1.18 shares of common stock for each one share of Series A. The Company was required to apply the proceeds of the sale of the Securities primarily to the construction and operation of the Company's initial plant in Anaheim, California. The holders of the Series A are entitled to recommend for election to the Company's Board of Directors two individuals designated by such holders. Two employee directors resigned from the board of directors upon the election of the holders' designees. Additionally, in the event the Operational Date (generally defined as if and when the Company's initial plant in Anaheim, California first generates total operating cash flow of at least $672,000 for any consecutive three month period) has not occurred by September 30, 2006, the holders of the Series A have the right to elect a majority of the members of the Company's board of directors. This right would terminate, however, upon the first to occur of the Operational Date or the date on which less than 50% of the shares of Series A remain outstanding. Holders of Series A are entitled to receive cumulative dividends, payable quarterly in additional shares of Series A, at the rate of 8% per annum. This dividend rate was increased to 9% as of January 28, 2006 pursuant to the terms of the Series A as a result of the Company's failure to comply with certain registration rights provisions. Each share of Series A is entitled to that number of votes equal to the number of whole shares of Common Stock into which it is convertible. In addition, so long as at least 50% of the shares of Series A remain outstanding, the Company is prohibited from taking certain actions without the approval of the holders of a majority of the outstanding shares of Series A. The holders of a majority of the shares of Series A have the option to require the Company to redeem all outstanding shares of Series A on April 28, 2010 at a redemption price equal to $2.50 per share, plus accrued and unpaid dividends to that date. 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, as described below. 16 Each share of Series A will automatically convert into shares of Common Stock at the then-effective conversion rate (i) in the event the Company consummates an underwritten public offering of its securities at a price per share not less than $5.00 and for a total gross offering amount of at least $10 million, (ii) in the event of a sale of the Company resulting in proceeds to the holders of Series A of a per share amount of at least $5.00, (iii) in the event that the closing market price of the Common Stock averages at least $7.50 per share over a period of 20 consecutive trading days and the daily trading volume averages at least 75,000 shares over such period, (iv) upon the approval of a majority of the then-outstanding shares of Series A, or (v) unless the Company is otherwise obligated to redeem the shares as described above, on April 28, 2010. Each holder has the right to convert its shares of Series A into shares of Common Stock at the then-effective conversion rate at any time following the first to occur of (i) September 30, 2006 and (ii) the Operational Date. The Warrants are exercisable for a period of five years commencing as of their issuance date, initially at an exercise price of $4.00 per share (which exercise price was subsequently revised as described below). The fair value of the Warrants was $1,328,066. The value of the Warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 6.75%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 5 years. The value of the Warrants was deducted from the face amount of the Series A Preferred and is being amortized as dividends. In accordance with EITF 00-19, the value of the Warrants has been recorded as a liability until such time as the Company meets the registration obligation of the underlying shares. In accordance with SFAS 133, the warrant liability is adjusted at the end of each reporting period to its fair value, and the adjustment is classified as other income (expense). In accordance with EITF 98-5 and 00-27 it was determined that the Series A's effective conversion price was issued at a discount to fair value. The value of this discount, called a beneficial conversion feature, was determined to be $1,328,066. The beneficial conversion feature was deducted from the carrying value of the Series A and is amortized over five years. The amortization amount is treated consistent with the treatment of preferred stock dividends. In connection with the issuance of the Securities, on April 28, 2005, the Company entered into a registration rights agreement granting the holders certain demand and piggyback registration rights with respect of the common stock issuable upon conversion of the Series A and exercise of the Warrants. The Company filed a registration statement with the SEC on August 4, 2005 to register these shares for resale. This registration statement was withdrawn on December 19, 2005. A new registration statement covering the resale of these shares was filed with the SEC on July 27, 2006. As of August 16, 2006, this registration statement had not yet been declared effective by the SEC. In connection with this transaction, certain of the Company's officers and significant shareholders (the "Locked Up Holders"), beneficially owning approximately 13 million shares of Common Stock, agreed that, subject to certain exceptions, they would not offer, sell, contract to sell, lend, pledge, grant any option to purchase, make any short sale or otherwise dispose of any shares of Common Stock, or any options or warrants to purchase any shares of Common Stock with respect to which the holder has beneficial ownership until the earlier of 90 days following the conversion into Common Stock of at least 50% of the shares of Series A, or 90 days following the closing of a Qualified Public Offering (as defined in the registration rights agreement). Chadbourn Securities, Inc. served as the Company's placement agent in connection with the offering, and for serving as such, received a cash fee from the Company of $375,000, and was issued warrants to acquire up to 244,536 shares of Common Stock at an exercise price of $2.50 per share and otherwise on the same terms as the Warrants sold to the investors. Laird Cagan, a Managing Director of CMCP, acted as a registered representative of Chadbourn in connection with this offering. Our chief executive officer also works for CMCP. The fair value of the placement warrants was $861,852. The value of the warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 6.75%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of four years. The value of the warrants was deducted along with the cash placement fees paid, $321,200, from the face value of the Series A. 17 The accounting for the Series A is as follows: Gross proceeds $10,189,000 Less: beneficial conversion feature (1,328,066) Less: offering costs (1,564,152) Less: warrant value at issuance date (1,328,066) ----------- Subtotal 5,968,716 Cumulative amortization of the beneficial conversion feature 309,881 Cumulative amortization of offering costs 364,964 Cumulative amortization of warrant costs 309,881 Cumulative in kind dividend 1,054,129 ----------- Balance at June 30, 2006 $ 8,007,571 =========== The consent of the holders of the Series A was required in order to consummate the issuance of the Senior Secured Debt discussed in Note 5 above. On February 6, 2006, the holders of the Series A gave such consent pursuant to a letter agreement with the Company (the "Series A Agreement"). Pursuant to the Series A Agreement, among other things, (i) the Company agreed to call a shareholders meeting to approve an amendment of certain provisions of the certificate of determination governing the terms of the Series A (including the change to the conversion rate described above), and (ii) the holders of Series A agreed to waive certain of their veto rights and contractual rights, in order to facilitate the Company's next round of financing. In consideration of the foregoing, the Company agreed to deliver to the holders of Series A warrants, ("Additional Warrants")to purchase up to a total of 407,560 shares of the Company's Common Stock at an exercise price of $0.01 per share. The Additional Warrants are exercisable for a period of five years commencing as of their issuance date. The fair value of the warrants, $1,647,250, was expensed during the quarter ended March 31, 2006 as financing expense. The value of the warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 4.82%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of five years. On April 12, 2006, in connection with obtaining the consent of the holders of the Series A to the issuance of shares of the Company's Series B Preferred Stock described below, the Company agreed to increase the number of shares issuable upon exercise of the original Warrants from 407,560 shares to 1,018,900 shares ("New Warrants"), and to decrease the exercise price from $4.00 per share to $2.75 per share. The change in the estimated value calculated using the Black-Scholes option pricing model between the original Warrants and the New Warrants of $1,135,487 was charged to other expense during the second quarter of 2006. The value of the warrants was calculated with the following assumptions: average risk-free interest of 5.42%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 3 years. In addition, the conversion price of the Series A was decreased. Following the guidance of FAS 123R, par. 35 for modification to equity instruments, the incremental value of the modification, computed as the difference between the fair value of the conversion feature at the new conversion price and conversion feature at the old conversion price on the modification date was deducted from earnings available to common stockholders as an effective dividend to preferred shareholders, following the presentation guidance in EITF Topic D-42. The change in the estimated value of the conversion feature using the Black-Scholes option pricing model between the original conversion price to the new conversion price was $3,065,931. The values of the conversion features were calculated with the following assumptions: average risk-free interest of 4.97%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70% and a term of 3 years. Series B On May 25 and May 30, 2006, the Company issued and sold a total of 284,888 shares of its newly created 8% Series B Cumulative Redeemable Convertible Participating Preferred Stock (the "Series B") and common stock purchase warrants. A portion of these securities were sold for $25,000,000 in cash and a portion were issued in exchange for the cancellation of $3,488,800 aggregate principal amount of Senior Debt (including accrued interest). Each share of Series B converts into 40 shares of common stock (subject to anti-dilution adjustments). The shares of Series B are convertible into a total of 11,395,520 shares of Common Stock and the warrants provide the holders with the right to purchase up to a total of 2,848,880 additional shares of common stock of the Company. Holders of Series B are entitled to receive cumulative dividends, payable quarterly in additional shares of Series B, at the rate of 8% per annum. If the Company does not comply with certain registration rights provisions, the Company is subject to liquidated damages of 1% of the total purchase price for each month that the Company fails to so comply, for up to a total of 6%. Each share of Series B is entitled to that number of votes equal to the number of whole shares of the Common Stock into which it is convertible. In addition, so long as at least 50% of the shares of Series B remain outstanding, the Company is prohibited from taking certain actions without the approval of the holders of a majority of the outstanding shares of Series B. The holders of a majority of the shares of Series B have the option to require the Company to redeem all outstanding shares of Series B on April 28, 2010 at a redemption price equal to $100 per share, plus accrued and unpaid dividends to that date. In the event the holders do not exercise this redemption right, all shares of Series B Preferred will automatically convert into shares of Common Stock on such date, as described below. 18 Each share of Series B will automatically convert into shares of Common Stock at the then-effective conversion rate (i) in the event the Company consummates an underwritten public offering of its securities at a price per share not less than $5.00 and for a total gross offering amount of at least $20 million, (ii) in the event of a sale of the Company resulting in proceeds to the holders of Series B Preferred of a per share amount of at least $200.00, (iii) in the event that the closing market price of the Common Stock averages at least $7.50 per share over a period of 20 consecutive trading days and the daily trading volume averages at least 75,000 shares over such period, (iv) upon the approval of a majority of the then-outstanding shares of Series B, or (v) unless the Company is otherwise obligated to redeem the shares as described above, on April 28, 2010. Each holder has the right to convert its shares of Series B into shares of Common Stock at the then-effective conversion rate at any time (subject to certain restrictions in the event such conversion would result in the holder being the beneficial holder of more than 4.99% of the Company's outstanding shares of common stock). The Warrants are exercisable for a period of five years commencing as of their issuance date, at an exercise price of $2.75 per share. The fair value of the warrants was $7,225,630. The value of the warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 5.42%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 3 years. In accordance with APB Opinion 14, the fair value of the warrants issued to the investors is shown as a discount to the face value of the Series B at its relative fair value of $5,697,760. The warrant value was deducted from the carrying value of the Series B and is being amortized over 47 months. The amortization amount is treated consistent with the treatment of preferred stock dividends. In accordance with EITF 98-5 and 00-27 it was determined that the Series B effective conversion price was issued at a discount to fair value. The value of this discount, called a beneficial conversion feature, was determined to be $18,207,102. The beneficial conversion feature was deducted from the carrying value of the Series B and is being amortized over 47 months. The amortization amount is treated consistent with the treatment of preferred stock dividends. In connection with the issuance of the Series B and related warrants, the Company entered into registration rights agreements granting the holders of the Series B certain demand and piggyback registration rights with respect to the common stock issuable upon conversion of the Series B and exercise of the warrants. The Company filed a registration statement with the SEC on July 27, 2006 to register these shares for resale. As of August 14, 2006 this registration statement had not been declared effective by the SEC. If the registration statement is not declared effective with 6 months of the close of the transaction, the Company must pay 1 percent per month for a maximum of 6 months. Per paragraph 16 of EITF 00-19, this was determined to be an economic settlement alternative. Therefore, the warrants have been classified as equity. In connection with this transaction, certain of the Locked-Up Holders agreed that, subject to certain exceptions, they would not offer, sell, contract to sell, lend, pledge, grant any option to purchase, make any short sale or otherwise dispose of any shares of Common Stock, or any options or warrants to purchase any shares of Common Stock with respect to which the holder has beneficial ownership until the earlier of 90 days following the conversion into Common Stock of at least 50% of the shares of Series B, or 90 days following the closing of a Qualified Public Offering (as defined in the applicable registration rights agreement). The Company used three placement agents in connection with the offerings of the Series B. The placement agents received cash fees from the Company of $2,275,043, and were issued warrants to acquire up to 869,180 shares of Common Stock at an exercise price of $2.75 per share and otherwise on the same terms as the Warrants sold to the investors. Chadbourn Securities, Inc. served as one of three of the Company's placement agents in connection with the offering , and for serving as such, received a cash fee from the Company of $446,050, and was issued warrants to acquire up to 210,980 shares of Common Stock at an exercise price of $2.75 per share and otherwise on the same terms as the Warrants sold to the investors. These placement fees are included in the Fees discussed in the paragraph above. Laird Cagan, a Managing Director of CMCP, acted as a registered representative of Chadbourn in connection with this offering. Our chief executive officer also works for CMCP. The fair value of the placement warrants was $2,224,903. The value of the warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 5.42%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 4 years. The value of the warrants was deducted along with the cash placement fees paid and expenses, $2,359,035, from the face value of the Series B, and is being amortized over 47 months. The amortization amount is treated consistent with the treatment of preferred stock dividends. 19 The accounting for the Series B is as follows: Gross proceeds $28,488,800 Less: beneficial conversion feature (18,207,102) Less: offering costs (4,583,938) Less: warrant value at issuance date (5,697,760) ----------- Subtotal -- Cumulative amortization of the beneficial conversion feature 387,385 Cumulative amortization of offering costs 97,531 Cumulative amortization of warrant costs 121,229 Cumulative in kind dividend 203,014 ----------- Balance at June 30, 2006 $ 809,159 =========== Note 7. SHAREHOLDERS' EQUITY Prior to the merger with Waste Solutions, Inc (WSI), WSI received $750,000 for the issuance of a promissory note and obtained a commitment for an additional $250,000 from an investor. The investor also received a warrant for the purchase of 133,333 shares of common stock for $0.01 per share in connection with these additional funds. These warrants were exercised in March of 2004. After the merger, the promissory note was exchanged for 500,000 shares of common stock in World Waste Technologies, Inc. In April 2004, the Company received the additional $250,000 for the purchase of an additional 166,667 shares of common stock. The relative fair value allocated to the warrant was $170,844 using the Black-Scholes calculation. The value of the warrant was estimated using the Black Scholes option pricing model with the following assumptions: average risk free interest of 3.6%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 4 years. Prior to the merger of the Company with Voice Powered Technologies, Inc (VPTI), 500,000 shares of common stock were contributed to the Company by the founder of VPTI in connection with an agreement in which the founder sold approximately 1,000,000 other shares of common stock to accredited investors in a private sale. During the second and third quarters ended June 30, 2004 and September 30, 2004 respectively, the Company obtained through a private placement an additional $3,093,910 from the sale of 2,311,872 shares of common stock, net of fees paid of $273,890 (2,245,206 of these shares were issued prior to the merger with VPTI on August 24, 2004). Under a Registration Rights Agreement, the Company agreed to use commercially reasonable efforts to prepare and file a registration statement to register the resale of such shares within ninety days of completion of the Merger, August 23, 2004, and use commercially reasonable efforts to cause such registration statement to be declared effective by the SEC as soon as practicable. The registration statement, which was filed on August 6, 2005, was withdrawn on December 19, 2005. As of May 22, 2006, the registration statement has not been re-filed. During July 2004, the Company issued a warrant to a consultant for the purchase of 50,000 shares of common stock at an exercise price of $0.01 per share in consideration for investment banking, financial structuring and advisory services provided. The fair value of the warrant was $74,567. The value of the warrant was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 3.6%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 26.4%; and a term of 4 years. The fair value of the warrant was expensed during the year ended December 31, 2004. The warrant was exercised in full in September 2004. Effective August 24, 2004, World Waste Technologies, Inc. was merged into VPTI. Prior to the merger with VPTI, the holders of the convertible promissory notes converted these notes into 1,193,500 shares of common stock of World Waste Technologies, Inc. Subsequent to the merger with VPTI, during the third and fourth quarters of the year ended December 31, 2004, in connection with a private placement of securities, the Company sold 1,192,000 units; each unit comprised of one (1) share of common stock in the Company and warrants exercisable for 0.25 shares (298,000 shares) of common stock of the Company at an exercise price of $0.01 per share for 5 years. The fair value of the warrants was $742,222. The value of the warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 3.6%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 1 to 4 years. The consideration paid for the units was $2.50 per unit, for aggregate net proceeds to the Company of $1,879,770. As of December 31, 2004, 152,000 of these warrants had been exercised for net proceeds to the Company of $1,520. Under the Registration Rights Agreement, the Company has agreed to use commercially reasonable efforts to prepare and file a registration statement within ninety days of completion of the private placement and use commercially reasonable efforts to cause such registration statement to be declared effective by the SEC as soon as practicable registering the resale of the shares and shares underlying the warrants. The registration statement was filed on July 27, 2006. As of August 14, 2006 it has not been declared effective. 20 During the quarter ended June 30, 2005, in connection with private placements of unregistered securities, the Company raised gross proceeds of $3,387,000 by issuing 1,354,800 units (each unit comprised of one (1) share of common stock in the Company (1,354,800 shares of common stock) and warrants exercisable for 0.25 shares (338,700 warrants)) at a purchase price of $2.50 per unit. The warrants expire five years after the date of the sale of the shares and are exercisable at $0.01 per share, subject to adjustment. All of the warrants were exercised during the quarter ended March 31, 2005. The fair value of the warrants was $843,487. The value of the warrants was estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 3.75%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of one year. Under the Registration Rights Agreement, the Company has agreed to use commercially reasonable efforts to prepare and file a registration statement within ninety days of completion of the private placement and use commercially reasonable efforts to cause such registration statement to be declared effective by the SEC as soon as practicable registering the resale of shares and the shares underlying the warrants. The registration statement was filed on July 27, 2006. As of August 14, 2006 the registration statement has not been declared effective. Note 8. COMMITMENT AND CONTINGENCIES The Company is obligated to pay Bio Products 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. The Company is also obligated to pay CMCP $5,000 per month for advisory services through December 31, 2006. Note 9. RELATED PARTY TRANSACTIONS In December 2003, the Company entered into an agreement, amended in March 2004, with Cagan McAfee Capital Partners, LLC ("CMCP"). The agreement provides for CMCP to provide advisory and consulting services and for NASD broker dealer, Chadbourn Securities Inc. ("Chadbourn"), to provide investment banking services to the Company. The agreement calls for, among other things, the Company to pay to CMCP a monthly advisory fee of $15,000, increased to $20,000 beginning in September 2004. The total professional fees paid to CMCP for the year ended December 31, 2004 for advisory services was $200,000. In May 2005, the agreement was amended to provide for the payment to CMCP of a monthly advisory fee of $5,000 and the Company entered into a separate agreement with John Pimentel to pay him a monthly advisory fee of $15,000. In September 2005, John Pimentel was hired to serve as the Company's Chief Executive Officer, at which time his advisory agreement was terminated. CMCP's total monthly advisory fees for the year ended December 31, 2005 was $120,000. Prior to May 2005, John Pimentel was paid by CMCP to provide services to the Company. Subsequent to May 2005 and prior to his hiring as CEO, Mr. Pimentel was paid $60,000 for consulting services by the Company. Chadbourn and Laird Q. Cagan, a registered representative of Chadbourn, acted as the placement agent (collectively, the "Placement Agent") for us in connection with the private placement of 3,923,370 shares of our common stock in 2004. In connection with those private placements, we paid the Placement Agent a commission of 8% of the price of all shares sold by it, or approximately $487,200. In addition, we paid the Placement Agent a non-accountable expense allowance (equal to 2% of the purchase price of the shares or approximately $90,000) and issued the Placement Agent, or its affiliates, warrants to purchase 392,337 of our common shares, at exercise prices between $1.00 and $2.50. The values of the warrants, $369,245,were estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest of 3.6%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 4 years. During 2005, the Placement Agent acted as the placement agent for us in connection with the private placement of 1,354,800 shares of our common stock and warrants to purchase 338,700 shares of our common stock, the private placement of 4,075,600 shares of our Series A Preferred Stock and warrants to purchase 407,560 shares of our common stock, and $4,015,000 aggregate principal amount of our senior secured promissory notes and warrants to purchase up to a total of 529,980 shares of Common Stock. In connection with those private placements, we paid the Placement Agent a commission of approximately $961,550. In addition, we paid the Placement Agent a non-accountable expense allowance of $267,740 and issued the Placement Agent, or its affiliates, warrants to purchase 548,486 of our common shares, at exercise price of $2.50. The values of the warrants, $756,247, were estimated using the Black-Scholes option pricing model with the following assumptions: average risk-free interest rate 3.6% to 6.75%; dividend yield of 0%; average volatility factor of the expected market price of the Company's common stock of 70%; and a term of 4 years. 21 During the quarter ended March 31, 2006, the Placement Agent acted as the placement agent for the Company in connection with the private placement of the Company's senior secured promissory notes and warrants to purchase up to a total of 297,000 shares of Common Stock. In connection with this private placement, the Company paid the Placement Agent a commission of $27,500. Chadbourn served as one of three of the Company's placement agents in connection with the offering of the Company's Series B Preferred Stock, and for serving as such, received a cash fee from the Company of $446,050, and was issued warrants to acquire up to 210,980 shares of Common Stock at an exercise price of $2.75 per share and otherwise on the same terms as the Warrants sold to the investors. Note 10. SUBSEQUENT EVENTS On July 27, 2006, the Company filed a registration statement on Form SB-2 with the SEC covering the resale of up to 33,142,571 shares held by or issuable to certain of our stockholders and warrantholders. This registration statement has not yet been declared effective by the SEC. Note 11. AMENDMENT AND RESTATEMENT OF FORM 10-KSB On May 12, 2006, the Company determined that it would amend its Annual Report on Form 10-KSB for the year ended December 31, 2005 and each of the 10-QSBs included in such year to correct certain accounting errors in the financial statements included in such reports. The accounting errors corrected in the financial statements for the quarter ended June 30, 2005 related to the fair value of options and warrants and the classification of Redeemable Preferred Stock, as follows: 1) Fair value of options and warrants: As previously disclosed in our reports filed with the SEC, on August 24, 2004 World Waste Technologies, Inc., a private company ("WWT") completed a reverse merger with and into a subsidiary of Voice Powered Technologies International, Inc ("VPTI"), a publicly-traded company with no assets, liabilities or operations. As a result of this merger, VPTI (renamed World Waste Technologies, Inc.) succeeded to all of the assets, liabilities and operations of WWT. In order to properly account for the expense associated with the issuance of options and warrants, it is required to determine the fair value of these securities. In determining this value the Company undertook a "Black Scholes" analysis, a method of valuation that takes into account the expected volatility of the stock underlying the convertible securities being valued. Because at the time of this valuation the Company had no stock trading history as a company with the operations of WWT (i.e. all of the trading had been as VPTI, a company with no operations), in determining its expected volatility, the Company decided to use the trading prices of a representative sample of companies within its industry as opposed to VPTI's trading history. Based on discussions with the staff of the SEC as to current practices in applying the applicable accounting guidelines (SFAS 123R) and further review of the authoritative accounting literature for new public companies, the Company concluded that the use of a volatility factor more consistent with its stage of life cycle and financial leverage would be more appropriate than a volatility factor based on the trading of shares of companies within its industry. As a result, the Company changed the volatility factor previously used from approximately 20% to 70%. Based on this analysis, the Company also changed the price used in calculating the fair value of the warrants issued in connection with a private placement of our Series A Preferred Stock from the price such shares were actually sold at to the quoted market price of the Company's stock as of the closing of such issuance. These changes affected primarily the recorded value on our balance sheet of the following line item accounts: Debt Offering Costs, Patent and Licenses, Senior Secured Debt, Redeemable Preferred Stock, Warrant Liability, Additional Paid in Capital and Deficit Accumulated during the Development Stage. This change had the impact on the Company's Consolidated Statement of Operations for the quarter ended June 30, 2005 of General and Administrative Expense increased by $63,944 for the increase in employee option expense and Change in fair value of warrant liabilities increase by $235,957 resulting in a net decrease in the Net Loss of $172,014. Also in 2005, the amortization of Preferred Stock warrants, offering costs and beneficial conversion feature classified similar to Preferred Stock dividends increased by $122,984. 2) Redeemable Convertible Preferred Stock: The Redeemable Convertible Preferred Stock had been classified as a liability because it is redeemable at the end of five years, at the option of the holders. Upon further review of authoritative literature, Convertible Redeemable Preferred Stock will be reclassified as "mezzanine equity" rather than as a liability. This change had no impact on the Company's 2004 or 2005 Consolidated Statement of Operations. The impact of these adjustments on the operating results of for the quarter ended June 30, 2005 was an increase in general and administrative expense of $46,000, increase in other income of $236,000 and an increase in amortization of the beneficial conversion feature and warrant value of $123,000. 22 Item 2. -- Management's Discussion and Analysis of Financial Condition or Plan of Operations Forward-Looking Statements The following Plan of Operations, 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 "Factors That May Affect Future Results and Market Price of Our Stock" below. Overview We were formed as a result of two mergers that occurred in 2004. First, in March 2004, World Waste of America, Inc. ("WWA") merged with and into a wholly owned subsidiary of Waste Solutions, Inc. ("WSI"), a California corporation. Cagan McAfee Capital Partners and its affiliates were the controlling shareholders of WSI. As a result of this merger, WSI continued as the surviving corporation, assumed the operations and business plan of WWA, the stockholders of WWA became stockholders of WSI, and WSI changed its name to World Waste Technologies, Inc. ("Old WWT"). In March 2004, Old WWT entered into an Agreement and Plan of Reorganization with Voice Powered Technologies International, Inc., a California corporation ("VPTI"), to merge with and into a wholly owned subsidiary of VPTI. VPTI was a publicly traded company trading under the stock symbol VPTI.OB. VPTI had no material assets, liabilities or operations. The merger of Old WWT with VPTI's wholly owned subsidiary was completed on August 24, 2004. Pursuant to the merger, Old WWT's shareholders become the holders of approximately 95% of the outstanding shares of VPTI. Upon completion of this merger, VPTI changed its name to World Waste Technologies, Inc. VPTI was incorporated on June 21, 1985 and provided voice recognition and voice activated products. We currently do not plan to conduct any business other than operations heretofore conducted or contemplated to be conducted by WWT. Because the shareholders of Old WWT became the controlling shareholders of VPTI after the merger, Old WWT was treated as the acquirer for accounting purposes, and therefore the transaction was accounted for as a reverse merger. Accordingly, for accounting purposes, the historical financial statements presented are those of Old WWT. Additionally, the prior operating results of VPTI are not indicative of our future operations, and none of the assets or liabilities on our balance sheet as of December 31, 2004 relate to VPTI prior to the merger. Since the formation of WWA in 2002, our efforts have been principally devoted to research and development activities, construction of our initial facility, raising capital, and recruiting additional personnel and advisors. To date, we have not marketed or sold any significant amount of product and have not generated any significant revenues. We anticipate becoming fully operational and generating significant revenues sometime during 2007. Plan of Operations Through the six months ended June 30, 2006, we purchased certain assets, including additional equipment needed to construct our first facility to process residual municipal solid waste ("RMSW") delivered to us after processing through a materials recovery facility (MRF). WWT has a license for a patented technology capable of separating MSW into cellulose biomass and other commodities. This process, known as "pressurized steam classification," uses a pressurized, rotating autoclave to treat MSW and convert it into separable streams of metals, plastics, and cellulose biomass. The process minimizes detrimental discharges to the air and water. The main product of the process is a cellulose biomass material with significant cellulose fiber content which after thorough screening and cleaning may be sold for the production of corrugated medium, linerboard and other packaging grade materials or other industrial uses. In addition to recovering cellulose, the process creates a saleable stream of standard recycled materials of aluminum, tin, steel and plastics. Although the Company has not reached a conclusion on the economic feasibility at a commercial stage, we may be able to produce other paper products and additional products such as ethanol, refuse derived fuel, cellulose insulation and other energy products and we may be able to sell additional residual materials into other markets. In December 2005, we began testing the "pressurized steam classification" process at our first facility. Through August 15, 2006, we have run the plant on a test basis and have shipped small quantities of wetlap to our prospective buyers for testing. Customer feedback indicates a desire to utilize our product in larger quantities. As we work toward full operations in our first plant in Anaheim we are concurrently conducting a rigorous review of the equipment in our process, our design strategy for the plant, our incoming materials composition and other key operating factors which will be critical to successful operation of the Anaheim plant and will provide insights for the improved operation and profitability of future plants. In this ramp-up and review process we may supplement, change or realign existing equipment, bring in outside advisors to assist in our planning, and we may work with our MSW supplier to change the composition, quantity and terms for delivery of our feedstock. The goal for any such adjustments will be to maximize throughputs and yields at the Anaheim plant and to capture and incorporate our accumulated experience from the Anaheim plant into the design, construction and operation of future plants. 23 Laboratory testing of the cellulose biomass created during the trials between December 2005 and June 30, 2006 has indicated that higher than anticipated levels of biological oxygen demand (BOD) will be present in our wastewater discharge. We believe technology to address and remove these BOD levels is readily available to us and that equipment incorporating such technology can be installed at this first facility. We also believe it may be economically advantageous to us to purchase and install this additional equipment which may increase our capital requirements. Our current plan of operation for the remainder of the year ending December 31, 2006 primarily involves commissioning, ramping up and operating our first facility and making incremental improvements to the equipment and process. We currently do not expect to reach a full stage of operations until 2007, if ever. We currently anticipate hiring an additional 40 to 50 employees during the next twelve months, assuming we continue to ramp up production. The amounts we expend on research and development and related activities during the remainder of 2006 may vary significantly depending on numerous factors, including pace and success of the ramp up of processing of our first facility, and the possible acquisition of additional equipment. Based on our current estimates, we believe that our current cash will sustain operations until at least December 2008, based on our current expected burn rate, exclusive of capital expenditures. Upon the successful consistent production of wetlap at our first facility, we anticipate that we will begin the planning process of our second facility, including site location, permitting, design, engineering and the ordering of equipment. Our ability to commence construction of a second facility will be contingent upon our ability to raise additional capital. Also in the remainder of 2006 and into 2007 the Company will be in discussion with any number of potential partners for the purpose of developing additional products and markets in our core business of extracting paper fiber from MSW. We will also continue pursuing various partnerships, joint ventures and acquisitions which may enable our entry into new and potentially higher value products that are adjacent to our pulp and paper production business. We have and we continue to have such discussions with operating companies, exporters, technology providers, foreign companies and others who have operating businesses or some level of expertise in the following areas: converting cellulose biomass to ethanol, specialty chemicals and other energy sources; making building products and building product additives; recycling plastic and metal into reusable forms; utilizing our pulp residuals for composting materials and other beneficial uses. However, at this time we cannot assure you that any of these discussions will lead to formal business partnerships, acquisitions or new ventures. You should read this discussion in conjunction with the selected historical financial information and the financial statements and related notes included elsewhere in this report. Financial information for the year ended December 31,2005 and for the quarter ended June 30, 2006 is the historical financial information of Old WWT and VPTI combined. Reverse Stock Split On March 25, 2004, VPTI's controlling stockholder approved a one-for-60 reverse stock split of our common stock to be effectuated upon the closing of the merger between VPTI and Old WWT, which became effective at the close of business on August 24, 2004. 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. Industry sources estimate that from 1991 to 2001 over one-half of the landfills in the United States were closed. 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 its 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 the California standard of requiring 50% of all MSW to be diverted from landfills. Industry sources estimate that over the ten year period from 1994 to 2004, the demand for corrugating container medium has increased 35%. Due in part to increasing demands for packaging material from China and India, the increasing demand is expected to continue into the future. 24 The resale price our products, including wetlap pulp, aluminum, steel and tin will be tied to commodity markets. The resale and market demand for these materials can be volatile, significantly impacting our results of operations. High prices for hydrocarbon-based fuels have lead 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. We believe this may be a promising area for potential investment by our company. 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. Our significant accounting policies are summarized in Note 1 to our unaudited financial statements dated June 30, 2006. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: Amendment and Restatement On July 7, 2006 the Company filed an amended 10-KSBA amending its Annual Report on Form 10-KSB, originally filed March 30, 2006, as amended, restating the financial statements for the years ended December 31, 2005 and 2004 included therein. 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 three and six month periods ended June 30, 2006 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 and restated consolidated financial statements for the year ended December 31, 2005 included in Amendment Number Two to the Company's Annual Report on Form 10-KSB filed with the SEC on July 7, 2006. See Note 11. 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. Revenue Recognition Revenue for receiving MSW is recognized when the MSW is delivered. Revenue for products sold are recognized when the product is delivered to the customer. 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 remain life of the lease, which ever is shorter. The Company completed the construction of its initial plant in Anaheim, California at the end of March 2006. The Company capitalized all costs directly associated with developing the plant, including interest and labor, throughout the construction period. The Company placed into service and began depreciating the assets related to this facility in the second quarter of 2006. 25 Research and Development Research and development costs are charged to operations when incurred. 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, the Company adopted SFAS No. 123R, "Share Based Payments." The adoption had no material effect on the financial statements of the Company. Redeemable Preferred Stock Preferred Stock which may be redeemable for cash at the determination of the holder is classified as a long term liability. Results of Operations Comparison of three and six month periods ended June 30, 2006 and 2005 We completed construction of our first facility at the end of the first quarter of 2006. During the second quarter of 2006 we have been commissioning the equipment and performing plant start-up procedures. Revenues Prior to the second quarter of 2006, we did not generate any revenue. During the second quarter of 2006 we recorded revenue of approximately $14,000 from the sale of metals and aluminum separated from the processed MSW during the start-up phase. We did not sell any unbleached fiber, "wetlap." We shipped approximately 60 tons of wetlap to potential customers free of charge in accordance with our letters of intent with these potential customers for testing purposes. We expect to continue to ship wetlap free of charge through the third quarter of 2006 in accordance with our letters of intent. We did not generate any operating revenues in the quarter ended March 31, 2006 or the three and six month periods ended June 30, 2005. Expenses Prior to the second quarter of 2006, we had no operations and consequently no cost of goods sold. Cost of goods sold during the second quarter comprised of 2006 of Disposal of rejects of $14,247, plant operating expenses of $664,809 and depreciation of $595,346 were related to costs incurred during the start up phase of our first facility in Anaheim California and are not indicative of the cost of goods sold what we expect to incur going forward. General and administrative expenses of $2,006,000 and $1,037,451 for the six and three month periods ended June 30, 2006 increased by approximately $436,000 and $127,000 compared to the same periods in 2005 primarily due to increases in employee option expense due to grants made to employees and directors in the fourth quarter of 2005 and legal and accounting fees related to additional SEC filings. Interest expense of $274,616 and $290,190 for the six and three month periods ended June 30, 2006 related to interest on the Senior Secured Debt which was issued in November of 2005 and February of 2006. All of the Senior Secured Debt was extinguished in May of 2006. Financing expense was comprised of: a) $1,647,250 attributable to the value of warrants issued to the holders of the Series A Preferred Stock for their consent to issue 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 which occurred in the first quarter of 2006; b)the unamortized warrant value and offering costs of $1,593,758 related to the Senior Secured Debt expensed upon the early extinguishment of the Debt which occurred in the second quarter of 2006; and c) the change in the fair value of $4,201,418 of the conversion feature of the Series A Preferred due to the modification of its conversion price as a result of the application of an anti-dilution adjustment and the change in fair value of the Series A Warrants which occurred in the second quarter of 2006. Change in fair value of warrant liability of $135,642 and of $255,796 for the three and six month periods ended June 30, 2006, respectively, relates to the fair value of warrants to purchase common stock issued with registration rights as part of our Series A Preferred Stock offering in 2005. In accordance with SFAS 133 and EITF 00-19, the fair value of the warrants is required to be recorded as a liability until the Company satisfies specified registration requirements. 26 Liquidity and Capital Resources At June 30, 2006, we had cash on hand of approximately $19.3 million. During the quarter ended June 30, 2006, we raised approximately $20.9 million from the issuance of Series B Preferred Stock, net of offering costs of approximately $1.3 million and the repayment of Senior Secure Debt of approximately $2.8 million. We used cash during the six months ended June 30, 2006 primarily for start-up costs at the Anaheim facility of approximately $680,000 and general operating expenses of approximately $1,500,000 and for the purchase of fixed assets related to the completion of our first plant of approximately $3,000,000. We estimate that our cash will sustain operations through approximately December 2008, based on our current expected burn rate, exclusive of the costs to construct additional facilities, if we choose to do so. As of June 30, 2006, our only long-term debt obligations, capital lease obligations, operating lease obligations, purchase obligations, or other similar long-term liabilities, were our agreement with Taormina, the monthly payment due Bio-Products as part of the license agreement, and the lease of certain equipment at the plant. 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. New Accounting Pronouncements SFAS No. 156, Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140 The FASB has issued FASB Statement No. 156, Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140. This standard amends the guidance in FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Among other requirements, Statement 156 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. Statement 156 is effective as of the beginning of an entity's first fiscal year that begins after September 15, 2006. Management does not believe that this statement will have a material effect on the financial statements. FIN No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109 Summary - 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. 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. As the Company provides for a 100% reserve against its deferred tax asset, Management does not believe that this statement will have a material effect on the financial statements. Factors that May Affect Future Results and Market Price of Our Stock An investment in our common stock is subject to a high degree of risk. The risks described below should be carefully considered, as well as the other information contained in this quarterly report and in the documents incorporated by reference. If any of the following risks actually occur, our business, financial condition or operating results and the trading price or value of our securities could be materially adversely affected. 27 RISKS RELATED TO OUR BUSINESS We may be unable to achieve commercial production levels at our initial facility on a timely basis or at all. We recently completed construction of our initial facility in Anaheim, California. Prior to completion, laboratory testing of the cellulose biomass created during certain trial runs of our process indicated that the level of biological oxygen demand ("BOD") that will result from our process could be higher than the levels previously anticipated. We believe that the sewer surcharges by the local sanitation district as a result of such discharges would negatively affect our profitability. We believe that the technology capable of significantly reducing these BOD discharges to acceptable levels is readily available to us and that equipment incorporating such technology is available for purchase and installation at our facility. We estimate, however, that it will take us until 2007 before we are able to install the necessary equipment. In the meantime, we have commenced a controlled startup of the facility. During the startup of operations, we have also determined that we will need to make modifications to the plant equipment and design in order to achieve commercial production levels and refine plans for future plants. We do not anticipate that we will commence full production until such time as we determine what equipment is required and such equipment is installed and fully functional. Our success depends on our ability to protect our proprietary technology. Our success depends, to a significant degree, upon the protection of our, and that of our licensors', proprietary technologies. We exploit our technology through owning the patent itself and through a sublicense of the patent from Bio-Products International, Inc (BPI). BPI licenses this patent from the patent owner, which had been, until recently, the University of Alabama in Huntsville (UAH). Although we recently acquired ownership of the patent from the University, our use of the technology is still subject to our sublicense with BPI. Additionally, the need to pursue additional protections for our intellectual property is likely as new products and techniques are developed and as existing products are enhanced, and such protections may not be attained in a timely manner or at all. Legal fees and other expenses necessary to obtain and maintain appropriate patent protection in the U.S. could be material. Insufficient funding may inhibit our ability to obtain and maintain such protection. Additionally, if we must resort to legal proceedings to enforce our intellectual property rights, or those of our licensors', the proceedings could be burdensome and expensive and could involve a high degree of risk to our proprietary rights if we are unsuccessful in, or cannot afford to pursue, such proceedings. We also rely on trade secrets and contract law to protect certain of our proprietary technology. If any of our contracts is breached or if any of our trade secrets becomes known or independently discovered by third parties, we could face significant increased competition and our business could be harmed. If other persons independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets and know-how, the result could be significant increased competition for our services. In addition, we may be required to obtain licenses to patents or other proprietary rights from third parties. If we are unable to obtain such licenses on acceptable terms, we may encounter delays in product development or find that the development, manufacture or sale of products requiring such licenses could be foreclosed. We may face delays in the development of our technology, and our technology may not work as well as expected or be economically viable. The steam classification and processing technology that we intend to use has not yet been widely applied within the municipal solid waste industry and may not work as well as expected or be economically viable. The successful application of the technology at large scale and high volumes to create commercially usable cellulose fiber has yet to be proven. Any inability under our current plan to operate the plant in a manner that will produce large volumes of commercially usable cellulose fiber may require additional investment in capital equipment and/or increased operating expenses beyond currently contemplated business and construction plans. Potential issues may include, but are not limited to, issues such as handling large quantities of textiles,contamination levels of the water discharge to the sewer, and capturing suffiencent cellulose in the process. Unforeseen difficulties in the development or market acceptance of this cellulose fiber may lead to significant delays in production and the subsequent generation of revenue. For example, laboratory testing of the cellulose biomass created during trials since December 2005 has indicated that higher than anticipated levels of biological oxygen demand (BOD) will result from our fiber cleaning and screening process. Although we believe technology to address and remove these BOD levels is readily available to us and that equipment incorporating such technology can be installed at this facility, if we are unable to resolve this problem within our anticipated budget, we might need to raise additional financing (which would reduce the percentage ownership of our company held by our existing stockholders) or might be forced to curtail or cease operations altogether. 28 Our limited operating history makes it difficult to predict future results. We are in the development stage and are subject to all the business risks associated with a new enterprise, including uncertainties regarding product development, constraints on our financial and personnel resources, and dependence on and need for third party relationships. For the period from June 18, 2002 (inception) to June 30, 2006, we incurred total net losses of approximately $18 million. To date we have not generated substantial revenues and do not know when or whether we will be able to develop meaningful sources of revenue or whether our operations will become profitable, even if we are able to begin generating sufficient revenue. If we are unable to generate sufficient revenue, we would need to develop a new business plan or curtail or cease operations completely. We may be unable to obtain the large amount of additional capital that we need to execute our business plan. Our business plan includes the construction and operation of additional plants. Each plant is expected to cost between $50 million to $70 million. We anticipate that we will fund the construction and startup operation of these plants through the sale of securities or issuance of debt. We may be unable to raise the funds necessary to build and operate these additional plants. You should not rely on the prospect of future financings in evaluating us. Any additional funding that we obtain may reduce the percentage ownership of the company held by our existing stockholders. The amount of this dilution may be substantially increased if the trading price of our common stock has declined at the time of any financing from its current levels. We may not be able to obtain or sustain market acceptance for our services and products. We do not intend to engage in advertising during our development phase. Failure to establish a brand and presence in the marketplace on a timely basis could adversely affect our financial condition and operating results. We may fail to successfully complete the development and introduction of new products or product enhancements, and new products that we develop may not achieve acceptance in the marketplace. We may also fail to develop and deploy new products and product enhancements on a timely basis. Any of the foregoing could require us to revise our business plan, raise additional capital or curtail operations. The market for services and products in the solid waste processing and recycling industry is competitive, and we may not be able to compete successfully. The market for services and products in the solid waste processing industry is highly competitive. Most of these competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we have, and may be able to respond more quickly than we can to new or changing opportunities and customer requirements. Also, our competitors have greater name recognition and more extensive customer bases that they can leverage to gain market share. These competitors are able to undertake more extensive promotional activities, adopt more aggressive pricing policies and offer more attractive terms to purchasers than we can, which could adversely affect our competitive position and business. The demand for our services may be adversely affected by environmental laws and regulations. To a certain extent, demand for our services is created by environmental laws and regulations, including (a) requirements to safely dispose of RMSW by various methods including in properly constructed and operated landfills, (b) requirements to attempt to recycle a certain proportion of RMSW, and (c) requirements that businesses operating in the solid waste industry comply with applicable land, water and air emission regulations. The lack of environmental laws and regulations, or the loosening or non-enforcement of existing regulations, would decrease demand for our services and may have a material adverse affect on our business. If we do not obtain a significant supply of solid waste and timely payment for that solid waste, our operating results could be adversely affected. If we do not obtain a supply of solid waste at quantities and qualities that are sufficient to operate our proposed facilities at the expected operating levels, or if third parties do not promptly pay for the solid waste they deliver to us for processing, our financial condition and operating results could be adversely affected. Additionally, our current waste supply agreement does not include a specification requirement for the composition of materials in our incoming waste stream. One or more of the following factors could impact the price and supply of waste: o defaults by waste suppliers under their contracts; o changing composition of the material in the waste stream, including the percentage of paper fiber; 29 o a decline in recyclables in the solid waste supply due to increased recovery by material recovery facilities; o composting of municipal solid waste; o incineration of municipal solid waste; o legal prohibitions against processing of certain types of solid waste in our facilities; or o increased competition from landfills and recycling facilities. The loss of key executives and the failure to attract qualified management could limit our growth and negatively impact our operations. We depend highly upon our senior management team. We will continue to depend on operations management personnel with waste handling and pulp industry experience. At this time, we do not know the availability of such experienced management personnel or how much it may cost to attract and retain such personnel. The loss of the services of any member of senior management or the inability to hire experienced operations management personnel could have a material adverse effect on our operations and financial condition. Our results of operations may be adversely affected by changing resale prices or market requirements for recyclable materials. The resale price for our recycled products, including our unbleached fiber product, aluminum, and steel, will be tied to commodity pricing. Our results of operations may be adversely affected by changing resale prices or market requirements for these recyclable materials. The resale, and market demand for, these materials can be volatile due to numerous factors beyond our control, which may cause significant variability in our period-to-period results of operations. Our revenues and results of operations will fluctuate. Our revenues and results of operations will vary from quarter to quarter in the future. A number of factors, many of which are outside our control, may cause variations in our results of operations, including: o demand and price for our products; o the timing and recognition of product sales; o unexpected delays in developing and introducing products; o unexpected delays in building and permitting our processing facilities; o unexpected downtime in operations to maintain or improve equipment; o increased expenses, whether related to plant operations, marketing, product development or administration or otherwise; o the mix of revenues derived from products; o the hiring, retention and utilization of personnel; o waste collection companies are impacted by seasonal and cyclical changes that may adversely affect our business and operations; o general economic factors; and o changes in the revenue recognition policies required by generally accepted accounting principles. We may engage in strategic transactions that may fail to enhance stockholder value. From time to time, we may consider possible strategic transactions, including the potential acquisitions of products, technologies and companies, and other alternatives with the goal of maximizing stockholder value. We may never complete a strategic transaction(s) and in the event that we do complete a strategic transaction(s), it may not be consummated on terms favorable to us. Further, such transactions may impair stockholder value or otherwise adversely affect our business. Any such transaction may require us to incur non-recurring or other charges and may pose significant integration challenges and/or management and business disruptions, any of which could harm our results of operation and business prospects. 30 Environmental regulations and litigation could subject us to fines, penalties, judgments and limitations on our ability to expand. We are subject to potential liability and restrictions under environmental laws, including those relating to handling, recycling, treatment, storage of wastes, discharges to air and water, and the remediation of contaminated soil, surface water and groundwater. The waste management industry has been, and will continue to be, subject to significant regulation, including permitting and related financial assurance requirements, as well as to attempts to further regulate the industry through new legislation. Our business is subject to a wide range of federal, state and, in some cases, local environmental, odor and noise and land use restrictions and regulations. If we are not able to comply with the requirements that apply to a particular facility or if we operate without necessary approvals, we could be subject to civil, and possibly criminal, fines and penalties, and we may be required to spend substantial capital to bring an operation into compliance or to temporarily or permanently discontinue, and/or take corrective actions. We may not have sufficient insurance coverage for our environmental liabilities. Those costs or actions could be significant to us and significantly impact our results of operations, as well as our available capital. In addition to the costs of complying with environmental laws and regulations, if governmental agencies or private parties brought environmental litigation against us, we would likely incur substantial costs in defending against such actions. We may be, in the future, a defendant in lawsuits brought by parties alleging environmental damage, personal injury, and/or property damage. A judgment against us, or a settlement by us, could harm our business, our prospects and our reputation. Future costs under environmental, health and safety laws may adversely affect our business. We could be liable if our operations cause environmental damage to our properties or to the property of other landowners, particularly as a result of the contamination of drinking water sources or soil. Under current law, we could even be held liable for damage caused by conditions that existed before we acquired the assets or operations involved. Any substantial liability for environmental damage could have a material adverse effect on our financial condition, results of operations and cash flows. We may be unable to obtain permits that are required to operate our business. Our failure to obtain or retain the permits required to operate our initial facility or additional facilities we may seek to construct would have a material negative effect on our business operations. Permits to operate waste processing facilities have become increasingly difficult and expensive to obtain and retain as a result of many factors including numerous hearings and compliance with zoning, environmental and other regulatory measures. The granting of these permits is also often subject to resistance from citizen or other groups and other political pressures. Our failure to obtain or retain the required permits to operate our facilities could have a material negative effect on our future results of operations. A substantial portion of our revenues will be generated from our agreement with Taormina Industries, which agreement may be terminated by Taormina under certain circumstances. In June 2003, we signed a 10-year contract with Taormina Industries, a division of Republic Services, Inc. The agreement provides for Taormina to deliver up to 500 tons of MSW per day to us for processing at our Anaheim facility on the campus of Taormina in Anaheim, California. The second phase calls for us to build an additional plant in the Orange County area at which Taormina will deliver up to an additional 2,000 tons of MSW per day. The agreement grants Taormina a right of first refusal to participate in potential additional projects in an additional 10 counties throughout California where Taormina has operations. Under the terms of the agreement, Taormina is required to pay us a per ton tipping fee. We anticipate that a substantial portion of our revenues will be generated from this agreement for the foreseeable future. The Taormina agreement, as amended, provides that Taormina can terminate under certain circumstances. If this agreement is terminated for any reason or if we are unable to extend this agreement on terms favorable to us or at all prior to its expiration, our business, financial condition and results of operations would be materially harmed. We may be exposed to substantial liability claims in the ordinary course of our business. Since our personnel are expected to routinely handle solid waste materials, we may be subject to liability claims by employees, customers and third parties. We currently have liability insurance in place, but such insurance may not be adequate to cover claims asserted against us. Also, we may be unable to maintain or purchase such insurance in the future. Either of these events could have a material adverse affect on our financial condition or our ability to raise additional capital. 31 Claims by other companies that we infringe their intellectual property or proprietary rights may adversely affect our business. If any of our products or processes is found to violate third party intellectual property rights, we may be required to re-engineer one or more of those products or processes or seek to obtain licenses from third parties to continue offering our products or processes without substantial re-engineering, and such efforts may not be successful. We may be unable to obtain such licenses at a reasonable cost, if at all. Failure to do so could result in significant curtailment of our operations. Future patents may be issued to third parties upon which our technology may infringe. We may incur substantial costs in defending against claims under any such patents. Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief, which effectively could block our ability to further develop or commercialize some or all of our products or services, and could result in the award of substantial damages against us. In the event of a claim of infringement, we may be required to obtain one or more licenses from third parties. We may be unable to obtain such licenses at a reasonable cost, if at all. Defense of any lawsuit or failure to obtain any such license could have a material adverse effect on our business and results of operations. Our license agreement with Bio-Products International, Inc. is not exclusive in all respects and imposes certain requirements on us to maintain exclusivity in specified applications. Our license agreement with BPI grants us the exclusive rights to exploit the technology covered by the license in the United States with respect to most applications. We do not, however, have the exclusive right to applications in which the cellulose biomass product of waste, including municipal solid waste, processed utilizing the licensed technology is either used directly as a fuel source or converted into an end product for energy production. Accordingly, BPI may grant third parties the right to use the technology for the production of marketable solid combustion fuel end products on a non-exclusive basis. In order to maintain exclusivity with respect to the other applications, we are required to continue to improve our initial facility in Anaheim, California on a regular schedule or construct new facilities. Our failure to maintain exclusivity of the license could have a material adverse effect on our business, financial condition and results of operations. If we fail to implement new technologies, we may not be able to keep up with our industry, which could have an adverse affect on our business. We expect to utilize patented and proprietary steam classification technology in our processing facilities and to adopt other technologies from time to time. Our future growth is partially tied to our ability to improve our knowledge and implementation of waste processing and energy development technologies. Inability to successfully implement commercially viable waste processing technologies in response to market conditions in a manner that is responsive to our customers' requirements could have a material adverse effect on our business and results of operation. We may not be able to implement Section 404 of the Sarbanes-Oxley Act on a timely basis. The SEC, as directed by Section 404 of the Sarbanes-Oxley Act, adopted rules generally requiring each public company to include a report of management on the company's internal controls over financial reporting in its annual report on Form 10-KSB that contains an assessment by management of the effectiveness of the company's internal controls over financial reporting. In addition, the company's independent registered accounting firm must attest to and report on management's assessment of the effectiveness of the company's internal controls over financial reporting. This requirement will first apply to our annual report on Form 10-KSB for the fiscal year ending December 31, 2007 (unless such date is extended by the SEC). We have not yet developed a Section 404 implementation plan. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. How companies should be implementing these new requirements including internal control reforms to comply with Section 404's requirements and how independent auditors will apply these requirements and test companies' internal controls, is still reasonably uncertain. We expect that we will need to hire and/or engage additional personnel and incur incremental costs in order to complete the work required by Section 404. We can not assure you that we will be able to complete a Section 404 plan on a timely basis. Additionally, upon completion of a Section 404 plan, we may not be able to conclude that our internal controls are effective, or in the event that we conclude that our internal controls are effective, our independent accountants may disagree with our assessment and may issue a report that is qualified. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could negatively affect our operating results or cause us to fail to meet our reporting obligations. 32 Changes in stock option accounting rules may adversely affect our reported operating results, our stock price and our ability to attract and retain employees. In December 2004, the Financial Accounting Standards Board published new rules that require companies to record all stock-based employee compensation as an expense. The new rules apply to stock option grants, as well as a wide range of other share-based compensation arrangements including restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. During the fourth quarter of 2004, we adopted this accounting policy, retroactive to our inception. As a small company with limited financial resources, we have depended upon compensating our officers, directors, employees and consultants with such share-based compensation awards in the past in order to limit our cash expenditures and to attract and retain officers, directors, employees and consultants. Accordingly, if we continue to grant stock options or other stock based compensation awards to our officers, directors, employees, and consultants, our future earnings, if any, will be reduced (or our future losses will be increased) by the expenses recorded for those grants. These compensation expenses may be larger than the compensation expense that we would be required to record were we able to compensate these persons with cash in lieu of securities. The expenses we will have to record as a result of future options grants may be significant and may materially negatively affect our reported financial results. For example, for the six month period ended December 31, 2005, we incurred approximately $463,000 of expenses as a result of share-based compensation. The adverse effects that the new accounting rules may continue to have on our future financial statements should we continue to rely heavily on stock-based compensation may reduce our stock price and make it more difficult for us to attract new investors. However, reducing our use of stock plans to reward and incentivize our officers, directors, employees and consultants, could result in a competitive disadvantage to us in the employee marketplace. RISKS RELATED TO OUR COMMON STOCK Substantial sales of our common stock could cause our stock price to fall. As of June 30, 2006, we had outstanding 25,030,230 shares of common stock, not including 25,364,807 shares of common stockissuable upon conversion of our outstanding preferred stock and exercise of our outstanding options and warrants. all of which were "restricted securities" (as that term is defined under Rule 144 promulgated under the Securities Act of 1933, as amended). A substantial portion of these shares are either freely tradable shares or eligible for public resale under Rule 144. Although Rule 144 restricts the number of shares that any one holder can sell during any three-month period under Rule 144, because more than one stockholder holds these restricted shares, a significant number of shares are now eligible for sale. Sales of the shares subject to Rule 144 or the possibility that substantial amounts of common stock may be sold in the public market under Rule 144 , may adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through the sale of our equity securities. The limited market for our common stock may adversely affect trading prices or the ability of a shareholder to sell our shares in the public market. Our common stock is thinly-traded on the OTC Bulletin Board, meaning that 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 is attributable to a number of factors, including the fact that we are a small company that 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, early stage 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 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. Due to these conditions, an investor may be unable to sell its shares at or near ask prices or at all if it needs money or otherwise desires to liquidate its shares. You may have difficulty selling our shares because they are deemed "penny stocks". Since our common stock is not listed on the Nasdaq Stock Market, if the trading price of our common stock remains below $5.00 per share, trading in our common stock will be subject to the requirements of certain rules promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which require additional disclosure by broker-dealers in connection with any trades involving a stock defined as a penny stock (generally, any non-Nasdaq equity security that has a market price of less than $5.00 per share, subject to certain exceptions). 33 Such rules require the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and the risks associated therewith and impose various sales practice requirements on broker-dealers who sell penny stocks to persons other than established customers and accredited investors (generally defined as an investor with a net worth in excess of $1,000,000 or annual income exceeding $200,000 individually or $300,000 together with a spouse). For these types of transactions, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to the sale. The broker-dealer also must disclose the commissions payable to the broker-dealer, current bid and offer quotations for the penny stock and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Such information must be provided to the customer orally or in writing before or with the written confirmation of trade sent to the customer. Monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. The additional burdens imposed upon broker-dealers by such requirements could discourage broker-dealers from effecting transactions in our common stock, which could severely limit the market liquidity of our common stock and the ability of holders of our common stock to sell their shares. The holders of our preferred stock have certain rights that could adversely affect the value of our common stock. Under our articles of incorporation, our board of directors has the power, without further action by the holders of our common stock, to designate the relative rights and preferences of the preferred stock, and to issue the preferred stock in one or more series as designated by our board of directors. The designation of rights and preferences could include preferences as to liquidation, redemption and conversion rights, voting rights, dividends or other preferences, any of which may be dilutive of the interest of the holders of our common stock or the preferred stock of any other series. The issuance of preferred stock may have the effect of delaying or preventing a change in control of our company without further stockholder action and may adversely affect the rights and powers, including voting rights, of the holders of our common stock. We have two such series of preferred stock, designated as "8% Series A Cumulative Redeemable Convertible Participating Preferred Stock" and "8% Series B Cumulative Redeemable Convertible Participating Preferred Stock." Our directors, executive officers and their affiliates hold a substantial amount of our common stock and may be able to prevent other stockholders from influencing significant corporate decisions. Our directors and executive officers and their affiliates beneficially own a substantial amount of our outstanding common stock. These stockholders, if they were to act together, would likely be able to direct the outcome of matters requiring approval of the stockholders, including the election of our directors and other corporate actions such as: o our merger with or into another company; o a sale of substantially all of our assets; and o amendments to our articles of incorporation. The decisions of these stockholders may conflict with our interests or those of our other stockholders. The market price of our stock may be adversely affected by market volatility. The market price of our common stock is likely to be volatile and could fluctuate widely in response to many factor, including: o developments with respect to patents or proprietary rights; o announcements of technological innovations by us or our competitors; o announcements of new products or new contracts by us or our competitors; o actual or anticipated variations in our operating results due to the level of development expenses and other factors; 34 o changes in financial estimates by securities analysts and whether our earnings meet or exceed such estimates; o conditions and trends in the waste industries and other industries; o new accounting standards; o general economic, political and market conditions and other factors; and the occurrence of any of the other risks described in this Form 10-QSB. Item 3. -- 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 June 30, 2006 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II-- OTHER INFORMATION Item 5 -- Other Information None Item 6. -- Exhibits and Reports on Form 8-K (a) 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 Pursuant to Section 906 of the Sarbanes-Oxley Act 32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act (b) On January 3, 2006, the Company filed a Current Report on Form 8-K disclosing the entry into of a material definitive agreement and the sale of unregistered sale of equity securities. On February 16, 2006, the Company filed a Current Report on Form 8-K disclosing the entry into of a material definitive agreement. 35 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. WORLD WASTE TECHNOLOGIES, INC. (Registrant) Date: August 14, 2006 By: /s/ David Rane ------------------------------------- David Rane Chief Financial Officer 36 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 Pursuant to Section 906 of the Sarbanes-Oxley Act 32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act 37