UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K/A

(Mark One)

x

 

ANNUAL REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the fiscal year ended December 31, 2006

 

 

 

o

 

TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to               

Commission File No. 001-33253

FORCE PROTECTION, INC.

(Exact name of issuer as specified in its charter)

 

Nevada

 

84-1383888

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

9801 Highway 78, Building No. 1, Ladson,
SC

 

29456

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (843) 740-7015

Securities registered under Section 12(b) of the Exchange Act:

 

Common Stock, par value $0.001 per
share.

 

NASDAQ Stock Market

(Title of class)

 

(Name of Each Exchange On Which
Registered)

 

Securities registered under Section 12(g) of the Exchange Act: None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o  No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past twelve months (or 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   o

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K   o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (Check one).

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No   x

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of March 14, 2007 was $1,102,410,688 based on a total of 66,934,468 shares of our common stock held by non-affiliates on March 14, 2007 at the closing price of $16.47 per share.

We had 67,817,003 shares of common stock outstanding as of March 14, 2007.

 




TABLE OF CONTENTS

FORCE PROTECTION, INC. FORM 10-K

 

Page

 

 

 

EXPLANATORY NOTE

 

1

 

 

 

PART I

 

1

 

 

 

ITEM 1A.RISK FACTORS

 

1

 

 

 

PART II

 

5

 

 

 

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

5

 

 

 

ITEM 9A.CONTROLS AND PROCEDURES

 

41

 

 

 

PART IV

 

43

 

 

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

43

 

 

 

SIGNATURES

 

47

 

i




EXPLANATORY NOTE

Management has reassessed the effectiveness of our internal control over financial reporting as of December 31, 2006.  As a result, management has concluded that our internal control over financial reporting was not effective as of December 31, 2006, because of certain material weaknesses.  Management’s revised assessment is contained, and the material weaknesses are described, in Item 9A of this Form 10/KA.

As a result of that reassessment, Jaspers + Hall, PC has revised and reissued its reports with respect to our consolidated financial statements as of December 31, 2006 and with respect to management’s assessment of its internal control over financial reporting, and those revised reports appear in Item 8.  There are no changes, however, to the financial statements included in Item 8.

We have also made conforming changes to one “Risk Factor” contained in Item 1A.

PART I

ITEM 1A.  RISK FACTORS

An investment in our common stock is subject to risks and uncertainties. Investors should consider the following factors, in addition to the other information contained or incorporated by reference in this Annual Report on Form 10-K, as well as our other filings with the SEC, before deciding to purchase our securities.

We depend on the U.S. government for a substantial amount of our sales. If we do not find acceptance of our products within the U.S. government, our business may fail.

We serve the defense market and our sales are highly concentrated within the U.S. government. The customer relationship with the U.S. government involves certain risks that are unique such as the ongoing development of high-technology products, price, availability and quality of materials and suppliers.

U.S. defense spending has historically been cyclical. Defense budgets have received their strongest support when perceived threats to national security raise the level of concern over the country’s safety. As these threats subside, spending on the military tends to decrease. Accordingly, while Department of Defense funding has grown rapidly over the past few years, there is no assurance that this trend will continue. Rising budget deficits, the cost of the Global War on Terrorism and increasing costs for domestic programs continue to put pressure on all areas of discretionary spending, which could ultimately impact the defense budget. Wartime support for defense spending could wane if the country’s troop deployments in support of operations in Iraq and Afghanistan are reduced. A decrease in U.S. government defense spending or changes in spending allocation could result in one or more of our programs being reduced, delayed or terminated. Reductions in our existing programs, unless offset by other programs and opportunities, could adversely affect our ability to sustain and grow our future sales and earnings.

U.S. government contracts generally are not fully funded at inception and are subject to termination. If the U.S. government does not order as many vehicles as we anticipate, our business will be adversely affected.

Government contracts and subcontracts typically involve long purchase and payment cycles, competitive bidding, qualification requirements, delays or changes in funding, extensive specification development, price negotiations and milestone requirements. Each government agency also maintains its own rules and regulations with which we must comply and which can vary significantly among agencies. Governmental agencies also often retain some portion of fees payable upon completion of a project and collection of these fees may be delayed for several months or even years, in some instances.

In addition, an increasing number of government contracts are fixed price contracts which may prevent us from recovering costs incurred in excess of our budgeted costs. Fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements. The financial viability of any given project depends in large part on our ability to estimate such costs accurately and complete the project on a timely basis. In the event actual costs exceed the fixed contractual cost, we may not be able to recover the excess costs.




Some government contracts are also subject to termination or renegotiation at the convenience of the government, which could result in a large decline in revenue in any given quarter. Although government contracts have provisions providing for the reimbursement of costs associated with termination, the termination of a material contract at a time when our funded backlog does not permit redeployment of staff could result in a reduction in the number of employees. In addition, the timing of payments from government contracts is also subject to significant fluctuation and potential delay, depending on the government agency involved. Any such delay could result in a temporary shortage in working capital.

We must comply with environmental regulations or we may have to pay expensive penalties or clean up costs.

We are subject to federal, state, local and foreign laws, and regulations regarding protection of the environment, including air, water, and soil. Our manufacturing business involves the use, handling, storage, and contracting for recycling or disposal of, hazardous or toxic substances or wastes, including environmentally sensitive materials, such as batteries, solvents, lubricants, degreasing agents, gasoline and resin. We must comply with certain requirements for the use, management, handling, and disposal of these materials. We do not maintain insurance for pollutant cleanup and removal. If we are found responsible for any hazardous contamination, we may have to pay expensive fines or penalties or perform costly clean-up. Even if we are charged, and later found not responsible, for such contamination or clean up, the cost of defending the charges could be high. If we do not comply with government regulations, we may be unable to ship our products or have to pay expensive fines or penalties. We are subject to regulation by county, state and federal governments, governmental agencies, and regulatory authorities from several different countries. If we fail to obtain regulatory approvals or suffer delays in obtaining regulatory approvals, we may not be able to market our products and services, and generate product and service revenues. Further, we may not be able to obtain necessary regulatory approvals. Although we do not anticipate problems satisfying any of the regulations involved, we cannot foresee the possibility of new regulations, which could adversely affect our business. Further our products are subject to export limitations and we may be prevented from shipping our products to certain nations or buyers.

Our earnings and margins depend on our ability to perform under our contracts and if we do not perform our margins may erode.

Our contracts require management to make various assumptions and projections about the outcome of future events over a period of several years. These projections can include future labor productivity and availability, the nature and complexity of the work to be performed, the cost and availability of materials, the impact of delayed performance, and the timing of product deliveries. If there is a significant change in one or more of these assumptions, circumstances or estimates, or if we are unable to control the costs incurred in performing under these contracts, the profitability of one or more of these contracts may be adversely affected.

If the pricing and availability of subcontractor performance and raw materials change, our profitability may be adversely affected.

We rely on subcontractors and other companies to provide raw materials, major components and subsystems for our products or to perform a portion of the services that we provide to our customers. Occasionally we rely on only one or two sources of supply, which, if disrupted, could have an adverse effect on our ability to meet our commitments to customers. We depend on these subcontractors and vendors to fulfill our contractual obligations in a timely and satisfactory manner in full compliance with customer requirements. If one or more of our subcontractors or suppliers are unable to satisfactorily provide on a timely basis the agreed-upon supplies or perform the agreed-upon services, our ability to perform our obligations as a prime contractor may be adversely affected.

Some of our product components are manufactured in other foreign countries and if any of those become unstable or government regulations change, our costs may increase or we may become unable to source certain parts.

Some of our product components are manufactured in and supplied from other foreign countries. If import tariffs or taxes increase for any reason, our cost of goods would increase. Our financial performance may be affected by changes in political, social and economic environment. The role of the central and local governments in the economy is significant. Policies toward economic liberalization, and laws and policies affecting foreign companies, foreign investment, currency exchange rates and other matters could change, resulting in greater restrictions on our ability to do business with suppliers based in other countries. The government could impose surcharges, increase tax rates, or revoke, terminate or suspend operating licenses without compensating us. Also, other countries, from time to time, experience instances of civil unrest and hostilities. Confrontations have occurred between the military, insurgent forces, and civilians. If for these or any other reason, we lose our ability to sub-contract or manufacture the components to our products, or the cost of doing business increases, our business, financial condition, and results of operations would be materially and adversely affected.

2




We may be subject to personal liability claims for our products and if our insurance is not sufficient to cover such claims, our expenses may increase substantially.

As a result, a significant lawsuit could adversely affect our business. We may be exposed to liability for personal injury or property damage claims relating to the use of the products. Any future claim against us for personal injury or property damage could materially adversely affect the business, financial condition, and results of operations and result in negative publicity. Even if we are not found liable, the costs of defending a lawsuit can be high. We do not currently maintain insurance for this type of liability. Additionally, even if we do purchase insurance, we may experience legal claims outside of our insurance coverage, or in excess of our insurance coverage, or that insurance will not cover.

We must develop new technologies and maintain a qualified workforce in order to remain competitive.

Virtually all of the products we produce and sell are highly engineered and require sophisticated manufacturing and system integration techniques and capabilities. Government markets in which the company operates are characterized by rapidly changing technologies. The product and program needs of our government customers change and evolve regularly. Accordingly, our future performance in part depends on our ability to identify emerging technological trends, develop and manufacture competitive products, and bring those products to market quickly at cost-effective prices. In addition, because of the highly specialized nature of our business, we must be able to hire and retain the skilled and appropriately qualified personnel necessary to perform the services required by our customers. If we are unable to develop new products that meet customers’ changing needs or successfully attract and retain qualified personnel, future sales and earnings may be adversely affected.

We rely on proprietary designs and rights and if we have to litigate those rights, our expenses could substantially increase.

Our success and ability to compete depend, in part, on the protection of our designs and technology. In addition, our technology could infringe on patents or proprietary rights of others. We have not undertaken or conducted any comprehensive patent infringement searches or studies. If any third parties hold any conflicting rights, we may be required to stop making, using or selling our products or to obtain licenses from and pay royalties to others. Further, in such event, we may not be able to obtain or maintain any such licenses on acceptable terms, if at all. We may need to engage in future litigation to enforce intellectual property rights or the rights of customers, to protect trade secrets or to determine the validity and scope of proprietary rights of others, including customers. This litigation could result in substantial costs and diversion of resources and could materially and adversely affect our results of operations.

We have identified material weaknesses in our internal control over financial reporting, which could adversely affect our ability to report our financial condition and results of operations accurately or on a timely basis.    As a result, current and potential stockholders could lose confidence in our financial reporting, which could harm our business and the trading price of our stock.

As required by Section 404 of the Sarbanes-Oxley Act of 2002, our management has conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2006.   We previously restated our financial statements in our annual reports on Form 10-K for the fiscal years ended 2003, 2004 and 2005 and we amended our annual report on Form 10-K for the 2006 fiscal year.  Following our restating and amending of our prior annual reports, we identified a number of material weaknesses in our internal control over financial reporting and have now concluded that, as of December 31, 2006, we did not maintain effective control over financial reporting.  For a discussion of our internal control over financial reporting and a description of the identified material weaknesses, see “Item 9A:  Controls and Procedures - Management’s Report on Internal Control over Financial Reporting” of this Form 10-K/A.

Each of our material weaknesses results in more than a remote likelihood that a material misstatement of the annual or interim financial statements that we prepare will not be prevented or detected. As a result, we must perform extensive additional work to obtain reasonable assurance regarding the reliability of our financial statements. Even with this additional work, there is a risk of additional errors not being prevented or detected, which could result in additional restatements. Moreover, other material weaknesses may be identified.

Material weaknesses in our internal control over financial reporting could adversely impact our ability to provide timely and accurate financial information.  If we are unsuccessful in implementing or following our remediation plan, or fail to update our internal control over financial reporting as our business evolves, we may be  unable to report financial information timely and accurately or to

3




maintain effective disclosure controls and procedures.  Any such failure in the future could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding disclosure controls and the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. If we are unable to report financial information in a timely and accurate manner or to maintain effective disclosure controls and procedures, we could be subject to, among other things, regulatory or enforcement actions by the SEC and NASDAQ, including a delisting from the NASDAQ Stock Market, securities litigation, and a general loss of investor confidence, any one of which could adversely affect our business prospects and the valuation of our common stock.

We also have extensive work remaining to remedy the identified material weaknesses in our internal control over financial reporting and this work will continue through the balance 2007 and perhaps beyond.  There can be no assurance as to when all of the material weaknesses will be remedied.  Until our remedial efforts are completed, management will continue to devote significant time and attention to these efforts, and we will continue to incur expenses associated with the additional procedures and resources required to prepare our financial statements. Certain of our remedial actions, such as hiring additional qualified personnel and implementing a new operating system, will be ongoing and will result in our incurring additional costs even after our material weaknesses are remedied.

4




PART II

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Stockholders of Force Protection, Inc.

We have audited the accompanying consolidated balance sheets of Force Protection, Inc. and subsidiary as of December 31, 2006, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Force Protection, Inc., and subsidiary as of December 31, 2006, 2005 and 2004, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the financial statements, certain errors resulting in adjustments to the Company’s accounting for preferred stock and warrants issued to investors, accounting for stock-based compensation to employees and non-employees and accounting for rent expense on a straight-line basis as of December 31, 2006, 2005 and 2004, were discovered by management of the Company during the current year. Accordingly, the 2006, 2005 and 2004 financial statements have been restated to correct these errors.

/s/ JASPERS + HALL, PC

 

Denver, Colorado

 

June 5, 2007

 

 

5




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Stockholders of Force Protection, Inc. and Subsidiary

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Force Protection, Inc. and subsidiary did not maintain effective internal control over financial reporting as of December 31, 2006, because of the effect of the material weakness identified in management’s assessment, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organization of the Treadway Commission (COSO). Force Protection, Inc. and subsidiary’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment. Force Protection, Inc. and subsidiary’s financial and accounting organization was not adequate to support their financial accounting and reporting needs.  Specifically, they did not maintain a sufficient complement of personnel with an appropriate level of accounting knowledge, experience with the Company and training in the application of GAAP commensurate with our financial reporting requirements.  Force Protection, Inc. and subsidiary did  not maintain effective policies and procedures related to the accounting for specific equity issuances, including accounting for stock-based compensation in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 123, Share-Based Payment, and accounting for convertible and redeemable preferred stock and warrants. In addition, Force Protection, Inc. and subsidiary did not maintain effective controls to ensure the accuracy of disclosures in their financial statements and classification of certain financial transactions in the financial statements.

This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2006 financial statements, and this report does not affect our report dated June 5, 2007 on those financial statements.

In our opinion, management’s assessment that Force Protection, Inc. and subsidiary did not maintain effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Force Protection, Inc. and subsidiary has not maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

6




We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of Force Protection, Inc. and subsidiary as of December 31, 2006, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006, and our report dated June 5, 2007, expressed an unqualified opinion thereon.

/s/ JASPERS + HALL, PC

 

 

Denver, Colorado

 

June 5, 2007

 

 

7




FORCE PROTECTION INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF OPERATIONS
For the Years Ended December 31, 2006, 2005 and 2004

 

 

2006

 

2005

 

2004

 

 

 

 

 

Restated

 

Restated

 

Net Sales

 

$

196,017,446

 

$

49,712,829

 

$

10,272,757

 

Cost of sales

 

158,994,626

 

46,428,615

 

11,266,998

 

Gross Profit

 

37,022,820

 

3,284,214

 

(994,241

)

General and administrative expense

 

27,183,093

 

17,256,359

 

9,614,052

 

R & D expense

 

3,204,165

 

1,657,918

 

1,230,290

 

Operating Profit (Loss)

 

6,635,562

 

(15,630,063

)

(11,838,583

)

Other income

 

963,390

 

102,941

 

569,760

 

Interest expense

 

(1,728,500

)

(1,708,291

)

(684,980

)

Realized gain on derivative liability

 

 

2,830,791

 

 

Earnings (Loss) from Operations

 

5,870,452

 

(14,404,622

)

(11,953,803

)

Deferred Tax Benefit

 

12,326,491

 

 

 

Net Earnings (Loss)

 

$

18,196,943

 

$

(14,404,622

)

$

(11,953,803

)

Net earnings (loss)

 

$

18,196,943

 

$

(14,404,622

)

$

(11,953,803

)

Accretion of Series D 6% convertible preferred stock

 

(1,297,134

)

(2,041,697

)

 

Preferred Dividends

 

(325,685

)

(778,530

)

 

Net Earnings/(Loss) available to common shareholders

 

$

16,574,124

 

$

(17,224,849

)

$

(11,953,803

)

Basic earnings (loss) per common share

 

$

0.37

 

$

(0.51

)

$

(0.62

)

Diluted earnings (loss) per common share

 

$

0.36

 

$

(0.51

)

$

(0.62

)

Weighted-average shares used to compute:

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

44,786,083

 

33,926,573

 

19,357,939

 

Diluted earnings (loss) per share

 

50,428,466

 

33,926,573

 

19,357,939

 

 

The accompanying Notes are an integral part of these financial statements.

8




FORCE PROTECTION INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006, 2005 and 2004

 

 

2006

 

2005

 

2004

 

 

 

 

 

Restated

 

Restated

 

ASSETS

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

Cash

 

$

156,319,004

 

$

1,217,509

 

$

2,264,406

 

Accounts receivable, net of allowance for contractual adjustments of $6,068,087 for 2006, $1,018,051 for 2005, and $0 for 2004

 

36,011,568

 

3,666,358

 

1,053,973

 

Inventories

 

60,396,297

 

32,486,776

 

9,029,913

 

Other current assets

 

374,051

 

267,189

 

241,910

 

Current Portion of Deferred Taxes

 

9,562,500

 

 

 

Total current assets

 

262,663,420

 

37,637,832

 

12,590,202

 

Investment in Challenger Powerboats Inc, net of valuation allowance

 

 

 

 

Long Term Portion of Deferred Taxes

 

2,763,991

 

 

 

Property Plant and equipment, net

 

8,963,901

 

2,138,703

 

1,036,994

 

Total Assets

 

$

274,391,312

 

$

39,776,535

 

$

13,627,196

 

LIABILITIES & SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

38,653,813

 

$

14,688,855

 

$

1,867,363

 

Other accrued liabilities

 

2,968,859

 

1,898,020

 

1,354,466

 

Contract liabilities

 

1,850,000

 

1,686,062

 

729,461

 

Loans payable

 

 

7,500,000

 

360,975

 

Line of Credit

 

 

 

4,000,000

 

Current portion of long term liabilities

 

71,685

 

 

 

Deferred revenue

 

12,824,211

 

12,598,921

 

2,645,716

 

Total Current Liabilities

 

56,368,568

 

38,371,858

 

10,957,981

 

Long-term debt:

 

 

 

 

 

 

 

Other long term liabilities

 

167,937

 

 

110,732

 

Total Liabilities

 

56,536,505

 

38,371,858

 

11,068,713

 

Commitment and Contingencies (See Note 7)

 

 

 

 

 

 

 

Preferred stock series D, $0.001 par value, authorized: 20,000 shares, issued and outstanding: 0,13,004, 0 shares; for the years 2006, 2005 and 2004 respectively;

 

 

7,901,438

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Preferred stock: $0.001 par value, authorized: 10,000,000 shares

 

 

 

 

Preferred stock series B, $0.001 par value, authorized: 25 shares issued and outstanding 0, 0, 19.5 shares; for the years 2006, 2005 and 2004 respectively;

 

 

 

 

Preferred stock series C, $0.001 par value, authorized: 150 shares, issued and outstanding 0,0,0 shares; for the years 2006, 2005 and 2004 respectively;

 

 

 

 

Common stock, $0.001 par value, authorized: 300,000,000, issued and outstanding: 66,762, 566, 36,114,216, 19,357,938 shares; for the years 2006, 2005 and 2004

 

66,763

 

36,114

 

19,358

 

Warrants

 

 

5,780,952

 

2,602,800

 

Shares to be issued

 

31

 

 

 

Beneficial Conversion Feature

 

 

 

19,102,306

 

Additional Paid-in Capital

 

249,694,850

 

38,714,893

 

35,874,565

 

Accumulated deficit

 

(31,906,837

)

(51,028,720

)

(55,040,546

)

Total Shareholders’ Equity

 

217,854,807

 

(6,496,761

)

2,558,483

 

Total Liabilities and Shareholders’ Equity

 

$

274,391,312

 

$

39,776,535

 

$

13,627,196

 

 

The accompanying Notes are an integral part of these financial statements.

9




FORCE PROTECTION INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2006, 2005 and 2004

 

 

Series B

 

Series C

 

 

 

 

 

 

 

Preferred Stock

 

Preferred Stock

 

Common Stock

 

 

 

Shares

 

Par $.001

 

Shares

 

Par $.001

 

Shares

 

Par $.001

 

Balance, December 31, 2003

 

10

 

$                    0

 

132

 

$                    0

 

10,190,021

 

$         10,190

 

Issuance of common stock for cash

 

0

 

0

 

0

 

0

 

2,982,717

 

2,983

 

Issuance of common stock for services—Third Parties

 

0

 

0

 

0

 

0

 

163,501

 

163

 

Issuance of common stock for Compensation—Directors &
Employees

 

0

 

 

 

0

 

 

 

616,682

 

617

 

Issuance of common stock for cash (Warrant net change)

 

0

 

 

 

0

 

 

 

2,757,618

 

2,758

 

Cancellation of Common shares

 

 

 

 

 

 

 

 

 

(304,167

)

(304

)

Issuance of common shares for Debt

 

 

 

 

 

 

 

 

 

20,421

 

20

 

Conversion of preferred stock to common stock

 

(1

)

 

 

(80

)

 

 

2,931,145

 

2,931

 

Conversion between preferred Series B and Series C

 

11

 

 

 

(105

)

 

 

0

 

0

 

Change in Beneficial Conversion Feature

 

0

 

 

 

0

 

 

 

 

 

 

 

Issuance of Preferred Stock for Cash

 

0

 

 

 

1

 

 

 

0

 

0

 

Issuance of preferred stock for compensation

 

0

 

 

 

38

 

 

 

0

 

0

 

Issuance of preferred stock for conversion of debt

 

0

 

 

 

20

 

 

 

0

 

0

 

Rescinded and Redemption of preferred stock

 

0

 

 

 

(6

)

 

 

0

 

0

 

Net loss

 

0

 

 

 

0

 

 

 

0

 

0

 

Balance, December 31, 2004

 

20

 

$

0

 

0

 

$

0

 

19,357,938

 

$

19,358

 

Issuance of common stock for cash

 

0

 

0

 

0

 

0

 

185,321

 

185

 

Issuance of common stock for compensation

 

0

 

0

 

0

 

0

 

51,616

 

52

 

Issuance of common stock for settlement agreements

 

0

 

0

 

0

 

0

 

53,467

 

53

 

Issuance of common stock for interest

 

0

 

0

 

0

 

0

 

14,876

 

15

 

Issuance of Common Stock as Series D dividend shares

 

0

 

0

 

0

 

0

 

281,697

 

282

 

Issuance of Common Stock to round up post split shares

 

0

 

0

 

0

 

0

 

3,079

 

3

 

Issuance of common stock for cash-warrants

 

0

 

0

 

0

 

0

 

114,376

 

114

 

Warrant issued for Series D placement

 

0

 

0

 

0

 

0

 

 

 

 

 

Conversion of Series Series D preferred stock to common stock

 

0

 

0

 

0

 

0

 

1,331,429

 

1,331

 

Accretion of Series D Preferred Stock

 

0

 

0

 

0

 

0

 

 

 

 

 

Reclassification of Series D Warrants from Liability

 

0

 

0

 

0

 

0

 

 

 

 

 

Dividends for Series D-cash

 

0

 

0

 

0

 

0

 

 

 

 

 

Dividends for Series D-accrued

 

 

 

 

 

 

 

 

 

 

 

 

 

Conversion of Series B preferred stock to common stock

 

(20

)

0

 

0

 

0

 

14,803,750

 

14,804

 

Beneficial Conversion Feature

 

0

 

0

 

0

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Share Grants cancelled

 

0

 

0

 

0

 

0

 

(83,333

)

(83

)

Stock Based Compensation (FAS 123R)

 

 

 

 

 

 

 

 

 

 

 

 

 

Warrants-net (expired & issued)  not including Series D

 

0

 

0

 

0

 

0

 

 

 

 

 

Net loss

 

0

 

0

 

0

 

0

 

0

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2005

 

0

 

$

0

 

0

 

$

0

 

36,114,216

 

$

36,114

 

Issuance of common stock for cash (PIPE’s)

 

0

 

 

 

0

 

 

 

21,250,000

 

21,250

 

Issuance of common stock for stock options exercised

 

 

 

 

 

 

 

 

 

1,000

 

1

 

Issuance of common stock for compensation

 

0

 

 

 

0

 

 

 

313,644

 

314

 

Issuance of common stock for settlement agreements

 

0

 

 

 

0

 

 

 

30,000

 

30

 

Issuance of common stock for dividends on Series D

 

0

 

 

 

0

 

 

 

8,937

 

9

 

Issuance of Cash for dividends on Series D

 

 

 

 

 

 

 

 

 

0

 

0

 

Accretion of Series D Preferred Stock

 

0

 

0

 

0

 

0

 

 

 

 

 

Issuance of common stock for cash—warrants

 

 

 

 

 

 

 

 

 

2,852,140

 

2,852

 

Conversion of Series D preferred stock to common stock

 

 

 

 

 

 

 

 

 

6,192,628

 

6,193

 

Stock based compensation (FAS 123R)

 

 

 

 

 

 

 

 

 

0

 

0

 

Net earnings (loss)

 

0

 

0

 

0

 

0

 

0

 

0

 

Balance, December 31, 2006

 

0

 

$

0

 

0

 

$

0

 

66,762,565

 

$

66,763

 

 

10




 

 

 

 

 

 

 

Shares to

 

Additional

 

 

 

 

 

 

 

 

 

 

 

be Issued

 

Paid-in

 

Accumulated

 

 

 

 

 

Warrants

 

BCF

 

0

 

Capital

 

Deficit

 

Total

 

Balance, December 31, 2003

 

$      4,862,765

 

$         282,890

 

$                      0

 

$   18,805,887

 

$  (24,267,327

)

$        (305,595

)

Issuance of common stock for cash

 

 

 

 

 

 

 

7,200,234

 

0

 

7,203,217

 

Issuance of common stock for services—Third Parties

 

 

 

 

 

 

 

496,793

 

0

 

496,956

 

Issuance of common stock for Compensation—Directors &
Employees

 

 

 

 

 

 

 

1,431,187

 

 

 

1,431,804

 

Issuance of common stock for cash (Warrant net change)

 

(2,259,965

)

 

 

 

 

6,352,054

 

 

 

4,094,847

 

Cancellation of Common shares

 

 

 

 

 

 

 

304

 

 

 

0

 

Issuance of common shares for Debt

 

 

 

 

 

 

 

124,956

 

 

 

124,976

 

Conversion of preferred stock to common stock

 

 

 

 

 

 

 

(2,931

)

0

 

0

 

Conversion between preferred Series B and Series C

 

 

 

 

 

 

 

0

 

0

 

0

 

Change in Beneficial Conversion Feature

 

 

 

18,819,416

 

 

 

 

 

(18,819,416

)

0

 

Issuance of Preferred Stock for Cash

 

 

 

 

 

 

 

10,000

 

0

 

10,000

 

Issuance of preferred stock for compensation

 

 

 

 

 

 

 

1,316,081

 

0

 

1,316,081

 

Issuance of preferred stock for conversion of debt

 

 

 

 

 

 

 

200,000

 

0

 

200,000

 

Rescinded and Redemption of preferred stock

 

0

 

 

 

 

 

(60,000

)

0

 

(60,000

)

Net loss

 

 

 

 

 

 

 

 

 

(11,953,803

)

(11,953,803

)

Balance, December 31, 2004

 

$

2,602,800

 

$

19,102,306

 

$

0

 

$

35,874,565

 

$

(55,040,546

)

$

2,558,483

 

Issuance of common stock for cash

 

0

 

 

 

 

 

513,806

 

0

 

513,991

 

Issuance of common stock for compensation

 

 

 

 

 

 

 

125,357

 

0

 

125,409

 

Issuance of common stock for settlement agreements

 

 

 

 

 

 

 

144,842

 

0

 

144,895

 

Issuance of common stock for interest

 

 

 

 

 

 

 

20,626

 

0

 

20,641

 

Issuance of Common Stock as Series D dividend shares

 

 

 

 

 

 

 

418,148

 

(418,430

)

0

 

Issuance of Common Stock to round up post split shares

 

 

 

 

 

 

 

6,075

 

0

 

6,078

 

Issuance of common stock for cash-warrants

 

(122,903

)

 

 

 

 

334,418

 

0

 

211,629

 

Warrant issued for Series D placement

 

200,071

 

 

 

 

 

(200,071

)

 

 

0

 

Conversion of Series Series D preferred stock to common stock

 

 

 

 

 

 

 

1,440,694

 

 

 

1,442,025

 

Accretion of Series D Preferred Stock

 

 

 

 

 

 

 

(2,041,697

)

 

 

(2,041,697

)

Reclassification of Series D Warrants from Liability

 

5,173,409

 

 

 

 

 

 

 

 

 

5,173,409

 

Dividends for Series D-cash

 

 

 

 

 

 

 

 

 

(100,020

)

(100,020

)

Dividends for Series D-accrued

 

 

 

 

 

 

 

 

 

(260,080

)

(260,080

)

Conversion of Series B preferred stock to common stock

 

0

 

 

 

 

 

(14,804

)

0

 

0

 

Beneficial Conversion Feature

 

 

 

(19,102,306

)

 

 

 

 

19,102,306

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Share Grants cancelled

 

 

 

 

 

 

 

(209,916

)

 

 

(209,999

)

Stock Based Compensation (FAS 123R)

 

 

 

 

 

 

 

 

 

92,671

 

92,671

 

Warrants-net (expired & issued) not including Series D

 

(2,072,425

)

 

 

 

 

2,302,850

 

 

 

230,425

 

Net loss

 

 

 

 

 

 

 

0

 

(14,404,621

)

(14,404,621

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2005

 

$

5,780,952

 

$

0

 

$

0

 

$

38,714,893

 

$

(51,028,720

)

$

(6,496,761

)

Issuance of common stock for cash (PIPE’s)

 

0

 

0

 

0

 

185,806,511

 

0

 

185,827,761

 

Issuance of common stock for stock options exercised

 

0

 

0

 

4

 

5,996

 

0

 

6,001

 

Issuance of common stock for compensation

 

0

 

0

 

27

 

883,248

 

0

 

883,589

 

Issuance of common stock for settlement agreements

 

0

 

0

 

0

 

187,470

 

0

 

187,500

 

Issuance of common stock for dividends on Series D

 

0

 

0

 

0

 

48,816

 

(48,825

)

0

 

Issuance of Cash for dividends on Series D

 

0

 

0

 

0

 

0

 

(276,860

)

(276,860

)

Accretion of Series D Preferred Stock

 

 

 

 

 

 

 

(1,297,134

)

 

 

(1,297,134

)

Issuance of common stock for cash—warrants

 

(5,780,952

)

0

 

0

 

16,152,672

 

0

 

10,374,572

 

Conversion of Series D preferred stock to common stock

 

0

 

0

 

0

 

9,192,378

 

0

 

9,198,571

 

Stock based compensation (FAS 123R)

 

0

 

0

 

0

 

0

 

1,250,625

 

1,250,625

 

Net earnings (loss)

 

0

 

0

 

0

 

0

 

18,196,943

 

18,196,943

 

Balance, December 31, 2006

 

$

0

 

$

0

 

$

31

 

$

249,694,850

 

$

(31,906,837

)

$

217,854,807

 

 

The accompanying Notes are an integral part of these financial statements.

11




FORCE PROTECTION INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2006, 2005 AND 2004

(In dollars)

 

 

2006

 

2005

 

2004

 

 

 

 

 

Restated

 

Restated

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

Net Earnings (loss) from continuing operations

 

$

18,196,943

 

$

(14,404,622

)

$

(11,953,803

)

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

769,454

 

386,152

 

207,271

 

Deferred Tax Benefit

 

(12,326,491

)

 

 

Realized gain on derivative liability

 

 

(2,830,791

)

 

Stock issued for services and compensation

 

883,589

 

(84,590

)

3,244,841

 

Common stock issued for settlement

 

187,500

 

144,895

 

 

Common stock issued for interest

 

 

20,641

 

 

Stock based compensation

 

1,250,625

 

 

 

Change in assets and liabilities:

 

 

 

 

 

 

 

Decrease (increase) in accounts receivable

 

(32,345,210

)

(2,612,385

)

(909,041

)

Decrease (increase) in inventories

 

(27,909,521

)

(23,456,863

)

(8,202,576

)

Decrease (increase) in other current assets

 

(106,862

)

(25,279

)

(181,910

)

Increase (decrease) in accounts payable

 

23,964,958

 

12,821,492

 

1,152,297

 

Increase (decrease) in other accrued liabilities

 

1,125,762

 

543,554

 

1,603,942

 

Increase (decrease) in contract liabilities

 

163,938

 

956,601

 

549,077

 

Deferred Revenue

 

225,290

 

9,953,205

 

2,436,541

 

Net cash used in operating activities

 

(25,920,025

)

(18,587,990

)

(12,053,361

)

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

Purchase of property and equipment

 

(7,536,693

)

(1,511,337

)

(935,197

)

Proceeds from sale of assets

 

 

155,442

 

 

Net cash used in investing activities

 

(7,536,693

)

(1,355,895

)

(935,197

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from issuance of Private Placement common stock

 

185,827,761

 

 

 

Proceeds from issuance of common stock

 

 

513,991

 

11,298,064

 

Proceeds from issuance of Series D preferred stock

 

 

15,305,965

 

 

Redemption of Preferred Stock

 

 

 

(50,000

)

Preferred Stock Dividends paid

 

(276,860

)

(100,020

)

 

Issuance of common stock for cash-warrants

 

10,374,572

 

211,629

 

 

Issuance of common stock for stock options exercised

 

6,001

 

 

 

Proceeds from (Payments on) loans, net

 

(7,500,000

)

7,139,025

 

(175,187

)

Proceeds from (Payments on) Line of Credit, net

 

 

(4,000,000

)

3,823,039

 

Proceeds from (Payments on) long term liabilities

 

239,622

 

(110,732

)

78,271

 

Payments on Capitalized lease

 

(112,883

)

(62,870

)

 

Net cash provided by Financing Activities

 

188,558,213

 

18,896,988

 

14,974,187

 

Net increase (decrease) in cash

 

155,101,495

 

(1,046,897

)

1,985,629

 

CASH—beginning of period

 

1,217,509

 

2,264,406

 

278,777

 

CASH—end of period

 

$

156,319,004

 

$

1,217,509

 

$

2,264,406

 

Interest Paid

 

$

1,722,119

 

$

1,010,160

 

$

454,512

 

Taxes Paid

 

 

 

 

 

The accompanying Notes are an integral part of these financial statements.

12




FORCE PROTECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

These notes are an integral part of the Company’s financial statements set forth above.

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Restated)

2006 Amendment

The financial information included in this 10-K referring to the year ended December 31, 2006 has been amended to include the effect of the updated restatement to the financial statements for the year ended 2005 (see Note 1, 2005 and 2004 Restatement), and the effect on the basic earning per shares (EPS) of accretion on preferred stock and the calculation of weighted average common shares used to compute diluted earnings per share.

Earnings Per Share

The Company has reviewed the Financial Accounting Standards Board’s Statement of Financial Accounting Standard No. 128—Earnings Per Share (EPS) and determined that income available to common shareholders did not include the accretion related to preferred stock and the weighted average number of common shares outstanding used to calculate diluted earnings per share did not give effect to common shares issued upon conversion for the entire year.

Effects of Amendment

Effects on Consolidated Balance Sheet

 

2006

 

Increase in Additional Paid-in-capital

 

374,309

 

Increase in Accumulative deficit

 

374,309

 

 

Effects on Earnings Per Share

 

2006

 

Decrease in Basic earnings per common share

 

$

(0.03

)

Decrease in Diluted earnings per common share

 

$

(0.03

)

 

2005 and 2004 Restatement

Restatement of Accounting for Preferred Stock and Warrants Issued to Investors

Force Protection, Inc. (the “Company”) will be filing an amendment to its Annual Report on Form 10-K for the year ended December 31, 2005 to amend and restate financial statements and other information for the years 2005 and 2004. The restatement adjusts the Company’s accounting for preferred stock and warrants issued to investors, accounting for stock-based compensation to employees and non-employees and accounting for rent expense on a straight-line basis. The financial information included in this 10-K referring to prior years ended December 31, 2005 and 2004 includes each accounting restatement. Given that the company is still in the process of finalizing the restatement with the SEC, there is the potential that the restated numbers may change pending final resolution. The Company believes that the restatement did not have any material impact on its 2006 financial results.

The items identified by the Company relate to the valuation method used to account for certain equity issuances which did not properly include a full analysis of the embedded conversion feature associated with such issuances as required under EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, or which were otherwise incorrectly valued. As a result, a number of shares of the Company’s stock issued as compensation to certain executives and other third parties and recorded as general and administrative compensation expense appear to have been valued at less than fair value.

The Company has reviewed its accounting for preferred stock and warrants issued to investors as follows:

13




·                  Series B and Series C Convertible Preferred Stock are recorded as equity at fair value using the Black-Scholes Method at the time of issuance using a one year holding period assumption.

·                  A Beneficial Conversion Feature (BCF) treated as equity is created when the value received for each issuance is less than the fair value from the Black-Scholes calculation. Changes in conversion rates of Preferred Stock into Common Stock also can create a Beneficial Conversion Feature if the Preferred Stock can be converted into more common shares than at issuance or last amendment.

·                  Series D 6% Convertible Preferred Stock is recorded at fair value equaling the net cash proceeds from issuance minus the fair value of warrants issued in conjunction with the Series D 6% Convertible Preferred Stock. The Series D Preferred Stock falls outside the scope of SFAS No. 150 but the guidance in Rule 5-02.28 of Regulation S-X, Accounting Series Release No. 268 (ASR 268) and EITF Topic D-98: “Classification and Measurement of Redeemable Securities” are applicable. As such, the Company has recorded the Series D Preferred Stock as mezzanine equity on the accompanying balance sheet. Dividends for Series D 6% Convertible Preferred Stock were distributed either as Common Stock shares or in cash.

·                  The warrants issued in conjunction with the Series D 6% Convertible Preferred Stock were initially recorded at fair value as a liability as liquidating damages were paid as a result of a late SEC registration of the underlying Common Stock. The Black-Scholes Method was used to determine the fair value at issuance using a three year holding period. These warrants are adjusted each reporting period to the new fair value using the Black-Scholes Method until the registration was accepted by the SEC. At that point, the fair value using the Black-Scholes Method was reclassified into Equity. A realized gain on derivative liability in the amount of $2,830,791 was recorded in 2005 as a result of the change in fair value from issuance to reclassification to equity for these warrants.

·                  Other warrants are recorded at fair value using the Black-Scholes Method.

Restatement of Accounting for Stock-Based Compensation for Services and Compensation.

The Company has reviewed its accounting for stock based compensation issued for services and compensation during 2005, 2004 and 2003 taking into account, where applicable, Financial Accounting Standards Board’s Statement of Financial Accounting Standard No. 123. Stock based compensation issued for services and compensation were valued at the market price at the time of issuance. As a result of revaluation, a reduction in expense of $565,035 was recorded in 2005 and additional expense of $1,621,985 and $2,946,137 was recorded in 2004 and 2003.

The Company has reviewed the Financial Accounting Standards Board’s Statement of Financial Accounting Standard No. 123(Revised) (“SFAS 123(R)”) and has determined that the Company will adopt SFAS 123(R) as of July 1, 2005. Stock option expense of $92,671 was recorded for 2005.

Restatement of Accounting for Operating Lease Commitments

The Company has reviewed the Financial Accounting Standards Board’s Statement of Financial Accounting Standard No. 13 and has determined that in 2005, 2004 and 2003 the Company’s accounting for rent expense was not recorded on a straight-line basis over the term of the Company’s operating lease commitments. Several of the Company’s operating leases in effect during 2005, 2004 and 2003 included certain terms which provided for several months at the beginning of the lease term whereby rents were not due. Additionally, rent escalation clauses were included within certain operating leases which previous to this filing had improperly deferred rent expense over the course of the leases. The Company has calculated the necessary adjustments for 2005, 2004 and 2003 in order to restate its financial statements and record rent expense associated with operating lease commitments for 2005, 2004 and 2003. Additional rent expense for 2005, 2004 and 2003 was recorded in the amount of $12,039, $79,985 and $44,588, respectively.

In light of the restatement, readers should not rely on previously filed financial statements and other financial information for the years and for each of the quarters in the years 2005, 2004 and 2003.

14




Effects of Restatement

Effects on Statements of Earnings

 

2005

 

2004

 

Increase in cost of sales

 

2,012,989

 

 

Increase in general and administrative expense

 

669,745

 

1,701,970

 

Increase in operating loss

 

2,682,734

 

1,701,970

 

Increase in unrealized gain

 

2,830,791

 

 

(Decrease) in non recurring warranty expense

 

(2,012,089

)

 

Increase/(decrease) in loss from continuing operations before tax

 

(2,161,046

)

1,701,970

 

Increase/(decrease) in net (loss)

 

(2,161,046

)

1,701,970

 

 

Effects on Balance Sheet

 

2005

 

2004

 

(Decrease) in accounts receivable

 

(367,233

)

 

(Decrease) in total assets

 

(367,233

)

 

Increase in other accrued liability

 

279,569

 

124,575

 

(Decrease) in contract liabilities

 

(367,233

)

 

Increase in total liabilities

 

(87,654

)

124,575

 

Increase in mezzanine equity—Series D preferred stock

 

7,901,438

 

 

Increase in Warrants

 

5,779,452

 

2,601,300

 

Increase/(decrease) in beneficial conversion feature

 

(19,102,306

)

19,102,306

 

Increase/(decrease) in accumulated deficit

 

1,815,639

 

23,078,723

 

Increase/(decrease) in shareholders equity

 

(8,181,007

)

(124,573

)

 

Nature of the Business

Force Protection, Inc. and its subsidiaries (the “Company”) design, manufacture and market blast and ballistics armored vehicles for sale to military customers.

Principles of Consolidation

The consolidated financial statements include the accounts of Force Protection, Inc., and its two wholly-owned subsidiaries, Force Protection Industries, Inc. and Force Protection Technologies, Inc. All inter-company balances and transactions are eliminated in consolidation.

General Statement

The Securities and Exchange Commission, or SEC, has issued Financial Reporting Release No. 60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies,” or FRR 60, suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the SEC defined the most critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. The methods, estimates and judgments the Company uses in applying these most critical accounting policies have a significant impact on the results the Company reports in its financial statements.

The Company believes the following critical accounting policies and procedures, among others, affect its more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements:

·                  Revenue recognition;

·                  Inventory cost and Associated Reserves; and

·                  Allocation of direct and indirect cost of sales.

Revenue Recognition

The Company’s revenue is derived principally from the sale of its vehicles and associated spare parts and training services. Revenue from product sales and spare part sales, net of an allowance for contractual adjustments, is recognized when the products or spare parts

15




are delivered to and “formally” accepted by the customer. The Company defines “formal acceptance” as taking place when a representative of the United States government signs the United States Form DD250 entitled “Material Inspection and Receiving Report” which under the Federal Acquisition Regulations signifies contractual inspection and acceptance of the work performed by the contractor. It also acts as the contractual invoice creating payment liability on the United States Government. In accordance with standard industry practice, there is a representative from the United States Defense Contractor Manufacturing Agency (“DCMA”) acting as a contractual representative of the United States Government present at the Company’s facilities. This DCMA representative inspects each vehicle as it is delivered by the Company and upon confirmation of the vehicle’s conformity with the contractual specifications the inspector signs the Form DD250 and formally accepts delivery of the vehicle. The Company only recognizes revenues arising from its U.S. Government contracts upon execution of the Form DD250 by the DCMA inspector. Under some of the Company’s U.S. Government contracts, it receives performance based payments based on completion of specific milestones stipulated under the contract (for example, delivery of raw material to the Company’s Ladson facility). These payments are recorded as “deferred revenue” and carried on the Company’s balance sheet until the final delivery of the products and formal acceptance by the U.S. Government pursuant to the Form DD250. Upon acceptance of the products and the execution of the Form DD250, the Company recognizes the full sale price of the product as revenue.

Revenues from services provided are recorded in accordance with specific contractual terms. Services have historically consisted of the Company providing on-site personnel on an as-needed basis in a timely manner, and have generally been provided in foreign locations.

The Company negotiates contracts with its customers which may include revenue arrangements with multiple deliverables, as outlined by Emerging Issues Task Force No. 00-21 (EITF 00-21). The Company’s accounting policies are defined such that each deliverable under a contract is accounted for separately. Historically, the Company has negotiated and signed contracts with its customers which outline the contract amount and specific terms and conditions associated with each deliverable.

Allowance for Contractual Adjustments

The Company’s contracts with the U.S. Government are negotiated as a “sole source” or “open competition” bid process. A sole source process is one in which the Company is the sole bidder for the contract. An open competition could involve various bidders. Once a bid is accepted, the U.S. Government expects work to commence immediately. An open competition results in a final agreed-upon contract price which the U.S. Government has agreed to. A sole source process results in an agreed-upon contract with the U.S. Government, subject to an adjustment process at a later date, termed the “definitization process.” The definitization process commences upon delivery of a product, whereby the U.S. Government completes a detailed review of the Company’s costs involved in the manufacturing and delivery process. The U.S. Government and the Company then work to determine an adequate and fair final contract price. As a result of the potential adjustments related to the definitization process, the Company maintains an allowance for contractual adjustments account. This account is reviewed on a monthly basis to determine adequate adjustments, if necessary. The allowance is maintained and deemed adequate based on the analysis of historical data and calculation of pro-rata percentages of current contracts in place, which remain subject to the definitization process.

Historically, the Company has not encountered sales returns. The Company does not anticipate sales returns in the future.

Research and Development

Research, development, and engineering costs are expensed as incurred, in accordance with SFAS No. 2, Accounting for Research and Development Costs .. Research, development, and engineering expenses primarily include payroll and headcount related costs, contractor fees, infrastructure costs, and administrative expenses directly related to research and development support.

Cash Equivalents

For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with maturity of three months or less to be cash equivalents.

Inventories

Inventories are stated at the lower of cost or market. The cost is determined under the first-in-first-out (FIFO) valuation method. An allowance for excess or obsolete inventory is maintained by the Company. The Company determines an appropriate balance in this account based on historical data and specific identification of certain inventory items.

16




Property, Plant and Equipment

Property and equipment are stated at cost or at the value of the operating agreement. The Company capitalizes additions and improvements which include all material, labor and engineering cost to design, install or improve the asset. Routine repairs and maintenance are expensed as incurred. Depreciation and amortization are computed using the straight-line method over the following estimated useful lives:

Leasehold Improvements

 

2-5 years

Furniture and fixtures

 

3 years

Machinery and equipment

 

7 years

Tooling and molds

 

7 years

Vehicles

 

5 years

 

Impairment of Long-Lived Assets

The Company reviews long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the Company would recognize an impairment loss based on the estimated fair value of the asset.

Goodwill

Under SFAS No. 142, Goodwill and other Intangible Assets, all goodwill amortization ceased effective January 1, 2002. Rather, goodwill is now subject to only impairment reviews. A fair-value based test is applied at the reporting level. This test requires various judgments and estimates. A goodwill impairment loss will be recorded for any goodwill that is determined to be impaired. Goodwill is tested for impairment at least annually.

Foreign Currency Transaction

Assets and liabilities in foreign currencies are translated at the exchange rate prevailing at the balance sheet date. Revenues and expenses are translated at the exchange rate prevailing at the transaction date, and the resulting gains and losses are reflected in the statements of operations. Gains and losses arising from translation of a subsidiary’s foreign currency financial statements are shown as a component of stockholders’ equity (deficit) as accumulated comprehensive income (loss).

Income Taxes

The Company uses the asset and liability method of accounting for income taxes. The asset and liability method accounts for deferred income taxes by applying enacted statutory rates in effect for periods in which the difference between the book value and the tax bases of assets and liabilities are scheduled to reverse. The resulting deferred tax asset or liability is adjusted to reflect changes in tax laws or rates. The company records a valuation allowance for any deferred tax allowance that it believes will not be realized.

Stock-Based Compensation

The Company applied the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees , and related Interpretations in accounting for those plans through June 30, 2005.

In December 2004, FASB issued Statement No. 123(R), Share-Based Payment, which establishes accounting standards for transactions in which an entity receives employee services in exchange for (a) equity instruments of the entity or (b) liabilities that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of equity instruments. Effective on July 1, 2005, the Company adopted SFAS 123(R), which requires the Company to recognize the grant-date fair value of stock options and equity based compensation issued to employees in the statement of operations. The statement also requires that such transactions be accounted for using the fair-value-based method, thereby eliminating use of the intrinsic method of accounting in APB No. 25,  Accounting for Stock Issued to Employees,  which was permitted under Statement 123, as originally issued.

Earnings (Loss) per Common Share

The Company utilizes SFAS No. 128, “Earnings per Share” to calculate earnings/loss per share. Basic earnings/loss per share is computed by dividing the earnings/loss available to common stockholders (as the numerator) by the weighted-average number of

17




common shares outstanding (as the denominator). Diluted earnings/loss per share is computed similar to basic earnings/loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potential common stock (including common stock equivalents) had all been issued, and if such additional common shares were dilutive. Under SFAS No. 128, if the additional common shares are dilutive, they are not added to the denominator in the calculation. Where there is a loss, the inclusion of additional common shares is anti-dilutive (since the increased number of shares reduces the per share loss available to common stock holders).

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates and assumptions are periodically reviewed and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.

Reclassifications

Certain reclassifications to the Company’s income statement have been made in 2006, 2005, and 2004 in order for the 2006, 2005 and 2004 financial statements to conform to the presentation of these financial statements. These reclassifications are the restatement of the Research and Development expenses from General and Administrative expenses.

Recent Accounting Pronouncements

In June 2006, the FASB issued FIN No. 48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” This interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation, and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN No. 48 is effective for Force Protection in the first quarter of fiscal 2007. The Company is currently assessing the impact that FIN No. 48 will have on the results of its operations, financial position, or cash flows.

In June 2005, the Emerging Issues Task Force, or EITF, reached a consensus on Issue 05-6, Determining the Amortization Period for Leasehold Improvements,  which requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. EITF 05-6 is effective for periods beginning after July 1, 2005. The Company does not expect the provisions of this consensus to have a material impact on the financial position, results of operations or cash flows.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”) which replaces Accounting Principles Board Opinions No. 20 “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements—An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and a correction of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by the Company in the first quarter of 2006. The Company is currently evaluating the effect that the adoption of SFAS 154 will have on its results of operations and financial condition but does not expect it to have a material impact.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 provides guidance relating to the identification of and financial reporting for legal obligations to perform an asset retirement activity. The Interpretation requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 also defines when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The provision is effective no later than the end of fiscal years ending after December 15, 2005. The Company will adopt FIN 47 beginning the first quarter of fiscal year 2006 and does not believe the adoption will have a material impact on its consolidated financial position or results of operations or cash flows.

 

NOTE 2—CONCENTRATIONS

The Company’s future operations and continued expansion is subject to a significant concentration risk. During the years ended December 31, 2006, 2005 and 2004, the Company’s revenues from military units of the U.S. Government accounted for 84%, 90% and 97% of total revenues, respectively. The Company’s accounts receivable from military units of the U.S. Government at December 31, 2006, 2005 and 2004 amounted to 81%, 60% and 95% of total accounts receivable, respectively.

18




NOTE 3—ACCOUNTS RECEIVABLES & “DEFINITIZATION”

The majority of the Company’s contracts are with the United States Government and as such they are “public sector” contracts subject to the Federal Acquisition Regulations set out at Title 41 of the United States Code or “FAR”, and may result either from competitive bidding or may be awarded as “sole source” contracts “subject to definitization” as provided under FAR Section 252.217-7027.

Following the award of a sole source contract, a central component of the definitization process is the negotiation and finalization of the contract price between the contractor and the United States contracting officer. As part of this process, the parties make a mutual determination of the direct material and labor costs for the work based upon the bill of materials and other purchasing information and then the parties mutually agree upon “rates” for the indirect labor costs and the General and Administrative costs and upon a “fee” (or profit). While the direct material costs and labor can be established through objective evidence, the “rates” and fee are more subjective and are based upon an analysis of multiple factors including historical performance data and projected operational factors. The contractor has the right to submit proposed rates and fee, but these are subject to final review and approval by the contracting officer, who may insist on using alternate rates and fee. As provided in section 252.217-7027(c):

If agreement on a definitive contract action to supersede this undefinitized contract action is not reached by the target date in paragraph (b) of this clause, or within any extension of it granted by the Contracting Officer, the Contracting Officer may, with the approval of the head of the contracting activity, determine a reasonable price or fee in accordance with subpart 15.4 and part 31 of the FAR, subject to Contractor appeal as provided in the Disputes clause.

Finally, although both parties make an effort to definitize the contract as quickly as possible, the process is time consuming and can take months (or even years) to complete. During the definitization process the contractor is required to perform the contract work and to make deliveries under the contract before the final contract price has been established. For this reason, as part of the original letter award, the contractor provides a rough order of magnitude or “ROM”, price to be used for invoicing and accounting purposes pending definitization.

As a result of the potential adjustments related to the definitization process, the Company maintains an allowance for contractual adjustments account. This account is reviewed on a regular basis to determine adequate adjustments, if necessary. The allowance is evaluated and deemed adequate based on the analysis of historical data and calculation of pro-rata percentages of current contracts in place, which remain subject to the definitization process.

Below is a table detailing activity within the allowance for contractual adjustments account for the years ended December 31, 2006, 2005, and 2004 respectively.

 

Year Ended

 

Year Ended

 

Year Ended

 

 

 

Dec. 31, 2006

 

Dec. 31, 2005

 

Dec. 31, 2004

 

Beginning balance

 

$

1,018,051

 

$

 

$

 

Additions to allowance

 

6,317,077

 

1,018,051

 

 

Reduction to allowance

 

(1,267,041

)

 

 

Ending balance

 

$

6,068,087

 

$

1,018,051

 

$

 

The Company does not maintain an allowance for doubtful accounts. The Company’s significant sales for the years ended December 31, 2006, 2005 and 2004 involved contracts signed with the U.S. Government. As of the date of this report all non-direct government year-end receivables have been collected. The Company does not believe an allowance for doubtful accounts is necessary due to the credit-worthiness of the U.S. Government.

Historically, the Company has not encountered sales returns. The Company does not anticipate sales returns in the future.

NOTE 4—INVESTMENT IN CHALLENGER POWERBOATS INC.

On June 1, 2003, and modified on September 15, 2003, the Company sold the asset associated with its boat business to Rockwell Power Systems, Inc., which subsequently merged with Xtreme Companies, Inc, now called Challenger Powerboats, Inc., a public company traded on the Over the Counter Bulletin Board. As consideration for the sale, the Company received 1/3 of Challenger Powerboats’ outstanding common stock, which was distributed directly to the Company’s common stock shareholders. Additionally, the Company was to receive 500 shares of Challenger Powerboats Series A preferred stock. The Company has been in communications with Challenger Powerboats but has yet to receive these shares. The Company has elected to account for the investment in Challenger Powerboats’ Series A preferred stock under the cost method and has provided for a full valuation allowance against the fair market value of these shares as of December 31, 2006, 2005 and 2004, respectively.

19




 

 

2006

 

2005

 

2004

 

Challenger Powerboats, Inc. Series A preferred stock

 

$

 

$

 

$

 

Valuation Allowance

 

 

 

 

Net Investment in Challenger Powerboats, Inc

 

 

 

 

 

NOTE 5—INVENTORIES

Inventories at December 31, 2006, 2005 and 2004 consisted of the following:

 

2006

 

2005

 

2004

 

Raw materials and supplies

 

$

45,131,126

 

$

15,222,503

 

$

5,268,798

 

Work in process

 

17,688,784

 

17,762,554

 

3,756,921

 

Finished Goods

 

 

 

4,194

 

Less: Allowance for surplus and obsolete

 

(2,423,613

)

(498,281

)

 

Inventories, net

 

$

60,396,297

 

$

32,486,776

 

$

9,029,913

 

 

NOTE 6—PROPERTY, PLANT AND EQUIPMENT

Property, Plant and Equipment at December 31, 2006, 2005 and 2004 consisted of the following:

 

2006

 

2005

 

2004

 

Furniture and fixtures

 

$

1,022,984

 

$

227,613

 

$

252,608

 

Leasehold improvements

 

1,534,057

 

59,928

 

 

Machinery and equipment

 

6,534,550

 

2,024,436

 

983,955

 

Test Equipment

 

16,790

 

16,790

 

16,790

 

Manuals

 

104,797

 

104,798

 

104,798

 

Vehicles

 

143,464

 

56,464

 

10,110

 

Demo vehicles

 

1,095,925

 

425,845

 

192,530

 

Less depreciation and amortization

 

(1,488,666

)

(777,171

)

(523,797

)

Net property and equipment

 

$

8,963,901

 

$

2,138,703

 

$

1,036,994

 

 

Depreciation expense for the years ended December 31, 2006, 2005 and 2004 was $769,454, $386,152 and $207,271 respectively.

NOTE 7—COMMITMENTS AND CONTINGENCIES

Other Accrued Liabilities

The Company’s other accrued liabilities include the following:

 

2006

 

2005

 

2004

 

Compensation and benefits

 

$

1,222,143

 

$

1,396,024

 

$

1,195,705

 

Vehicle Fee Payable

 

1,139,250

 

 

 

Liquidated damage settlement

 

607,466

 

 

 

Dividends on preferred stock

 

 

260,080

 

 

Common Stock shares to be issued

 

 

212,606

 

 

Other

 

 

29,310

 

158,761

 

Total

 

$

2,968,859

 

$

1,898,020

 

$

1,354,466

 

 

Contract Liabilities

The Company’s sales contracts generally include a warranty such that the Company’s products are free from defects in design, material, and workmanship for a period of 1 year from the acceptance date. The warranty does not apply to any damage or failure to perform caused by the misuse or abuse of the vehicle, combat damage, fair wear and tear items (brake shoes, track pads, wiper blades, etc.), or by the customer’s failure to perform proper maintenance or service on the supplies.

20




The Company routinely reviews its exposure for warranty costs and determines warranty and pricing reserves based on historical data and known events. Below is a table detailing the Company’s accruals for warranty-related costs as of December 31, 2006, 2005 and 2004:

 

2006

 

2005

 

2004

 

General warranty

 

$

1,850,000

 

$

1,686,062

 

$

228,130

 

Loss contingency

 

 

 

501,331

 

 

 

$

1,850,000

 

$

1,686,062

 

$

729,461

 

 

Vehicle Fees

The Company is party to a Memorandum of Understanding with Mechem, a division of Denel PTY, a South African company pursuant to which Mechem agreed for a period of five years to work exclusively with the Company and not to cede, dispose or transfer to any third party other than the Company any of its technology, IPR or other proprietary information relating to its armored vehicles systems including, but not limited to, designs, drawings, full technical specifications, test data, hardware and software designs and technologies, supplier’s list, know-how and all and every piece of information and data relevant to such systems. In exchange for such exclusivity the Company agreed to pay Mechem a “vehicle fee” for every Buffalo, Cougar and Tempest the Company manufactures and sells. The Company is not obligated to pay a vehicle fee in respect of other vehicles it manufactures and sells. On September 13, 2006 the Company executed a new Memorandum of Agreement with Mechem, extending the period of exclusivity for an additional five years, and adding a provision that Mechem would upon request by the Company provide expertise and know-how on a “work for hire” basis to advise, assist and support the Company in its marketing activities. The Company also agreed to make a one time payment of $394,500 to Mechem, representing vehicle fees in respect of Cougar vehicles previously delivered and sold by the Company during 2005 and 2006. The agreement with Mechem expires in September 2011.

The Company is also party to an agreement with CSIR Defencetek (a division of the Council for Scientific and Industrial Research) a statutory council established in accordance with the Laws of the Republic of South Africa, pursuant to which the Company is obligated to pay the CSIR a similar vehicle fee. The agreement with the CSIR expires in March 2007.

The following table is a summary of the vehicle fees to be paid per vehicle:

 

Mechem

 

CSIR

 

Buffalo

 

$

5,000

 

$

3,000

 

Cougar

 

$

1,500

 

$

1,500

 

Tempest

 

$

3,000

 

$

1,500

 

Cheetah

 

$

0

 

$

0

 

Table of Contractual Obligations

The following is a table outlining the Company’s actual and projected significant contractual obligations as of December 31, 2006:

 

For the Years Ended

 

 

 

2007

 

2008

 

2009

 

2010

 

2011

 

Total

 

Operating Lease Commitments

 

$

1,624,286

 

$

992,479

 

$

56,609

 

 

 

$

2,673,374

 

Capital Equipment Note Payments

 

$

92,608

 

$

92,608

 

$

69,456

 

 

 

$

254,672

 

Mechem—Vehicle Fees(1)

 

Variable

 

Variable

 

Variable

 

Variable

 

Variable

 

Variable

 

CSIR—Vehicle Fees(2)

 

Variable

 

Variable

 

 

 

 

Variable

 

Total

 

$

1,716,894

 

$

1,085,087

 

$

126,065

 

 

 

$

2,928,046

 

 


(1)           Refer to the Mechem vehicle fee agreement detailed above in Footnote 7, Commitments and Contingencies, “Vehicle Fees.”

(2)           Refer to the CSIR vehicle fee agreement detailed above in Footnote 7, Commitments and Contingencies, “Vehicle Fees.”

21




Contract Definitization

The Company contracts for the sale of its vehicles to the U.S. Government under fixed price sales contracts, subject to the provisions of the U.S. Federal Acquisition Regulations (“FAR”). Under FAR 52.216-25, contract awards may be made subject to future “Contract Definitization” pursuant to which the contractor agrees to negotiate with the Government following commencement of the contract work to finalize detailed conditions of the contract, including pricing, scheduling and other applicable requirements. As part of such negotiations, the contractor is subject to audit by the U.S. Defense Contract Audit Agency (“DCAA”) of its direct material and labor costs, manufacturing overhead and margin. Based on such audit and the negotiations with the Government, the final “definitized” contract price may be less than the amount originally established (see additional discussions within Footnote 1 and Footnote 3).

Legal Proceedings

During June, 2006, the Company confirmed that two former employees had filed claims under 31 U.S.C. §3730 alleging inter alia  that the Company had failed to comply with the terms of the JERRV contract in respect to the allocation and use of the initial contract milestone payment for such “accelerated delivery costs.” On August 23, 2006, the Company agreed to settle with the United States Government and with these former employees all claims relating to or arising under the JERRV contract and the payment of such accelerated delivery costs for a total of $1,905,000 plus interest of $23,000. As of December 31, 2006, the Company has paid $1,297,534 under the terms of such settlement agreement and the Company has established a provision of $607,466 for the remaining liability.

The Company may be involved from time to time in ordinary litigation that will not have a material effect on our operations or finances. Other than the litigation described above, we are not aware of any pending or threatened litigation against the company or our officers and directors in their capacity as such that could have a material impact on our operations or finances.

NOTE 8—DEFERRED REVENUE

The Company only recognizes revenue from the sales of its vehicles upon formal acceptance by its customers. However, the Company does receive performance based payments in accordance with agreed milestones under some of its government contracts. The Company records such performance based payments as deferred revenue and carries them on its balance sheet until formal acceptance by the customer. As of December 31, 2006, 2005 and 2004 the Company had $12,824,211, $12,598,921 and $2,645,716, respectively as deferred revenue resulting from its contracts with the U.S. Army and the U.S. Marines.

NOTE 9—DEBT

On November 18, 2005, Longview Fund, LP and Longview Equity Fund, LP (collectively, “Longview”) issued secured promissory notes (the “Notes”) to the Company for gross proceeds of $7,500,000. The Notes matured on February 18, 2006. Interest is payable on the Notes at the annualized rate of 24%. The Company also executed a Security Agreement that granted Longview a first preferred UCC-1 security interest in all of the Company’s assets and property.

On February 18, 2006, the Company entered into a Modification and Assignment Agreement with Longview pursuant to which the Company paid $1,250,000 against the principle balance of the Notes and extended the maturity date of the Notes for an additional 60 days. In addition, the Company consented to the assignment of $2,500,000 of the Notes to Fort Ashford Funds LLC (the “Ashford Note”). Frank Kavanaugh, a director of the Company, is the principal owner of Fort Ashford Funds and a substantial shareholder of the Company’s common stock. Mr. Kavanaugh’s relationship to Fort Ashford Funds LLC was fully disclosed to the Company and Mr. Kavanaugh did not participate in the negotiations or decision process in respect of the Modification and Assignment Agreement. The Company paid $87,510 to Longview and $50,000 to Fort Ashford in cash as compensation for the extension of the maturity dates of the Notes.

On April 20, 2006, the Company paid $1,000,000 against the principle balance of the Notes and extended the maturity date on the Notes and the Ashford Note for an additional 60 days, through June 20, 2006. The Company paid $55,000 to Longview and $50,000 to Fort Ashford in cash as compensation for this extension.

On June 20, 2006, the Company paid off the principle balance and all applicable accrued interest under the Notes. Additionally, the Company extended the maturity date of the Ashford Note for an additional 30 days, through July 20, 2006. The Company paid $50,000 to Fort Ashford in cash as compensation for the extension of the Ashford Note.

On August 9, 2006, the Company paid off the principle balance of the Ashford Note, and all applicable accrued interest under the Ashford Note.

22




In October 2006 the Company acquired capital equipment valued at $234,875 using a note with implied interest of 11.25% from the supplier with a repayment based on usage of materials used with the equipment. It is expected that based on usage estimates the note payments in 2007, 2008, and 2009 will be $92,608, $92,608 and $69,456, respectively.

NOTE 10—FACTORING OF ACCOUNTS RECEIVABLE

The Company entered into an agreement with GC Financial Services, Inc. on June 29, 2005, pursuant to which the Company agreed to sell accounts receivables under our JERRV Contract (M67854-05-D-5091) in an amount not to exceed $63,000,000. Under the terms of such agreement, the Company received 98.1% of the value of receivables sold to the Factor within 24-48 hours of delivery of the invoice. During June 2006, the Company exceeded the agreed maximum value of receivable to be factored under the Factoring Agreement. On June 22, 2006, the Factoring Agreement was terminated and no further obligation remained between the Company and GC Financial Services, Inc.

The Company entered into an agreement with GC Financial Services, Inc. on June 28, 2004, pursuant to which the Company agreed to sell accounts receivables under our Buffalo contracts with the U.S. Army. Under the terms of such agreement, the Company receives approximately 98% of the value of receivables sold to the Factor within 24-48 hours of delivery of the invoice. The Factor was granted a security interest in the Company’s assets and retained the right of full recourse against the Company. The Company terminated such agreement in January 2005.

The Company’s factoring transactions in 2006, 2005 and 2004 are summarized below:

 

Year Ended

 

Year Ended

 

Year Ended

 

 

 

December 31, 2006

 

December 31, 2005

 

December 31, 2004

 

Sale of Receivables to Factor

 

$

44,692,632

 

$

17,170,086

 

$

11,895,363

 

Payments to Factor

 

(45,482,504

)

(16,380,214

)

(11,294,319

)

Balance at end of period

 

$

 

$

789,872

 

$

601,044

 

Charges by Factor

 

$

849,160

 

$

311,443

 

$

237,907

 

NOTE 11—STOCKHOLDERS’ EQUITY

The Company was originally incorporated on November 27, 1996 as a Colorado corporation. The Company incorporated Force Protection, Inc, a Nevada corporation on December 13, 2004 and effected a merger with Force Protection, Inc., a Colorado corporation, on January 1, 2005. The Colorado Corporation was dissolved upon the merger. The Company has continued its operations as the Nevada Corporation from January 1, 2005 forward. The Company has the authority to issue 310,000,000 shares, in aggregate, consisting of 300,000,000 shares of common stock and 10,000,000 shares of preferred stock, of which 1,600 have been designated “Series A,” 25 of which have been designated as “Series B,” 150 of which have been designated as “Series C” and 20,000 of which have been designated as “Series D.” At all times through December 31, 2004, the Company’s stock was all issued at “no par value.” By shareholder’s resolution effective January 1, 2005, all classes of stock were declared to have a par value of $0.001 per share. For further information regarding Series D 6% Convertible Preferred Stock, please refer to the separate footnote disclosure in Note 12.

The preferred stock has the following characteristics:

Dividends—Each holder of preferred stock shall be entitled to receive dividends in cash, stock or otherwise, if, when and as declared by the Company’s board of directors, with the exception of the preferred stock designated as Series A, which shall not be entitled to receive dividends. However, the Company will not declare or pay a dividend to common stockholders without first declaring and paying a dividend to the preferred shareholders. Each share of Series D Preferred Stock is specifically entitled to 6% cumulative dividends, payable semi-annually in cash or common stock. See Note 12 for further details regarding Series D 6% Convertible Preferred Stock.

Liquidation—In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the Company, the assets of the Company available for distribution to its stockholders shall be distributed as follows:

(a)    Series A Preferred Stock shall rank senior to Series B Preferred Stock, Series C Preferred Stock, Series D 6% Convertible Preferred Stock and common stock;

(b)    Series B Preferred Stock shall rank junior to Series A Preferred Stock, senior to Series C Preferred Stock, Series D 6% Convertible Preferred Stock and common stock;

23




(c)    Series C Preferred Stock shall rank junior to Series A Preferred Stock, Series B Preferred Stock and senior to Series D 6% Convertible Preferred Stock and common stock;

(d)    Series D 6% Convertible Preferred stock shall rank junior to Series A Preferred Stock Series B Preferred Stock, Series C Preferred Stock and senior to common stock; and

(e)    Common stock shall rank junior to Series A, B, C and D 6% Convertible Preferred Stock.

Additionally, upon a liquidation event, holders of Series A Preferred Stock will receive $1,000 per share of Series A Preferred Stock. Holders of Series B Preferred Stock will receive the greater of $2,500 or the pro-rata share of the Company’s remaining net assets to be distributed, after rank considerations. Holders of Series C Preferred Stock will receive a 150% return on the face value of the share of Series C Preferred Stock, or $1,500, after rank considerations. In any event whereby the preceding distributions are unable to be met, the rank considerations outlined above shall be considered and the distribution of the Company’s net assets shall be determined according to rank and on a pro-rata basis.

Conversion—Series A Preferred Stock shall convert into common stock at a rate of $4.00 per share, as adjusted accordingly. Each share of Series B Preferred Stock shall convert into 759,167 shares of common stock. Each share of Series C Preferred Stock shall convert into 75,917 shares of common stock. Each share of Series D 6% Convertible Preferred Stock shall convert into common stock at $2.10 per share.

In connection with the private placement sale of the Company’s common stock on January 19, 2005, the Company and the holders of Series B and Series C Preferred Stock agreed to convert all shares of the Series B and Series C Preferred Stock outstanding to shares of the Company’s common stock. As a result, all shares of Series B and Series C Preferred Stock were converted into common effective January 19, 2005. The Series D 6% Convertible Preferred Stock issued in connection with the January 19, 2005 private placement remained outstanding following the conversion of the Series B and Series C Preferred Stock. All outstanding shares of the Series D 6% Convertible Preferred Stock were converted in full in 2006, and no shares of the Series D 6% Convertible Preferred Stock remain outstanding as of September 30, 2006. Series D 6% Convertible Preferred Stock has been classified as Mezzanine Equity by the Company. Please refer to Note 12 for further details regarding Series D 6% Convertible Preferred Stock.

On January 18, 2005, the Company’s board of directors, acting pursuant to a resolution of the Company’s shareholders, approved a reverse split of the Company’s stock whereby each 12 shares of common stock outstanding on the date of record, February 4, 2005, would be exchanged for 1 new share of common stock. All references to common stock in the Company’s public filings refers to “post reverse split” shares.

The following disclosures reference accounting guidelines and certain accounting treatments which the Company has used throughout 2006, 2005 and 2004. The Company considers the following terms and definition significant in ensuring the reader of these financial statements understands the accounting treatments applied by the Company:

·                  The Emerging Issues Task Force (“EITF”) provides accounting guidance and interpretations on emerging issues in business and accounting.

·                  Statements on Financial Accounting Standards (“SFAS”) are a primary source of accounting guidance under which many of the Company’s accounting policies are based.

·                  Beneficial conversion feature is a topic addressed in EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios , EITF 00-19  Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in , a Company’ s Own Stock  and EITF 00-27  Application of Issue No. 98-5 to Certain Convertible Instruments , is an accounting term defined in EITF 98-5 that represents a situation in which a convertible security (debt or equity) is convertible into the Company’s common stock at a price which is at a discount to the market, at the time the convertible security is issued.

·                  The Black-Scholes option pricing model (Black-Scholes) is an analytical model used to value an option to purchase a security based on certain market fundamentals such as the volatility of a security, the market for effective interest rates over a period of time and constraints placed on the option to purchase the security such as time horizons or the expiration of the option to purchase the security. The Company utilizes Black-Scholes to value stock options issued to employees, preferred stock issued to employees and service providers, preferred stock purchased by investors and warrants issued to investors.

24




During the year ended December 31, 2006, the Company recorded the following transactions within its stockholders’ equity accounts:

COMMON STOCK TRANSACTIONS

On July 24, 2006, the Company closed a private placement sale and issued 8,250,000 shares of common stock to investors for gross proceeds of $41,250,000. Net proceeds received after expenses were $39,187,500.

On December 20, 2006, the Company closed a private placement sale and issued 13,000,000 shares of common stock to investors for gross proceeds of $152,750,000. Net proceeds received after expenses were $146,640,261.

The following issuances of the Company’s common stock during 2006 were valued by the Company using the Company’s closing bid price of its common stock as quoted on the OTC Bulletin Board market as of the date of the associated contract or the issuance date if no contract existed:

Effective January 1, 2006, the Company’s board of directors granted the Company’s Chief Executive Officer 300,000 shares of the Company’s unregistered common stock valued at $216,000. The shares were fully vested upon issuance.

On April 21, 2006, the board of directors adopted a resolution approving payment of annual compensation to each member of the Company’s board of directors. Each member is to receive annual cash compensation of $24,000. In addition, each member received a guarantee of an annual grant of 15,353 shares of the Company’s unregistered common stock. The shares of the Company’s unregistered common stock are required to be held until the individual’s service as a member of the Company’s board of directors is complete. The Company awarded 96,149 and issued 69,360 shares of the Company’s common stock to the members of the Company’s board of directors in 2006. A total of 26,789 shares of the Company’s common stock were included in shares to be issued in the stockholders’ equity table as of December 31, 2006 relating to this award. The value for the 96,149 shares of common stock awarded to the members of the board of directors was recorded as stock based compensation of $445,990.

On June 2, 2006, the Company granted and issued 12,500 shares of its unregistered common stock to a member of the Company’s board of directors, valued at $40,500 as compensation due under a previous employment contract with the Company. During 2006, the Company granted and issued 165,202 shares of its unregistered common stock valued at $405,786 under various employment agreements. Included within these issuances were common stock issuances related to certain employee agreements which were modified during 2006. A total of 233,418 shares of common stock were rescinded as a result of the modifications to employee agreements. These transactions resulted in a reduction of the total stock-based compensation for 2006 of $224,688.

On August 8, 2006, the Company agreed to issue 30,000 shares of common stock under a settlement agreement with Atlantis Partners, Inc. The shares issued were valued at $187,500.

During 2006, employees exercised stock options to purchase 5,348 shares of the Company’s common stock valued at $6,001. A total of 4,348 shares of the Company’s common stock were included in shares to be issued in the stockholders’ equity table as of December 31, 2006 related to employee exercised stock options.

The Company adopted SFAS 123R as if July 1, 2005. Total stock option expense for 2006, which is inclusive of stock grants in 2006 was $1,250,625.

PREFERRED STOCK TRANSACTIONS

Series D 6% Convertible Preferred Stock:

·                  During the year ended December 31, 2006, 13,004 shares of Series D Preferred Stock were voluntarily converted to 6,192,628 shares of common stock. The fully accreted conversion value of these shares of common stock at the time converted was $9,198,571. See Note 12—Series D 6% Convertible Preferred Stock.

·                  During the three month period ended June 30, 2006, 586 shares of common stock were issued in lieu of cash dividends for the holders of Series D Preferred Stock. The shares issued were valued at $2,377 which was 85% of the average of the lowest market value for 3 of the prior 10 trading days.

25




·                  During the three month period ended September 30, 2006, 8,351 shares of common stock were issued in lieu of cash dividends for the holders of Series D Preferred Stock. The shares issued were valued at $46,448 which was 85% of the average of the lowest market value for 3 of the prior 10 trading days.

WARRANT TRANSACTIONS

·                  During 2006, warrants associated with Series D Preferred Stock were exercised and the Company issued 2,633,333 shares of common stock for gross proceeds of $9,874,999.

·                  During 2006, various warrants were exercised and the Company issued 218,807 shares of common stock for gross proceeds of $499,573.

·                  As of December 31, 2006, all warrants were exercised or expired. No warrants remained outstanding as of December 31, 2006.

SHARES TO BE ISSUED

·                  During the three month period ended December 31, 2006, 26,789 shares of common stock were granted for compensation to the Company’s board of directors. The shares were valued at $210,408 but were not issued as of December 31, 2006.

During the year ended December 31, 2005, the Company recorded the following transactions within its stockholders’ equity accounts:

COMMON STOCK TRANSACTIONS

In January 2005, the Company issued a total 188,400 shares of the Company’s common stock at an average price of $2.76 per share, generating $520,069 in net proceeds pursuant to the Investment Agreement between the Company and Dutchess Private Equities Fund, L.P., dated January 26, 2004.

The following issuances of the Company’s common stock during 2005 were valued by the Company using the Company’s closing bid price of its common stock as quoted on the OTC Bulletin Board market as of the date of the associated contract or the issuance date if no contract existed.

·                  41,666 shares of the Company’s common stock valued at $112,499 were issued to a director, a member of the board of directors, for services rendered to the Company. An expense of $112,499 was classified as compensation of directors and was recorded in 2005.

·                  9,950 shares of the Company’s common stock valued at $12,910, to the Company’s former President, for services rendered to the Company. An expense of $12,910 was classified as officer compensation and was recorded in 2005.

·                  The Company issued 53,467 shares of the Company’s common stock pursuant to the terms of the Company’s agreement with certain third parties and were valued at $144,895. An expense of $144,895 was classified as settlement expense and was recorded in 2005.

·                  The Company issued 14,876 shares of the Company’s common stock pursuant to the terms of the Company’s agreement with GC Financial Services, Inc. which were valued at $20,641. An expense of $20,641 was classified as interest expense and was recorded in 2005.

·                  The Company’s former Chief Executive Office, agreed to rescind 83,333 shares of common stock issued in 2004 valued at $209,999.

A total of 114,376 shares of common stock were issued by the Company for net proceeds of $211,629 in connection with the exercise of warrants issued through a PIPE offering completed on April 10, 2002.

The Company issued a warrant to purchase 65,833 shares of the Company’s common stock on January 19, 2005 to HPC Company. The warrant was valued at $200,071 using Black-Scholes. The Company recorded a reduction of stockholders’ equity associated with services provided as a placement agent for the Company’s Series D 6% Convertible Preferred Stock offering, which closed on

26




January 19, 2005. The inputs for this warrant in Black-Scholes are consistent with the inputs for the warrants issued with the Series D 6% Convertible Preferred Stock.

The Company issued warrants to purchase 75,000 shares of the Company’s common stock that can be exercised for $3.75 per share in a settlement agreement with H.C. Wainwright & Co. The value as determined by Black-Scholes was expensed as settlement expense in the amount of $158,071. The Company also issued a warrant to purchase 41,667 shares of the Company’s common stock that can be exercised for $3.96 per share in a settlement agreement with Westor Online. The value as determined by Black-Scholes was expensed as settlement expense in the amount of $72,354. The warrants were exercised in 2006. Below is a table depicting the valuation attributes used in Black-Scholes calculations related to these warrants issued in 2005:

Warrant Valuation Information

 

 

 

 

Valuation Assumptions

 

 

Stock price on grant date

 

$

2.05-$3.00

 

Number of shares of common stock convertible to

 

116,667

 

Conversion price

 

$

3.75-$3.96

 

Expected option term (in years)

 

1

 

Vesting term (in years)

 

N/A

 

Expected volatility

 

177.06

%

Risk-free interest rate

 

4.26

%

Expected forfeiture rate

 

0

%

Estimated corporate tax rate

 

0

%

Expected dividend yield

 

0

%

Outstanding warrants to purchase 2,143,085 common stock shares expired or were cancelled during 2005. The warrant valuation of $2,302,850 was added to Additional Paid in Capital accordingly in 2005.

The Company issued 14,803,750 shares of unregistered common stock resulting for the mandatory conversion on February 8, 2005 of all the outstanding shares of the Company’s Series B Convertible Preferred Stock. At the time of conversion, the conversion rate for the Series B Convertible Preferred Stock was 2% of fully diluted common stock. The beneficial conversion feature related to the Series B Convertible Preferred Stock in the amount of $19,102,306 was relieved in full on February 8, 2005.

PREFERRED STOCK TRANSACTIONS

Series D 6% Convertible Preferred Stock:

·                  On January 19, 2005, the Company issued 15,800 shares of the Company’s Series D 6% Convertible Preferred Stock for net cash of $15,305,966. The issuance of the Company’s Series D 6% Convertible Preferred Stock was recorded at $7,301,766 which is the net value of the cash received of $15,305,966 less the fair value of the associated warrants of $8,004,200. The Company classified the Series D 6% Convertible Preferred Stock as Mezzanine Equity. Refer to Note 12 for further information regarding Series D 6% Convertible Stock.

·                  On May 23, 2005, 2,796 shares of the Series D Preferred Stock were voluntarily converted into 1,331,429 shares of Common Stock. The conversion value of these shares of common stock at the time of conversion was $1,442,025.

During the year ended December 31, 2004, the Company recorded the following transactions within its stockholders’ equity accounts:

COMMON STOCK TRANSACTIONS

The Company closed on a private investment in public equity (“PIPE”) offering on March 23, 2004. The PIPE, sold to numerous accredited investors, consisted of the following:

·                  Common stock issuances, 1,771,874 shares of common stock were issued for $4,245,000 in net proceeds.

·                  Issuance of “A” warrants, 1,771,874 warrants to purchase common stock were issued in 2004, with an original exercise price of $1.44 per warrant. A total of 219,792 shares of common stock were issued by the Company for net proceeds of $316,497, in connection with the exercise of “A” warrants in 2004. The remaining “A” warrants expired on December 31, 2004.

27




·                  Issuance of “Green Shoe” warrants, 1,771,874 warrants to purchase common stock were issued in 2004, with an original exercise price of $2.40 per warrant. A total of 674,058 shares of common stock were issued by the Company for net proceeds of $1,677,713, in connection with the exercise of “Green Shoe” warrants in 2004. The remaining ”Green Shoe” warrants expired on December 31, 2004.

In November and December 2004, the Company issued a total 1,210,843 common shares generating $2,958,217 in net proceeds pursuant to the Dutchess Equity agreement.

A total of 1,863,768 shares of common stock were issued by the Company for net proceeds of $2,100,637 in connection with the exercise of warrants issued through a private investment in public equity (“PIPE”) offering dated April 10, 2002 for Regulation D Section 506 Private Placement Memorandum issued in 2003 to numerous accredited investors.

The following issuances of the Company’s common stock during 2004 were valued by the Company using the Company’s closing bid price of its common stock as quoted on the OTC Bulletin Board market as of the date of the associated contract or the issuance date if no contract existed.

·                  163,501 shares of the Company’s common stock valued at $496,956 were issued to a third party for services rendered to the Company. An expense associated with this issuance of $496,956 was recorded in 2004.

·                  70,833 shares of the Company’s common stock valued at $127,500 were issued to a member of the board of directors, for services rendered to the Company. An expense of $127,500 was classified as compensation of directors and was recorded in 2004.

·                  91,667 shares of the Company’s common stock valued at $231,000 were issued to a member of the board of directors, for services rendered to the Company. An expense of $231,000 was classified as compensation of directors and was recorded in 2004.

·                  208,333 shares of the Company’s common stock valued at $495,000 to the Company’s former Chief Executive Officer, for services rendered to the Company. An expense of $495,000 was classified as officer compensation and was recorded in 2004.

·                  125,000 shares of the Company’s common stock valued at $255,000 to the Company’s former Chief Financial Officer, for services rendered to the Company. An expense of $255,000 was classified as officer compensation and was recorded in 2004.

·                  41,682 shares of the Company’s common stock valued at $145,054 to an employee, for services rendered to the Company. An expense of $145,054 was classified as stock-based compensation and was recorded in 2004.

·                  79,167 shares of the Company’s common stock valued at $178,250, to various employees for services rendered to the Company. An expense of $178,250 was classified as stock-based compensation and was recorded in 2004.

304,167 shares of common stock issued in error in December 2003 were cancelled in the first week of January 2004.

The Company issued 20,421 shares of common stock to third parties upon the conversion of existing debts in the amount of $124,976.

PREFERRED STOCK TRANSACTIONS

For information regarding Series D 6% Convertible Preferred Stock, please refer to the separate footnote disclosure in Note 12.

Series B and Series C Convertible Preferred Stock are in the form of shares, and have no conditional or unconditional mandatory redemption provisions obligating the Company in the future other than liquidation or company wind-up provisions. Under SFAS 150— Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity , the issuances of Series B and Series C Preferred stock have been classified as equity. The conversion options are not considered derivative liabilities which must be valued at fair value under SFAS 133 or EITF 00-19. The conversion options are indexed to the Company’s own stock and the host instrument is classified as equity thus meeting the paragraph 11a scope exception under SFAS No. 133—Accounting for Derivative instruments and hedging activities. The Company determined that there is no intrinsic value of the conversion options for the Series B and Series C Preferred Stock under EITF 00-27.

In accordance with EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Rates,” the Company records “beneficial conversion feature expense” when and if the Company issues debt or equity instruments which are convertible into shares of the Company’s common stock, at a conversion price which is favorable to the

28




holder of the debt or equity instrument. Valuation of this favorable conversion feature is based on the circumstances of each debt or equity issuance but is generally based on the actual or estimated difference between the fair market value of the underlying common stock less the cost of acquiring the common stock or a beneficial increase in conversion rates of preferred shares into common stock.

The Company issued preferred stock shares for services provided as follows:

·                                          4 shares of the Company’s Series C Convertible Preferred Stock were issued to a member of the board of directors, for services rendered. The Company used Black-Scholes to determine the value of the shares as $137,583.

·                                          20 shares of the Company’s Series C Convertible Preferred Stock were issued to the Company’s former Chief Executive Office, for services rendered. The Company used Black-Scholes to determine the value of the shares as $692,996.

·                                          4 shares of the Company’s Series C Convertible Preferred Stock were issued to the Company’s former Chief Financial Officer, for services rendered. The Company used Black-Scholes to determine the value of the shares as $138,976.

·                                          10 shares of the Company’s Series C Convertible Preferred Stock were issued to a member of the board of directors, for services rendered. The Company used Black-Scholes to determine the value of the shares as $346,526.

The Company issued 20 shares of Series C Convertible Preferred Stock in exchange for existing debt in the amount of $200,000. The Company used Black-Scholes and calculated the value of shares at issuance. A beneficial conversion feature was generated as the value of the issuance using Black-Scholes was greater than the value of the debt converted in the amount of $385,530.

The Company issued 1 share of the Company’s Series C Convertible Preferred Stock for proceeds of $10,000. The value of this issuance was calculated using Black-Scholes and was greater than the value of the proceeds in the amount of $22,612. The Company recorded a Beneficial Conversion Feature for this difference.

Below is a table depicting the valuation attributes used in Black-Scholes calculations related to the Series C Preferred Stock issued in 2004:

Series C Preferred Stock Valuation Information for the Year Ended December 31, 2004

 

Valuation Assumptions

 

Stock price on grant date

 

$1.80-$4.08

Number of shares of common stock convertible to

 

2,198,276

Conversion price

 

$1.80-$4.08

Expected option term (in years)

 

1

Vesting term (in years)

 

N/A

Expected volatility

 

90.29%-177.0 6%

Risk-free interest rate

 

4.00%-4.2 9%

Expected forfeiture rate

 

0 %

Estimated corporate tax rate

 

0 %

Expected dividend yield

 

0 %

The following transactions of the Company’s preferred stock during 2004 were recorded:

·                  The Company had 5 Shares of Series C Convertible Preferred Stock voluntarily redeemed for $60,000. A loss on redemption of $10,000 was recorded. Additionally, the Company recorded a gain on debt extinguishment related to the recapture of beneficial conversion feature expensed in connection with the issuance of the preferred stock in 2002 of $7,272.

·                  1,330,865 shares of the Company’s common stock were issued upon the voluntary conversion of 51 shares of Series C Convertible Preferred Stock. The conversion rate at the time of conversion was 0.2% of outstanding common stock. The Company recorded a gain on debt extinguishment related to the recapture of beneficial conversion feature expensed in connection with the issuance of the preferred stock in the amount of $243,690.

·                  1 share of the Company’s Series C Convertible Preferred Stock was voluntarily rescinded. A gain was recognized in the amount of $83,577 as a result. The gain was calculated using the Company’s closing bid price of its common stock as quoted on the OTC Bulletin Board market as of the date the shares were rescinded and the number of shares of common stock for which the preferred

29




stock was convertible into. Additionally, the Company recorded a gain on debt extinguishment related to the recapture of beneficial conversion feature expensed in connection with the issuance of the preferred stock in the amount of $3,234.

·                  1 share of the Company’s Series B Convertible Preferred Stock was voluntarily converted to 10 Series C Convertible Preferred Stock. The Company used Black Scholes and calculated a beneficial conversion feature of $269,044, associated as a result of differences between conversion rates between the two preferred stock classes.

·                  416,667 shares of the Company’s common stock were issued upon the conversion of 1 share of Series B Convertible Preferred Stock. The conversion rate at the time of conversion was 2% of fully diluted common stock. The Company recorded a gain on debt extinguishment related to the recapture of beneficial conversion feature expensed in connection with the issuance of the preferred stock in of $16,324.

The conversion rate for Series C Convertible Preferred Stock changed to 0.2% of fully diluted stock on September 14, 2004. At that time, there were 144 Series C Preferred Stock shares outstanding. The Company used Black-Scholes to calculate the value of this change as $18,558,870, which represents the beneficial conversion feature for this conversion rate increase for all outstanding Series C Preferred Stock Shares on September 14, 2004. After which, 14,263 shares of the Company’s common stock were issued upon the voluntary conversion of 1 share of Series C Convertible Preferred Stock. During October 2004, all outstanding shares of the Company’s Series C Preferred Convertible stock were either mandatory converted to Series B Convertible Preferred stock or into shares of common stock. The conversion rate was 10 shares of Series C Convertible Preferred stock for 1 share of Series B Convertible Preferred Stock or 0.2% of fully diluted common stock. In total, 115 shares of Series C Convertible Preferred stock were redeemed for 11.5 shares of Series B Convertible Preferred Stock. 1,169,350 shares of common stock were issued for the conversion of the remaining 28 Series C Convertible Preferred Stock. These transactions resulted in the Company recorded recording a gain on debt extinguishment related to the recapture of beneficial conversion feature expensed in connection with the issuance of the preferred stock in the amount of $146,120.

NOTE 12—Series D 6% Convertible Preferred Stock

On January 19, 2005, the Company issued 15,800 shares of Series D 6% Convertible Preferred Stock (“Series D Preferred) at $1,000 per share pursuant to a purchase agreement (the “Purchase Agreement”) for gross proceeds of $15,800,000. Issuance costs of $494,034 were incurred and treated as a discount to reduction of the carrying value which netted to $15,305,966. The Series D Preferred may convert at any time, at the holder’s discretion, into shares of Common Stock. The conversion price is $2.10 per share. Each share of the Series D Preferred converts into the number of shares of Common Stock equal to $1,000 divided by the conversion price which is approximately 467.19 shares. Additionally, the Company pays 6% dividends on the Series D Preferred in cash or Common Stock. The Series D Preferred Stock, if not converted to Common Stock, is redeemable for $1,000 per Series D Preferred share on January 19, 2008.

In the same private placement, the Company issued Warrants to purchase 2,633,333 shares of Common Stock at an exercise price of $3.75 per share. The Warrants expire on January 19, 2008. These warrants are further disclosed below.

The Series D Preferred falls outside the scope of SFAS No. 150 but the guidance in Rule 5-02.28 of Regulation S-X, Accounting Series Release No. 268 (ASR 268) and EITF Topic D-98: “Classification and Measurement of Redeemable Securities” are applicable. As such, the Company has recorded the Series D Preferred as mezzanine equity on the accompanying balance sheet.

The difference between the initial recorded amount and redemption value, the discount, is accreted to retained earnings or, in the absence of retained earnings, additional paid-in capital, over the period from the date of issuance to the earliest redemption date of the security using the interest method thus reducing net income attributable to common shareholders. This accretion is treated like a dividend on preferred stock. The accretion from the initial value to the redemption amount has been determined using T-Value based on the following inputs:

1.                                       Rate—8.00% (reasonable rate of interest)

2.                                       Number of payment periods—36 (three years)

The following table summarizes the transactions of the Series D Preferred:

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Series D 6% Convertible Preferred stock at issuance

 

$

15,800,000

 

Less:

 

 

 

Issuance costs

 

494,034

 

Fair value of warrants at issuance (see “Warrants”)

 

8,004,200

 

Subtotal Carrying Value at issuance

 

$

7,301,766

 

Plus:

 

 

 

Cumulative accretion of discount to redemption value first quarter 2005

 

420,695

 

Cumulative accretion of discount to redemption value second quarter 2005

 

593,609

 

Cumulative accretion of discount to redemption value third quarter 2005

 

508,577

 

Cumulative accretion of discount to redemption value fourth quarter 2005

 

518,816

 

Less:

 

 

 

Carrying Value of 2,796 Series D Preferred converted into Common Stock second quarter 2005

 

1,442,025

 

Carrying Value at December 31, 2005

 

$

7,901,438

 

Plus:

 

 

 

Cumulative accretion of discount to redemption value first quarter 2006

 

484,750

 

Cumulative accretion of discount to redemption value second quarter 2006

 

448,815

 

Cumulative accretion of discount to redemption value third quarter 2006

 

363,569

 

Less:

 

 

 

Carrying Value of 4,526 Series D Preferred converted into Common Stock first quarter 2006

 

2,872,466

 

Carrying Value of 3,601 Series D Preferred converted into Common Stock second quarter 2006

 

2,456,119

 

Carrying Value of 4,877 Series D Preferred converted into Common Stock third quarter 2006

 

3,869,987

 

Carrying Value at December 31, 2006

 

$

 

The Series B Preferred has the following rights, preferences and privileges:

Registration Rights

The Company and the holders of Series D Preferred entered into a “Registration Rights Agreement” on January 19, 2005. Among other things, the Company was obligated to file a registration statement on Form S-3 within 75 days of the agreement and use its commercially reasonable efforts to cause such registration statement to become effective. The Securities & Exchange Commission accepted the Registration Statement on Form S-3 on May 11, 2005, pursuant to which the shares of Common Stock issuable upon conversion of the Series D Preferred, as well as the shares of Common Stock issuable upon the exercise of warrants, were registered for resale. The agreement provides for any liquidated damages by the Company to the Series D Preferred holders if the Company is unable to complete the registration, not filing in timely manner or maintain such effectiveness.

Voting Rights

Each holder of shares of Series D Preferred shall have no voting rights so long as the Company shall not, without the affirmative vote of the holders of Series D Preferred then outstanding, alter or change the powers, preferences or rights of the holders of Series D Preferred, authorize or create any class of stock ranking as to dividends, redemption, or distribution of assets upon liquidation senior to Series D Preferred, amend corporate documents so as to affect adversely any rights of holders or increase the authorized number of shares of Preferred Stock.

Dividends

Cumulative Dividends are payable to all holders of Series D Preferred on March 1 and September 1 beginning with the first such date after the original issue date and on any conversion date. Dividends can be paid in cash unless certain criteria are met (mainly no cash available fro for payment) which allows the Company to issue shares of Common stock equivalent to the amount due at 85% of the average stock price of the preceding 10 trading days to the dividend payment date. Series D Preferred dividends are recorded as a

31




reduction (increase) to retained earnings (