Form 10-K for ETHOS ENVIRONMENTAL, INC.
Annual Report
ITEM 7. Management’s Discussion and Analysis or Plan of Operation.
The following discussion should be read in conjunction with our audited financial statements and notes thereto included herein. In connection with, and because we desire to take advantage of, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we caution readers regarding certain forward looking statements in the following discussion and elsewhere in this report and in any other statement made by, or on our behalf, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Forward looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward looking statements made by, or our behalf. We disclaim any obligation to update forward-looking statements.
Results of Operations and Analysis of Financial Condition
Results of Operations
The following financial data compares the balances as relates to Ethos Environmental, Inc. for the fiscal years ended December 31, 2008 and 2007.
Revenues
During the year ended December 31, 2008, the Company recognized revenues of $2,357,553 compared with $1,355,141 for the year ended December 31, 2007, an increase of 74.0%. The increase in overall sales revenue was a result of a stronger focus on the sales process during the year ended December 31, 2008 compared with the development of its internal processes rather than marketing of its products and finding new customers and distributors during the year ended December 31, 2007. The Company’s primary source of revenue is from the sale of Ethos FR�. Other components of revenue include freight and service.
The Company is continuing to focus on its future growth of Ethos FR�. Our main priorities continue to be: (1) increasing market awareness of Ethos FR� through our sales and marketing plan, including partnerships with marketing companies to help promote our company, (2) continued growth in the number of customers and vehicles per customer, especially in light of the poor economy and the cost savings that can be generated by individuals and companies through the use of Ethos FR�, and (3) providing extensive customer service and support.
Gross Profit
Gross profit for the year ended December 31, 2008, defined as revenues less cost of goods sold, was $934,795 or 39.7% of sales compared with $610,005 or 45.0% for the year ended December 31, 2007. The decrease in gross profit margin was due to increased costs of production incurred by the Company that could not be passed onto the consumers given the poor economic conditions and the competitiveness of the fuel reformulating sector.
Operating Expenses
The Company’s current operating expenses are comprised of costs associated with general and administrative costs such as staff salaries, consulting, marketing, and legal and accounting, and selling expenses such as marketing and business development.
Depreciation Expense
For the year ended December 31, 2008, the Company incurred depreciation expense of $81,355 compared to $201,093 for the year ended December 31, 2007. The decrease in depreciation expense was attributed to the sale leaseback of the Company’s building and certain manufacturing equipment during 2007. The Company’s amortization policy is to amortize production and office equipment on a straight-line basis over a 5-year period, and amortize building costs straight-line basis over a 25-year period. The majority of the depreciation expense for the years ended December 31, 2008 and 2007 was charged to cost of sales as the assets used were directly resulting in the production of revenue-producing goods.
General and Administrative
For the year ended December 31, 2008, the Company incurred general and administrative expense of $7,555,563 compared with $17,655,463 for the year ended December 31, 2007. The decrease in general and administrative expenses is attributed to the fact that the Company incurred stock based compensation expense of $6,646,171 in 2007 relating to the issuance of share purchase warrants to replace the convertibility features of its Promissory Note secured by the purchase of the Company’s building. Furthermore, the Company issued a lower value of common shares for services in the current year compared to 2007.
Selling Expense
For the year ended December 31, 2008, the Company incurred selling expense of $273,960 compared with $6,861,554 for the year ended December 31, 2007 and is related to marketing and business development expenditures that were settled by the issuance of common shares. During the year ended December 31, 2008, the Company limited its selling expense based on the fact that the Company’s focus was on internal operations and strategic development rather than marketing and promotion of the Company’s products.
Other Income (Expenses)
Interest Expense
For the year ended December 31, 2008, the Company incurred interest expense of $181,993 compared with $618,084 for the year ended December 31, 2007. The decrease in interest expense is due to the fact that the Company settled the interest-only of $4,750,000 that was used to finance the purchase of the Company’s building in 2007. For the year ended December 31, 2008, interest expense was attributed to accrued interest relating to the promissory notes and convertible notes that were issued by the Company as general financing of the Company’s continued operations.
Other Income
During the year ended December 31, 2008, the Company recorded other income of $201,137 compared with $390,206 for the year ended December 31, 2007.
Net Loss
For the year ended December 31, 2008, the Company incurred a net loss of $7,177,819 compared with a net loss of $24,582,613 for the year ended December 31, 2007. The decrease in the net loss is attributed to the fact that the Company increased its gross profit from fiscal 2007 by $324,790 and decreased the value of its issuance of common shares to settle debt and services by $9,143,110, and had an overall decrease in stock-based compensation expense relating to the issuance of share purchase warrants of $6,274,034.
Common Shares
December 31, 2008
During the year ended December 31, 2008, the Company issued 5,745,877 common shares to settle debt and services on behalf of the Company, issued 12,465,428 common shares as penalty and settlement shares as part of the Registration Rights Agreement executed in October 2007, issued 909,091 common shares for cash proceeds, and cancelled 13,600,000 common shares that were previously issued to the former Chief Executive Officer of the Company.
During the year ended December 31, 2008, the Company issued 12,465,428 common shares as penalty and settlement of a Registration Rights Agreement signed in October 2007. The common shares issued had a fair value of $2,818,840 using the end of day share trading price of the Company based on the date of issuance.
In November 2008, the Company cancelled 13,600,000 common shares that were previously issued by the former Chief Executive Officer of the Company.
In August 2008, the Company issued 909,091 common shares at $0.33 per common share for gross proceeds of $300,000.
December 31, 2007
During the year ended December 31, 2007, the Company issued 11,914,000 common shares to settle services incurred on behalf of the Company and issued 2,500,000 common shares for cash proceeds of $2,050,000.
In August 2007, the Company issued 2,500,000 common shares to Greenbridge Capital Partners (”Greenbridge”) as part of the sale leaseback transaction where the Company sold the rights to its office building to Greenbridge and 2,500,000 common shares in exchange for proceeds of $7,875,000. The sale price was allocated as $5,875,000 to the building and $2,000,000 to the common shares as fair value under a arms-length transaction.
Of the common shares issued for settlement of services, 5,000,000 common shares were issued to Enrique de Vilmorin, the Company’s Chief Executive Officer for the year ended December 31, 2007 and as at September 5, 2008 before his resignation. The common shares were issued as part of compensation for his duties as President, Chief Executive Officer, and Directors of the Company and were issued at the closing share price of $0.95 per common share which represented a fair value of $4,750,000.
The remaining 6,914,000 common shares were issued for consulting services and professional fees at varying periods throughout the year and were assessed at fair value using the end-of-day share price of the Company’s common stock.
Share issuances ranged from $0.95 - $5.00 per common share and the 6,914,000 common shares were reported at a fair value of $11,107,708.
Liquidity and Capital Resources
At December 31, 2008, we had cash of $72,232, current assets of $390,270, and total assets of $866,239 compared with cash of $74,178, current assets of $1,413,104, and total assets of $2,004,247 at December 31, 2007. The decrease in current assets and total assets were attributed to a decrease in capital assets of $48,364 based primarily on amortization of existing assets, and decrease in inventory of $379,255 as the Company had limited cash flows and did not replenish their inventory amounts at December 31, 2008.
The Company had total liabilities of $2,400,039and stockholders’ deficit of $1,533,800 as at December 31, 2008 compared with total liabilities of $929,712 and stockholders’ equity of $349,446 as at December 31, 2007. The increase in total liabilities is attributed to net issuance of $835,059 of debt financing from various demand loans and promissory notes along with net increases in accounts payable and accrued liability of $576,308 due to timing differences from payment of expenditures given the limited nature of the Company’s cash flow.
Cash Flows from Operating Activities
For the year ended December 31, 2008, the Company used $1,104,012 of cash flows for operating activities compared with $3,454,124 for the year ended December 31, 2007. The decrease in cash flows used for operations are attributed to net cash loss for the year ended December 31, 2008 of $1,778,829 compared with net cash loss of $2,592,859 for the year ended December 31, 2007. Furthermore, the Company incurred less cash on inventory purchases compared to December 31, 2007 which resulted in a net cash savings of $570,739 and had net cash savings of $655,724 from accounts payable and accrued liabilities based on timing differences of when billed invoices were paid.
Cash Flows from Investing Activities
For the year ended December 31, 2008, the Company used cash flows of $32,991 for purchases of capital assets compared with receiving cash flows of $6,034,731 for the year ended December 31, 2007 which was related to the proceeds from the sale leaseback transactions of its building and manufacturing equipment.
Cash Flows from Financing Activities
During the year ended December 31, 2008 the Company received proceeds of $1,135,059 from cash flows from financing activities compared with use of cash of $2,571,298 for the year ended December 31, 2007. In fiscal 2008, the Company received $1,431,580 from the issuance of promissory notes and demand loans, $300,000 from the issuance of common shares, and repaid $350,000 in promissory notes and $246,521 in related party payables. In fiscal 2007, the Company received $2,050,000 from the issuance of common shares, $350,000 from the issuance of note payable, but also repaid $5,167,819 of existing demand loans and notes payable.
Loan Facilities
On February 7, 2007, the Company entered into an equipment lease agreement with Mazuma Capital Corp. wherein the Company agreed to a 24-month sale and leaseback arrangement for up to $800,000 of its manufacturing equipment. The lease calls for a monthly payment based on a factor of .04125 times the average outstanding loan balance during the month.
The contract for this sale and leaseback of equipment should be accounted for as an operating lease per SFAS 13 and 28, and will be shown as such as at December 31, 2008. There is no bargain purchase option at the end of the lease, and neither the 75% nor the 90% test has been met. The title may pass back to the Company at the end of the lease; however, the lease may also be continued at the end of the 24 month period.
Going Concern
As at December 31, 2008, the Company had a cash balance of $72,232. For the years ended December 31, 2008 and 2007, the Company recorded sales revenue of $2,357,553 and $1,355,141 respectively, and had gross profit of $934,795 and $610,005, respectively. The Company recorded a net loss of $7177,819 for the year ended December 31, 2008 compared with a net loss of $24,582,613 for the year ended December 31, 2007.
Based on the above factors, there is substantial doubt regarding the Company’s ability to continue as a going concern. The continuation of the Company as a going concern is dependent on the continuation of the Company’s profitability from its’ operations, continued financial support from its shareholders, and the ability to raise additional equity or debt financing to sustain operations. The consolidated financial statements presented in the Form 10-K/A does not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.
Critical Accounting Policies
Use of Estimates
The preparation of these consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company regularly evaluates estimates and assumptions related to valuation allowances on accounts receivable and inventory, valuation and amortization policies on property and equipment, and valuation allowances on deferred income tax losses. The Company bases its estimates and assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from the Company’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.
Revenue Recognition
The Company will recognize revenue from the sale of its fuel reformulating products in accordance with Securities and Exchange Commission Staff Bulletin No. 104 (”SAB 104″), “Revenue Recognition in Financial Statements”. Revenue will be recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is provided, and collectibility is assured.
Stock-Based Compensation
The Company records stock-based compensation in accordance with SFAS No. 123R “Share-Based Payments”, using the fair value method. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. Equity instruments issued to employees and the cost of the services received as consideration are measured and recognized based on the fair value of the equity instruments issued.
Recent Accounting Pronouncements
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. It is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles”. The adoption of this statement is not expected to have a material effect on the Company’s financial statements.
In March 2008, the Financial Accounting Standards Board (”FASB”) issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities - an amendment to FASB Statement No. 133″. SFAS No. 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years beginning after November 15, 2008, with early adoption encouraged. The Company is currently evaluating the impact of SFAS No. 161 on its financial statements, and the adoption of this statement is not expected to have a material effect on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations”. This statement replaces SFAS 141 and defines the acquirer in a business combination as the entity that obtains control of one or more businesses in a business combination and establishes the acquisition date as the date that the acquirer achieves control. SFAS 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date. SFAS 141R also requires the acquirer to recognize contingent consideration at the acquisition date, measured at its fair value at that date. This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, and earlier adoption is prohibited. The adoption of this statement is not expected to have a material effect on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements Liabilities -an Amendment of ARB No. 51″. This statement amends ARB 51 to establish accounting and reporting standards for the Noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, and earlier adoption is prohibited. The adoption of this statement is not expected to have a material effect on the Company’s financial statements.
In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including and amendment of FASB Statement No. 115″. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ending February 28, 2009. The Company is currently evaluating the impact of SFAS No. 159 on its consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin (”SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires companies to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. SAB No. 108 is effective for periods ending after November 15, 2006. The adoption of SAB No. 108 did not have a material effect on its consolidated financial statements.
ITEM 7A.
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