Annual Report — Form 10-K Filing Table of Contents
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(Exact
name of registrant as specified in its charter)
Nevada
88-0224817
(State
or other jurisdiction of incorporation or organization)
(I.R.S.
Employer Identification Number)
850
Spice Islands Drive, Sparks, NV
89431
(Address
of principal executive offices)
(Zip
Code)
Registrant’s
telephone number (775)
829-1310
Securities
registered pursuant to Section 12(b) of the Act:
Common
Stock, Par Value $0.001 Per Share
(Title
of
class)
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.
Yes
[ ] No [X]
Indicate
by check mark if the registrant is not
required to file reports pursuant to Section 13 or Section 15(d)
of the
Act.
Yes
[ ] 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 Securities Exchange Act of 1934 during the preceding 12 months
(or for
such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements
for the
past 90 days.
Yes
[X] No [ ]
Indicate
by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of
this chapter) is not contained herein, and will not be contained,
to the
best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K
or any
amendment to this Form 10-K.
[
]
Indicate
by check mark whether the registrant
is a large accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of “accelerated filer and large accelerated filer”
in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark
whether the
registrant is a shell company (as defined in Rule 12b-2 of the
Act).
Yes
[ ] No
[X]
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the stock was last
sold on June 30, 2006, was $518,411,995.
Indicate
the number of shares outstanding of each of the registrant’s classes of common
stock, as of the latest practicable date.
The
number of shares of Common Stock outstanding on March 21,
2007,
was
76,355,478.
This
report contains forward-looking statements within the meaning of the federal
securities laws that relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology, such as "may,""will,""should,""could,""expect,""plan,""anticipate,""believe,""estimate,""project,""predict,""intend,""potential"
or "continue" or the negative of such terms or other comparable terminology,
although not all forward-looking statements contain such terms.
In
addition, these forward-looking statements include, but are not limited to,
statements regarding implementing our business strategy; development,
commercialization and marketing of our products; our intellectual property;
our
estimates of future revenue and profitability; our estimates or expectations
of
continued losses; our expectations regarding future expenses, including research
and development, sales and marketing, manufacturing and general and
administrative expenses; difficulty or inability to raise additional financing,
if needed, on terms acceptable to us; our estimates regarding our capital
requirements and our needs for additional financing; attracting and retaining
customers and employees; sources of revenue and anticipated revenue; and
competition in our market.
Forward-looking
statements are only predictions. Although we believe that the expectations
reflected in these forward-looking statements are reasonable, we cannot
guarantee future results, levels of activity, performance or achievements.
All
of our forward-looking information is subject to risks and uncertainties that
could cause actual results to differ materially from the results expected.
Although it is not possible to identify all factors, these risks and
uncertainties include the risk factors and the timing of any of those risk
factors identified in “Item 1A. Risk Factors” section contained herein, as
well as the risk factors and those set forth from time to time in our filings
with the Securities and Exchange Commission (“SEC”). These documents are
available through our web site, http://www.sulphco.com,
or through the SEC’s Electronic Data Gathering and Analysis Retrieval System
(“EDGAR”) at http://www.sec.gov.
References
in this report to “we,” us,” “our company,” and “SulphCo” refer to SulphCo,
Inc., a Nevada corporation.
3
PART
I
ITEM
1. BUSINESS
Introduction
We
are
engaged in the business of developing and commercializing our patented and
proprietary technology for the “upgrading” of crude oil by reducing its
relative
density, its viscosity, and its sulfur and nitrogen content. Our patented and
proprietary process, which we refer to as Sonocracking,™ is based upon the novel
use of high power ultrasonics - the application of high energy, high frequency
sound waves - which alters the molecular structure of the crude oil. This
decreases the relative density and the viscosity of crude oil and
correspondingly increases the amount of lighter oils that can be recovered
during the refinery processes. Other beneficial changes to the crude oil as
a
result of the Sonocracking technology include a reduction in the weight
percentage of sulfur as well as a reduction in the parts per million of
nitrogen.
The
markets for our Sonocracking technology and our Sonocracker™ units are crude oil
producers and refiners. The economic value of crude oil is driven largely by
both the relative density of the crude and sulfur content. Because our
technology is expected to decrease the relative density of crude oil and at
the
same time reduce the sulfur content in a cost-effective way, the successful
commercialization of our technology can be expected to produce economic benefits
to future customers in these markets.
We
maintain our principal executive offices and facilities at 850 Spice Islands
Drive, Sparks, Nevada89431. Our telephone number is 775-829-1310. Our corporate
website is www.sulphco.com.
Our
website and the information contained therein are not part of this
report.
Business
Development During the Past Year
During
2006, we entered into Memorandums of Understanding (“MOU”), Letters of Intent
(“LOI”) and
testing
agreements with several major oil companies including Total in France, Petrobras
in Brazil, SK Corporation in South Korea, Hyundai Oilbank Co., Ltd in South
Korea, and OMV in Austria. These agreements indicate the market’s interest in
the SulphCo, Inc. Sonocracking ™ technology and provide us several avenues for
validation testing of the process. Furthermore, these testing agreements lay
the
groundwork for future commercial discussions and development options for the
technology.
In
2006,
we entered into an MOU with Pierson Capital International Ltd (“Pierson”). As
part of the agreement, Pierson accepted the appointment as SulphCo, Inc.’s
advisor and coordinator for operational logistics associated with the
Sonocracking ™ technology, beginning with the test facility under construction
in Fujairah, UAE. Included within the scope of Pierson’s involvement in Fujairah
are marine terminal capabilities, storage and tanker capacities, and import
and
export management.
We
continued construction of a 180,000 bbl/day Sonocracking™ test facility in
Fujairah, UAE throughout 2006. Over the course of the year, a land lease was
procured for the production site, and over $20 million was invested in a test
facility. Although progress in 2006 was hampered with delays due to poor
execution by our construction contractor, several steps have been taken to
remediate those issues, and we expect to commission the first Sonocracking
™
unit in the first half of 2007.
4
The
following sets forth a detailed summary and timeline of the significant events
and milestones that have occurred during the construction of the Fujairah test
facility:
·
December,
2005 - Formal request from Fujairah Oil Technology LLC to provide
processing equipment capable of upgrading 200,000 bbl/day by June1,2006.
·
December,
2005 - Contracted with NTG GmbH (“NTG”) to build seven 30,000 bbl/day
Sonocracking units to be completed by April 15,2006.
·
February,
2006 - Finalized contracts with NTG for construction of seven 30,000
bbl/day Sonocracking units and fourteen oil/water separators for
€1.1
million Euros, or approximately $1.3 million, per
unit.
·
February,
2006 - Placed an order with M’rkisches Werk GmbH (“MWH”) for the
manufacture of 60 ultrasonic
probes.
·
March,
2006 - Contracted with Vera Group (“Vera”) to design and construct the
building to house the Sonocracking
units.
·
March,
2006 - Contracted with Mustang International, LP (“Mustang”) to provide
overall program and construction
management.
·
April,
2006 - Construction of building
begun.
·
May,
2006 - Change in scope of building
construction.
·
May,
2006 - First shipment of equipment from Germany to
Fujairah.
·
June
through October, 2006 - Building construction continues, but with
several
unforeseen delays.
·
October,
2006 - Building progressed to the point that processing equipment
could be
installed, but there were further delays as Vera failed to implement
sufficient manpower and had not ordered the equipment required in
their
scope.
·
November,
2006 - Installation of equipment within the building
begins.
·
January,
2007 - Completion of installation of six 30,000 bbl/day Sonocracking
units, exclusive of reactors.
5
In
late
2006 and early 2007, we engaged two external vendors to facilitate the
development of ultrasound probes with improved operational performance and
reliability. We received and tested the first set of improved probe
prototypes in January, with encouraging results with respect to
reliability. The next set of improved probe prototypes was received
in late February and has been in reliability and performance testing over
the past few weeks. Preliminary results show improved reliability and the
current research focus centers on the necessary processing performance
required by the probe to affect the Sonocracking® process. Subsequent
improvements in the probe design and reliability are underway and are
expected to continue throughout 2007. In addition to these efforts, we
continue to pursue and evaluate other "off the shelf" solutions that are
available for ultrasound probes companies.
General
Description of Our Technology
The
key
to our technology is the use of high power ultrasound to alter naturally
occurring molecular structures in hydrocarbons, which are the predominant
molecular components of crude oil. The altering of these structures includes
breaking large hydrocarbon structures into smaller hydrocarbon structures,
thereby reducing the relative
density, and the viscosity of the crude oil. Carbon bonds that contain sulfur
and nitrogen are also broken in the same manner, thereby allowing the separation
through filtration of some of these compounds from the remaining hydrocarbon
compounds in the crude oil.
The
Market for Our Technology
The
Oil Producer Market
SulphCo
processing units are expected to provide economic benefits for oil producers
utilizing these units. These benefits include:
·
The
ability to obtain higher prices for crude oil processed by SulphCo’s
Sonocracker
units; and
The
price
of crude oil is based primarily on its relative density and sulfur content.
Because our technology is expected to reduce both the density and sulfur content
in crude oil in a commercial setting, this will allow a producer who treats
crude oil with our Sonocracking
technology to obtain a higher price for its crude oil from distributors and
refiners as a result of its lower density and sulfur content. In addition,
crude
oil reserves which are underutilized due to higher sulfur content may become
more economically viable as a result of treating extracted crude oil with our
processing units. Producers would operate these units to process crude oil
in
conjunction with oilfield collection points or crude storage tank
facilities.
The
world
consumes approximately 85 million barrels of oil per day, according to the
Energy Information Administration as of the end of 2006. Of this, approximately
60 million barrels per day comes from medium and heavy crude oil.
The
Refinery Market
SulphCo’s
Sonocracking
processing
units are expected to provide economic benefits for oil refiners through the
reduction of crude oil density and sulfur content. As each refinery is unique,
potential benefits of Sonocracking
technology
to an
individual refiner will vary, depending on such factors as plant configuration,
the type of crude oil processed and product specifications.
6
These
potential benefits include:
·
The
ability to produce a higher yield of higher value refinery end
product;
·
Lower
raw material (i.e. crude oil) costs;
and
·
Improved
operation of conventional desulfurization
equipment.
Upgrading
of Crude Oil Results in Higher Yield of Higher Margin End
Products
When
refined, a lighter crude oil usually produces a higher yield of higher margin
refined products such as gasoline, diesel and jet fuel. Therefore, it is more
expensive than heavy crude oil. In contrast, heavy crude oil produces more
low
margin by-products and heavy residual oils. Because our Sonocracker
units
are expected to upgrade the quality of crude oil by reducing crude oil density,
a refinery which “pre-treats” its feed crude oil with our Sonocracking
technology is expected to be able to produce a higher yield of higher value
end
products than would otherwise be the case without our Sonocracker
units.
Lower
Raw Material Costs
While
all
crude oils have differing characteristics, the relative cost of crude oil is
influenced primarily by its relative density and sulfur content. Typically,
there is a direct correlation between oil density and sulfur content, with
more
dense crude generally containing higher sulfur concentrations. Therefore, crude
oil with lower density and lower sulfur concentrations is generally sold at
a
higher price than higher density crude oil with higher sulfur
concentrations.
The
cost
of crude oil is generally considered to be the cost component with the greatest
leverage on the profitability of an oil refinery. Therefore, a refinery will
normally seek to purchase the most economical grade of crude oil which is
suitable for its refinery operations. Typically, no two refineries will have
identical requirements and suitability of a particular grade of crude oil will
normally depend upon the refining capabilities of a particular refinery and
the
types of finished products it produces. For example, complex refineries, (i.e.
refineries which have more extensive refining capabilities) can more readily
process heavier grades of crude oil containing higher sulfur concentrations.
Due
to price differentials based upon the density and sulfur content of crude oil,
a
refinery (regardless of complexity) will normally seek to purchase the most
economical heavy grade oil with the highest sulfur content that can be refined
within it’s capabilities. In turn, as the market “spread” between light sweet
crude oil and heavy sour crude oil increases, so too should a refinery’s profit
margin if it has the capability of processing heavier sour crude
oil.
Because
our Sonocracker units
are
expected to reduce crude oil density and sulfur content, a refinery which
“pre-treats” its crude oil with our units would be expected to be able to
realize cost reductions and improved profit margins by utilizing lower cost,
higher density, higher sulfur containing feed oil than would otherwise be
possible without our Sonocracking
technology.
7
Improved
Operation of Conventional Desulfurization Equipment
The
reduction of sulfur levels is an integral part of most refinery processes.
This
is most commonly accomplished through refinery equipment generally referred
to
in the industry as “hydrotreaters.” Hydrotreating is a refinery process in which
hydrogen gas is mixed with the hydrocarbon stream and exposed to a catalyst
under high temperature and pressure to effect the hydrotreating process. The
greater the temperature and pressure, the faster the hydrotreating process
will
go. Typically, the higher boiling point fractions from lower grade, lower API
gravity (heavier) crude requires higher temperature and pressure to complete
the
hydrotreating process.
By
utilizing our Sonocracker units, it is expected that the improvement and
upgrading of the crude oil stream should result in greater operating efficiency
in conventional hydrotreating operations. This is expected to give some refiners
more options with respect to crude oil feed choices, operating rates and other
refining decisions.
Our
Sonocracker
units
may
also reduce the need for some refineries to revamp existing hydrotreaters.
In
some instances, refineries are faced with revamping their existing hydrotreaters
to meet ever more stringent levels of sulfur reduction in petroleum products.
Our Sonocracker
units
are
expected to allow refiners to utilize higher sulfur crude oil more efficiently
in their existing hydrotreaters, thereby avoiding the cost of revamping their
existing equipment and the resulting costly downtime for the
refinery.
For
additional information regarding capital and operating costs related to our
Sonocracker
units,
see “Competitive Business Conditions” below.
Geographic
Scope of Our Market
We
have a
50% ownership interest in Fujairah Oil Technology LLC in the United Arab
Emirates and have entered into Memorandums of Understanding (MOU), Letters
of
Intent (LOI) and testing agreements with several major oil companies including
Total in France, Petrobras in Brazil, SK Corporation in South Korea, Hyundai
Oilbank Co., Ltd in South Korea, and OMV in Austria. As the potential markets
for our technology include countries with significant oil producing or refining
activities, we expect to conduct business in other countries in the future.
These activities may be conducted by us directly, or through partners, licensees
or other third parties, in connection with the potential commercialization
of
our technologies.
Development
and Commercialization Activities
We
have
been developing our Sonocracking technologies on an ongoing basis since the
formation of GRD, Inc. in January 1999. Beginning
in mid-2002, our development activities centered around re-designing, upgrading
and testing of laboratory scale prototypes utilizing more powerful ultrasonic
generators, and redesigning these prototypes to accommodate the more powerful
generators. Substantially all of the development work to date has been conducted
by SulphCo personnel. At this time, testing has been limited to samples produced
by prototypes which have processed up to 100 gallons per minute of crude oil
in
a laboratory setting. We continue to conduct testing in-house and through
relationships with third parties.
8
During
2005, we completed construction of a 5,000 bbl/day Sonocracking unit and a
15,000 bbl/day Sonocracking unit at our facilities in Sparks, Nevada, which
culminated months of testing the internal components of the unit at our
facility. These units are designed to be modular in order to facilitate both
scalability and maintenance. The 15,000 bbl/day unit incorporates three reactor
probe assemblies and associated equipment as used in the 5,000 bbl/day unit.
Both the 5,000 and 15,000 bbl/day units are prototypes that could be used for
demonstration to customers. These systems are automated using programmable
logic
controllers and come equipped with touch screen interfaces. We also designed
a
Sonocracking unit intended to process 30,000 bbl/day of material. This unit
is
based upon the design of the 5,000 and 15,000 bbl/day prototypes, whereby a
15,000 bbl/day unit consists of three 5,000 bbl/day units, and a 30,000 bbl/day
unit consists of six 5,000 bbl/day units. Seven 30,000 bbl/day units were
manufactured by NTG in 2006, with six units installed in our Fujairah facility.
As
stated
above, in Fujairah,
although progress has been delayed, we expect to commission the first
Sonocracking™ unit in the first half of 2007. The commissioning of this unit
will allow for further internal development and external demonstration of the
technology as in parallel we move forward with commercial discussions regarding
oil supply contracts and pipeline construction in 2007.
The
following sets forth a detailed summary and timeline of the significant events
and milestones that need to occur for the Fujairah facility to commence
commercial testing:
·
April,
2007 - Completion of building and infrastructure. $800,000 due to
The Vera
Group upon completion.
·
April,
2007 - Completion of successful testing of the probe transducer assembly.
·
April,
2007 - Contracting for testing oil and trucking
thereof.
·
April/May,
2007 - Begin testing of ultrasonic probes under commercial
conditions.
·
June,
2007 - Completion of commissioning of test unit.
Patents,
Trademarks and Copyrights
We
own
five United States patents, four of which relate to our basic Sonocracking
technology. We
believe United States Patent Nos. 6,402,939, 6,500,219, 6,827,844, and 6,897,628
provide substantial protection for our basic Sonocracking technology covering
the novel use of ultrasound to desulfurize crude oil. The first patent, patent
6,402,939, was issued on June 11, 2002, and expires on September 28, 2020.
This
patent was assigned to us by Dr. Teh Fu Yen of the University of Southern
California. It covers the oxidation of sulfur compounds in fossil fuels using
ultrasound. The second patent, No. 6,500,219, was issued on December 31, 2002,
and expires on March 19, 2021. This patent was based on additional work done
by
Dr. Gunnerman and focuses on the continuous process for the oxidation of sulfur
compounds in fossil fuels using ultrasound. The third patent, No. 6,827,844,
was
issued on December 7, 2004, and expires on October 23, 2022. This patent relates
to ultrasound-assisted desulfurization of fossil fuels in the presence of
dialkyl ethers. The fourth patent, No. 6,897,628 was issued on May 24, 2005,
and
expires on May 16, 2023. This patent relates to high-power ultrasonic generators
and their use in chemical reactions.
In
addition to these four issued U.S. patents which cover our basic desulfurization
process, we have one additional U.S. patent. Patent No. 6,652,992, covers a
silver coating process on ultrasonic horns which makes the horns corrosion
resistant. This patent was issued on November 25, 2003, and expires on December20, 2022. We have nine other patent applications pending which address specific
aspects of our upgrading process. We also have one hundred two (102) foreign
patent applications pending which relate to our U.S. patents.
9
We
have
applied to register the trademarks Sonocracking,™ Sonocracker,™ and Sonocracked
Crude™ with reference to our upgrading and desulfurization technology. The
trademark SulphCo™ was registered in the U.S. on May 30, 2006. We also rely on
copyright protection for the software utilized in our Sonocracking
units.
Competitive
Business Conditions
We
are a
new entrant in the market for development and sale of upgrading technology
to
the oil industry. SulphCo faces well established and well funded competition
from a number of sources. Our competitors in this area include oil companies,
oil refineries and manufacturers of conventional oil refinery equipment such
as
hydrotreaters. Most of these entities have substantially greater research and
development capabilities and financial, scientific, manufacturing, marketing,
sales and service resources than we do. Because of their experience and greater
research and development capabilities, our competitors might succeed in
developing and commercializing new competing technologies or products which
would render our technologies or products obsolete or
non-competitive.
Our
patented and proprietary Sonocracking process is based upon the novel use of
high power ultrasonics to effect beneficial changes in the chemical composition
of crude oil. These beneficial changes include an increase in the gravity of
the
crude oil and a corresponding increase in the amount of lighter, more valuable
oils that can be recovered during refining processes. Other beneficial changes
to the crude oil as a result of the Sonocracking technology include a reduction
in the weight percentage of sulfur as well as a reduction in the parts per
million of nitrogen.
We
believe that our Sonocracking technology is unique in that it “pre-treats” crude
oil by both reducing relative gravity of oil and reducing sulfur content prior
to being fed into the traditional refinery operation. Other than our proprietary
Sonocracking process, we are not aware of any process in commercial use which
is
capable of both reducing the density of crude oil and reducing sulfur content
other than the conventional refinery process itself.
SulphCo’s
Sonocracking units, which are intended to operate in conjunction with
traditional refinery equipment, are expected to provide additional upgrading
benefits at a substantially reduced capital and operating cost compared to
conventional refinery operations. These units are also expected to provide
a
cost-effective method for oil producers to upgrade their crude oil prior to
its
sale to refiners.
We
believe that our issued and pending patents and proprietary know-how will
provide us with a significant competitive advantage over other companies seeking
to commercialize new methods of increasing the gravity of crude oil or reducing
its sulfur content which are more cost-effective or more efficient than the
methods which are currently commercially available.
Research
and Development During the Last Three Years
During
the past three years, our business efforts were directed towards research and
development of upgrading and desulfurization of crude oil, including research
and development of our high power ultrasound technology. During this time,
our
research and development costs totaled approximately $7.1 million; $4 million
in
2006, $2.5 million in 2005, and $400,000 in 2004. In 2006, we expended
approximately $21.5 million for the construction of the building and for
equipment related to the test facility in Fujairah as discussed under
“Business
Development During the Past Year.” Expenditures of this magnitude will not be
repeated in the future until commercialization can be proven to be profitable,
whereupon similar expenditures will be capitalized as commercial equipment
rather than expensed as research and development.
10
In
2005,
we completed the design and construction of our first 15,000 bbl/day
Sonocracking unit, which has not been put into service.
We
expect
to continue to develop and test our technologies and prototypes and to explore
the expansion of the range of petroleum products that can be upgraded with
our
technologies.
Effects
of Government Regulation; Regulatory Approvals
Government
Regulation of Sulfur Levels in Petroleum Products
The
reduction of sulfur levels in petroleum products has become a major issue for
oil refiners. Developed countries in recent years have increasingly mandated
the
use of low or ultra low sulfur petroleum products. As a result, refineries
are
faced with incurring extremely expensive capital improvements for their refinery
processes, altering their end product mix, or in some instances ceasing the
production of low sulfur products entirely. Our technology is expected to
benefit from the impact of existing and proposed government mandates which
regulate sulfur content, in both the U.S. and in developed countries abroad.
For
example, refinery operations in the U.S. and many of the petroleum products
they
manufacture are subject to certain specific requirements of the federal Clean
Air Act (“CAA”) and related state and local regulations and with the
Environmental Protection Agency (“EPA”). The CAA may direct the EPA to require
modifications in the formulation of the refined transportation fuel products
in
order to limit the emissions associated with their final use. In
December 1999, the EPA promulgated national regulations limiting the amount
of
sulfur that is to be allowed in gasoline. The EPA has stated that such limits
are necessary to protect new automobile emission control systems that may be
inhibited by sulfur in the fuel. The regulations require the phase-in of
gasoline sulfur standards beginning in 2004, with special extended phase-in
provisions over the next few years for refineries meeting specified
requirements. In addition, the EPA recently promulgated regulations that limit
the sulfur content of highway diesel fuel beginning in 2006 to 15 parts per
million. The former standard was 500 parts-per-million. The EPA has also
proposed regulations intended to limit the sulfur content of diesel fuel used
in
non-road activities such as mining, construction, agriculture, railroad and
marine.
Regulatory
Approvals
The
regulatory environment that pertains to our business is complex, uncertain
and
changing rapidly. Although we anticipate that existing and proposed governmental
mandates regulating the sulfur content of petroleum products will continue
to
provide an impetus for customers to utilize our Sonocracking technology, it
is
possible that the application of existing environmental legislation or
regulations or the introduction of new legislation or regulations could
substantially impact our ability to commercialize our proprietary technology,
which could in turn negatively impact our business.
Operation
of our Sonocracking units is subject to a variety of federal, state and local
health and environmental laws and regulations governing product specifications,
the discharge of pollutants into the air and water, and the generation,
treatment, storage, transportation and disposal of solid and hazardous waste
and
materials. Permits with varying terms of duration may be required for the
operation of our Sonocracking units, and these permits may be subject to
revocation, expiration, modification and renewal. Governmental authorities
have
the power to enforce compliance with these regulations and permits, and
violators are subject to injunctions, civil fines and even criminal
penalties.
Our
activities to date have centered around the development and testing of our
prototype units. These activities require the use or storage of materials which
are, or in the future may be, classified as hazardous products or pollutants
under federal and state laws governing the discharge or disposal of hazardous
products or pollutants. We have undertaken a number of steps intended to ensure
compliance with applicable federal and state environmental laws. Regulated
materials used or generated by us are stored in above-ground segregated
facilities and are disposed of through licensed petroleum product disposal
companies. We also engage independent consultants from time to time to assist
us
in evaluating environmental risks. Our costs related to environmental compliance
have been included as part of our general overhead, and we do not presently
anticipate any material increase in expenditures relating to environmental
compliance in the near future based upon our current level of operations. We
do
not currently maintain insurance to protect us against risks relating to
violation of federal or state laws governing the environment.
11
Rules
and
regulations implementing federal, state and local laws relating to the
environment will continue to affect our business, and we cannot predict what
additional environmental legislation or regulations will be enacted or become
effective in the future or how existing or future laws or regulations will
be
administered or interpreted with respect to products or activities to which
they
have not been applied previously. Compliance with more stringent laws or
regulations, as well as more vigorous enforcement policies of regulatory
agencies, could have a materially adverse effect on our business.
Installation
and operation of our units at customer sites may subject us to increased risk.
We intend to address these risks by imposing contractual responsibility on
third
party users for maintaining necessary permits and complying with applicable
environmental laws related to the operation of our units. However, these
measures may not fully protect us against environmental risks. Furthermore,
although we may be entitled to contractual indemnification from third parties
for environmental compliance liabilities, this would not preclude direct
liability by us to governmental agencies or third parties under applicable
federal and state environmental laws. We are presently unable to predict the
nature or amount of additional costs or liabilities which may arise in the
future. However, future liabilities and costs could be material.
Employees
As
of
March 1, 2007, we had 24 total employees, including 22 full-time
employees.
ITEM
1A. RISK
FACTORS
We
are a development stage company with a limited operating history, which makes
it
more difficult to predict whether we will be able to successfully commercialize
our technology and implement our business plan.
12
We
are a
development stage company with a limited operating history, and our principal
technologies and products are not yet commercially proven. Accordingly, there
is
a limited operating history upon which to base an assumption that we will be
able to successfully implement our business plan.
Our
technologies are not fully developed, are commercially untested, and therefore,
the successful development and commercialization of our technologies remain
subject to significant uncertainty.
Our
activities, to date, have involved the research and development of our crude
oil
desulfurization and upgrading technologies and the construction of a test
facility. We have not yet generated any material revenues since commencing
these
activities in January 1999. Commercial application of our technologies will
require further investment, development and testing. We may be unable to
complete the commercialization of our technologies on a timely basis, or at
all.
Development
and commercialization of a new technology, such as our Sonocracking™ process, is
inherently subject to significant risks. Accordingly, we cannot assure that
our
technology will perform in a commercial scale setting as indicated in initial
laboratory or small scale testing or that we will be able to successfully
commercialize our technology. Introducing and enhancing a new technology
involves numerous technical challenges, substantial financial and personnel
resources, and often takes many months or years to complete. We cannot be
certain that we will be successful at commercializing our technology on a timely
basis, or in accordance with milestones, if at all. In addition, we cannot
be
certain that, once our processing unit is made operational in a commercial
setting, the unit will perform as expected. Our technology is complex and,
despite further vigorous testing and quality control procedures, may contain
undetected errors. Any inability to timely deliver a commercially viable unit
could have a negative effect on our business, revenues, financial condition
and
results of operations.
We
have a history of operating losses and have not generated material revenues
to
date, and we are unable to predict when or if we will generate material revenues
on a sustained basis or achieve profitability.
We
have
not generated any material revenues, and we have experienced significant
operating losses in each period since we commenced our current line of business
in January 1999. As of December 31, 2006, we had an accumulated deficit of
approximately $70.8 million, including approximately $10.1 million of
stock-based compensation expense. These losses are principally associated with
the research and development of our Sonocracking™ units for desulfurization and
upgrading crude oil and other petroleum products, research and development
of
ultrasound technologies, development of pre-production prototypes and related
marketing activity, and we expect to continue to incur expenses in the future
for development, commercialization and sales and marketing activities related
to
the commercialization of our technology. We cannot predict when or to what
extent our technology or resulting products will begin to produce revenues
on a
sustained basis, or whether we will ever reach profitability. If we are unable
to achieve significant levels of revenue on a sustained basis, our losses will
continue. If this occurs, we may be compelled to significantly curtail our
business activities or suspend or cease our operations.
We
may not have sufficient working capital in the future, and we may be unable
to
obtain additional capital, which could result in the curtailment, suspension
or
cessation of our business activity. If we obtain additional financing, you
may
suffer significant dilution.
In
the
past we have financed our research and development activities primarily through
debt and equity financings from our principal shareholder, Rudolf W. Gunnerman,
and equity financings from third parties. Our existing capital resources will
not be sufficient to fund our cash requirements for the next 12 months based
upon current levels of expenditures and anticipated needs. We expect that
additional working capital will be required in the future. There is substantial
doubt about our ability to continue as a going concern, as discussed in Note
1
to our financial statements. Our ability to continue as a going concern is
dependent on our ability to implement our business plan and raise additional
funds.
13
The
extent and timing of our future capital requirements will depend upon several
factors, including:
·
Completion
of the test facility
·
Continued
progress toward commercialization of our
technologies;
·
Rate
of progress and timing of product commercialization activities and
arrangements, including the implementation of our venture with Fujairah
Oil Technology; and
·
Our
ability to establish and maintain collaborative arrangements with
others
for product development, commercialization, marketing, sales and
manufacturing.
Accordingly,
our capital requirements may vary materially from those currently planned,
and
we may require additional financing sooner than anticipated.
Sources
of additional capital, other than from future revenues (for which we presently
have no commitments) include proceeds from the exercise of warrants issued
to
the investors in the June 2004 and March 2006 placements, funding through
collaborative arrangements, licensing arrangements and debt and equity
financings. We do not know whether additional financing will be available on
commercially acceptable terms when needed. If we cannot raise funds on
acceptable terms, we may not be able to successfully commercialize our
technology, or respond to unanticipated requirements. If we are unable to secure
such additional financing, we may have to curtail, suspend or cease all or
a
portion of our business activities. Further, if we issue equity securities,
our
shareholders may experience severe dilution of their ownership percentages,
and
the new equity securities may have rights, preferences or privileges senior
to
those of our common stock.
Commercial
activities by us in foreign countries could subject us to political and economic
risks which could impair future potential sources of revenue or impose
significant costs.
We
are
currently engaged in activities outside the U.S., including the United Arab
Emirates and South Korea, and we expect to continue to do so in the future,
either directly, or through partners, licensees or other third parties, in
connection with the commercialization of our technologies. The transaction
of
business by us in a foreign country, either directly or through partners,
licensees or other third parties, may subject us, either directly or indirectly,
to a number of risks, depending upon the particular country. These risks may
include, with respect to a particular foreign country:
·
Government
activities that may result in the curtailment of contract
rights;
·
Government
activities that may restrict payments or limit the movement of funds
outside the country;
·
Confiscation
or nationalization of assets;
·
Confiscatory
or other adverse foreign taxation
regulations;
·
Acts
of terrorism or other armed conflicts and civil
unrest;
·
Currency
fluctuations, devaluations and conversion restrictions;
and
·
Trade
restrictions or embargoes imposed by the U.S. or a foreign country.
Many
of
these risks may be particularly significant in some oil producing regions,
such
as the Middle East and South America.
14
We
may have difficulty managing our growth.
We
expect
to experience significant growth if we are successful in our efforts to rollout
our Sonocracking units in Fujairah, United Arab Emirates. This growth exposes
us
to increased competition, greater operating, marketing and support costs and
other risks associated with entry into new markets and the development of new
products, and could place a strain on our operational, human and financial
resources. To manage growth effectively, we must:
·
attract
and retain qualified personnel;
·
upgrade
and expand our infrastructure so that it matches our level of
activity;
·
manage
expansion into additional geographic areas;
and
·
improve
and refine our operating and financial systems and managerial controls
and
procedures.
If
we do
not effectively manage our growth, we will not be successful in executing our
business plan, which could materially adversely affect our business, results
of
operations and financial condition.
Our
strategy for the development and commercialization of our technologies
contemplates collaborations with third parties, making us dependent on them
for
our success.
We
do not
possess all of the capabilities to fully commercialize our desulfurization
and
upgrading technologies on our own. Our success may depend upon partnerships
and
strategic alliances with third parties, such as our joint venture with Fujairah
Oil Technology. Collaborative agreements involving the development or
commercialization of technology such as ours generally pose such risks
as:
·
Collaborators
may not pursue further development or commercialization of products
resulting from collaborations or may elect not to continue or renew
research and development programs;
·
Collaborators
may delay development activities, underfund development activities,
stop
or abandon development activities, repeat or conduct new testing
or
require changes to our technologies for
testing;
·
Collaborators
could independently develop, or develop with third parties, products
that
could compete with our future
products;
·
The
terms of our agreements with collaborators may not be favorable to
us;
·
A
collaborator may not commit enough resources, thereby delaying
commercialization or limiting potential revenues from the
commercialization of a product;
·
Collaborations
may be terminated by the collaborator for any number of reasons,
including
failure of the technologies or products to perform in line with the
collaborator’s objectives or expectations, and such termination could
subject us to increased capital requirements if we elected to pursue
further activities.
We
have very limited manufacturing, marketing and sales experience, which could
result in delays to the implementation of our business
plan.
We
have
very limited manufacturing, marketing and product sales experience. We cannot
assure you that contract manufacturing services will be available in sufficient
capacity to supply our product needs on a timely basis. If we decide to build
or
acquire commercial scale manufacturing capabilities, we will require additional
management and technical personnel and additional capital.
15
We
rely on third parties to provide certain components for our products. If our
vendors fail to deliver their products in a reliable, timely and cost-efficient
manner, our business will suffer.
We
currently depend on relationships with third parties such as contract
manufacturing companies and suppliers of components critical for the product
we
are developing in our business. If these providers do not produce these products
on a timely basis, if the products do not meet our specifications and quality
control standards, or if the products are otherwise flawed, we may have to
delay
product delivery, or recall or replace unacceptable products. In addition,
such
failures could damage our reputation and could adversely affect our operating
results. As a result, we could lose potential customers and any revenues that
we
may have at that time may decline dramatically.
Our
success depends to a significant degree on the continued services of our senior
management and other key employees, and our ability to attract and retain highly
skilled and experienced scientific, technical, managerial, sales and marketing
personnel. We cannot assure you that we will be successful in recruiting new
personnel or in retaining existing personnel. None of our senior management
or
key personnel has long term employment agreements with us. We do not maintain
key person insurance on any members of our management team or other personnel.
The loss of one or more key employees or our inability to attract additional
qualified employees could delay the implementation of our business plan, which
in turn could have a material adverse effect on our business, results of
operations and financial condition. In addition, we may experience increased
compensation costs in order to attract and retain skilled employees.
Because
the market for products utilizing our technologies is still developing and
is
highly competitive, we may not be able to compete successfully in the highly
competitive and evolving desulfurization and upgrading market.
The
market for products utilizing our technologies is still developing and there
can
be no assurance that our products will ever achieve market acceptance. Because
we presently have no customers for our business, we must convince petroleum
producers, refiners and distributors to utilize our products or license our
technology. To the extent we do not achieve market penetration, it will be
difficult for us to generate meaningful revenue or to achieve profitability.
The
success of our business is highly dependent on our patents and other proprietary
intellectual property, and we cannot assure you that we will be able to protect
and enforce our patents and other intellectual property.
Our
commercial success will depend to a large degree on our ability to protect
and
maintain our proprietary technology and know-how and to obtain and enforce
patents on our technology. We rely primarily on a combination of patent,
copyright, trademark and trade secrets law to protect our intellectual property.
Although we have filed multiple patent applications for our technology, and
we
have five issued patents in the U.S., our patent position is subject to complex
factual and legal issues that may give rise to uncertainty as to the validity,
scope and enforceability of a particular patent. Accordingly, we cannot assure
you that any patents will be issued pursuant to our current or future patent
applications or that patents issued pursuant to such applications will not
be
invalidated, circumvented or challenged. Also, we cannot assure you that the
rights granted under any such patents will provide the competitive advantages
we
anticipate or be adequate to safeguard and maintain our proprietary rights.
In
addition, effective patent, trademark, copyright and trade secret protection
may
be unavailable, limited or not applied for in certain foreign countries.
Moreover, we cannot assure you that third parties will not infringe, design
around, or improve upon our proprietary technology.
16
We
also
seek to protect our proprietary intellectual property, including intellectual
property that may not be patented or patentable, in part by confidentiality
agreements and, if applicable, inventor's rights agreements with our employees
and third parties. We cannot assure you that these agreements will not be
breached, that we will have adequate remedies for any breach or that such
persons will not assert rights to intellectual property arising out of these
relationships.
We
are a new entrant in our business and we face significant
competition.
We
are a
new entrant in the market for development and sale of upgrading and sulfur
reduction technology to the oil industry. We face well-established and
well-funded competition from a number of sources. Our competitors in this area
include manufacturers of conventional refinery desulfurization equipment and
major integrated oil companies and oil refineries. Most of these entities have
substantially greater research and development capabilities and financial,
scientific, manufacturing, marketing, sales and service resources than we
do.
Because
of their experience and greater research and development capabilities, our
competitors might succeed in developing and commercializing competing
technologies or products which would render our technologies or products
obsolete or non-competitive.
Regulatory
developments could have adverse consequences for our business.
The
regulatory environment that pertains to our business is complex, uncertain
and
changing rapidly. Although we anticipate that existing and proposed governmental
mandates regulating the sulfur content of petroleum products will continue
to
provide an impetus for customers to utilize our Sonocracking™ technology for
desulfurization, it is possible that the application of existing environmental
legislation or regulations or the introduction of new legislation or regulations
could substantially impact our ability to launch and promote our proprietary
technologies, which could in turn negatively impact our business.
Rules
and
regulations implementing federal, state and local laws relating to the
environment will continue to affect our business, including laws and regulations
which may apply to the use and operation of our Sonocracker™ units, and we
cannot predict what additional environmental legislation or regulations will
be
enacted or become effective in the future or how existing or future laws or
regulations will be administered or interpreted with respect to products or
activities to which they have not been applied previously. Compliance with
more
stringent laws or regulations, as well as more vigorous enforcement policies
of
regulatory agencies, could have a materially adverse effect on our
business.
To
date,
environmental regulation has not had a material adverse effect on our business,
which is presently in the development stage. However, future activities may
subject us to increased risk when we commercialize our units by reason of the
installation and operation of these units at customer sites. We intend to
address these risks by imposing contractual responsibility whenever practicable,
on third party users for maintaining necessary permits and complying with
applicable environmental laws governing or related to the operation of our
units. However, these measures may not fully protect us against environmental
risks. Furthermore, although we may be entitled to contractual indemnification
from third parties for environmental compliance liabilities, this would not
preclude direct liability by us to governmental agencies or third parties under
applicable federal and state environmental laws. We are presently unable to
predict the nature or amount of additional costs or liabilities which may arise
in the future related to environmental regulation. However, such future
liabilities and costs could be material.
17
We
may be sued for product liability, which could result in liabilities which
exceed our available assets.
We
may be
held liable if any product we develop, or any product which is made with the
use
of any of our technologies, causes injury or is found otherwise unsuitable
during product testing, manufacturing, marketing, sale or use. We currently
have
no product liability insurance. When we attempt to obtain product liability
insurance, this insurance may be prohibitively expensive, or may not fully
cover
our potential liabilities. Inability to obtain sufficient insurance coverage
at
an acceptable cost or otherwise to protect against potential product liability
claims could inhibit the commercialization of products developed by us. If
we
are sued for any injury caused by our products, our liability could exceed
our
available assets.
We
are the defendant in several lawsuits, in which an adverse judgment against
us
could result in liabilities which exceed our available assets.
Details
of the current status of outstanding litigation involving the Company are
available herein, under “Item 3. Legal Proceedings.” An adverse judgment in any
of these cases could result in material harm to our business or result in
liabilities that exceed our available assets.
Our
stock price is volatile, which increases the risk of an investment
in our common stock.
The
trading price for our common stock has been volatile, ranging from a sales
price
of $0.21 in October 2003, to a sales price of over $19.00 per share in
January of 2006. The price has changed dramatically over short periods with
decreases of more than 50% and increases of more than 100% percent in a single
day. An investment in our stock is subject to such volatility and, consequently,
is subject to significant risk.
As
of December 31, 2005 and in subsequent quarters through December 31, 2006 we
have concluded that our disclosure controls and procedures regarding information
required to be included in SEC reports were not effective due to material
weaknesses, and we might find other material weaknesses in the future which
may
adversely affect our ability to provide timely and reliable financial
information and satisfy our reporting obligations under federal securities
laws.
As a result, current and potential stockholders could lose confidence in our
financial reporting, which would harm our business and the trading price of
our
stock.
As
of
December 31, 2005 and in subsequent quarters through December 31, 2006, we
detected material weaknesses in our disclosure controls and procedures regarding
information required to be included in SEC reports. As a result of these
weaknesses management has concluded that as of December 31, 2005, and in
subsequent quarters through December 31, 2006, our disclosure controls and
procedures were not effective as of such dates. In particular, management
concluded that:
·
There
were deficiencies in the communications between previous management
to the
Board of Directors and the Audit
Committee;
18
·
We
did not have adequate controls over the accounting, review and processing
of transactions involving decisions to expense or capitalize certain
items
involving research and development, fixed assets and patent
maintenance;
·
We
did not have adequate transaction controls over the accounting, review
and
processing of liability recognition at the end of accounting
periods;
·
We
did not have adequate controls over the accounting, review and processing
of transactions involving issuances of stock and options or cash
commitments; and
·
We
lacked personnel with sufficient financial expertise and experience
to make appropriate judgments resulting in appropriate accounting
and
financial reporting.
The
Company has attempted to address these issues and continues to address them
as
it makes transitions with new management. The Company has hired a new CEO and
President and intends to hire additional personnel with the financial expertise
it currently lacks, and we have taken and are taking steps to remediate the
material weaknesses in our disclosure controls and procedures, including the
adoption of written policies for the areas found to be deficient. However,
we
have not completed our remediation effort and we cannot assure you that we
will
completely remediate our material weaknesses. We might find other material
weaknesses in the future. Our Chief Financial Officer resigned March 23, 2007,
and we are actively seeking a replacement, but cannot be assured that we will
easily find a qualified replacement or one who can smoothly assist us in
strengthening our disclosure controls and procedures.
To the
extent that any significant or material weaknesses exist in our disclosure
controls and procedures, such weaknesses may adversely affect our ability to
provide timely and reliable information necessary for the conduct of our
business and satisfaction of our reporting obligations under federal securities
laws, including the preparation of interim and annual financial statements
in
accordance with generally accepted accounting principles and SEC rules. As
a
result, current and potential stockholders could lose confidence in our
reporting, which would harm our business and the trading price of our
stock.
ITEM
1B. UNRESOLVED STAFF COMMENTS
None.
ITEM
2. PROPERTIES
Our
executive offices and facilities are located at 850 Spice Islands Drive, Sparks,
Nevada89431 in a leased facility consisting of approximately 92,125 square
feet. The lease for this space will expire at the end of May 2007. We are
looking at other options prior to the end of the lease.
We
currently have no investment policies in place regarding real estate
interests.
19
ITEM
3. LEGAL
PROCEEDINGS
We
are
not party to, and none of our property is subject to any pending or threatened
legal, governmental, administrative or judicial proceedings that may have a
material adverse effect upon our financial condition or operations, except
as
follows:
On
January 5, 2004, we filed a lawsuit in the Second Judicial District Court of
the
State of Nevada, in and for the County of Washoe, Case No. CV04 00013, Dept.
No.
9, against Alexander H. Walker, Jr., the Company’s former general counsel and
director, and Nevada Agency & Trust Company, the Company’s former transfer
agent. The lawsuit alleges breaches of fiduciary duty, contract violations,
conversion, and other related claims, in connection with the sale of shares
of
the Company’s common stock to Coldwater Capital, LLC and Mark Neuhaus in 2001.
The Company claims it did not receive approximately $737,000 of the purchase
price for the shares sold. The Defendants have answered the Complaint, generally
denying the allegations and raising affirmative defenses, and cross-complaining
against Coldwater Capital, LLC and Mark Neuhaus for the payment of the funds
owed to the Company. The Company subsequently obtained a pre-judgment writ
of
attachment requiring Mr. Walker to deposit the proceeds of the sale of the
Company stock he owned with the court, pending trial. Discovery has been
completed and trial in this matter is presently scheduled for April 23,2007.
In
Clean
Fuels Technology v. Rudolf W. Gunnerman, Peter Gunnerman, RWG, Inc. and SulphCo,
Inc.,
the
Company, Rudolf Gunnerman, Peter Gunnerman, and RWG, Inc., were named as
defendants in a legal action commenced in Reno, Nevada. The Plaintiff alleged
claims relating to “sulfur removal technology” originally developed by Professor
Teh Fu Yen and Dr. Gunnerman with financial assistance provided by Dr.
Gunnerman, and subsequently assigned to the Company. On December 18, 2006,
following a trial, the jury found in the Company’s favor on both claims asserted
against the Company by the Plaintiff. The Plaintiff has since requested
equitable relief, including the imposition of a constructive trust, from the
Judge who presided over the trial. The Company views the request for any
equitable relief as against the Company as without merit. Oral argument on
the
request for equitable relief took place on February 22, 2007, and the Company
is
awaiting a decision.
In
Talisman
Capital Talon Fund, Ltd. v. Rudolf Gunnerman and SulphCo, Inc.,
the
Company and Rudolf Gunnerman were named as Defendants in a legal action
commenced in federal court in Reno, Nevada. The Plaintiff alleged claims
relating to the Company’s rights to develop its “sulfur removal technology. The
Company regards these claims as without merit. Discovery in this case formally
concluded on May 24, 2006. Motions to compel additional discovery and summary
judgment motions by both parties are still pending, and no trial date has yet
been set.
In
The
Matter of the Arbitration between Stan L. McLelland v. SulphCo,
Inc.,
Mr.
McLelland, who was the Company's president from August 13, 2001, until he
resigned on September 12, 2001, is seeking to exercise options to purchase
two
million (2,000,000) shares of the Company’s common stock at 50 cents per share.
It is the Company’s position that those options had not vested prior to Mr.
McLelland's resignation. Mr. McLelland also seeks salary for the six months
following his resignation and $20,000 of alleged unpaid commuting expenses,
as
well as attorneys' fees and costs. Discovery is closed, and the arbitrator
recently denied the parties’ cross-motions for summary judgment on the options
issue. The arbitration hearing has been set for April 19 and 20, 2007 in Reno,
Nevada.
On
October 20, 2006, Mark Neuhaus filed a lawsuit against the Company and Rudolph
W. Gunnerman, Mark
Neuhaus v. SulphCo, Inc., Rudolph W. Gunnerman,
in the
Second Judicial District Court, in and for the County of Washoe, Case No. CV06
02502, Dept. No. 1. The lawsuit is based on a purported Non-Qualified Stock
Option Agreement and related Consulting Agreement between Mark Neuhaus and
the
Company dated March of 2002. Mark Neuhaus claims that according to the terms
of
the Non-Qualified Stock Option Agreement,
20
he
was
granted an option to purchase three million (3,000,000) shares of the Company’s
common stock at the exercise price per share of $0.01. On or about February
of
2006, Mark Neuhaus attempted to exercise the option allegedly provided to
him
under the Non-Qualified Stock Option Agreement. At that time, the Company
rejected Mr. Neuhaus’s attempt to exercise the option. Thereafter, Mr. Neuhaus
filed this lawsuit seeking to enforce the Non-qualified Stock Option Agreement.
In his suit, Mr. Neuhaus includes claims for specific performance, breach
of
contract, contractual breach of the covenant of good faith and fair dealing,
and
tortious breach of the covenant of good faith and fair dealing. He requests
the
Court to compel the Company to issue the shares or alternatively to award
him
damages equal to the fair market value of the three million (3,000,000) shares
of stock when he purported to exercise the options, minus the exercise price.
On
December 7, 2006, the Company moved to dismiss the lawsuit. On January 4,2007,
the Court issued an Order denying the motion on the ground that there were
factual issues to be resolved which prevented dismissal at that time. The
Company is now in the process of preparing an Answer to the Complaint. The
Company intends to vigorously defend the claims made by Mr. Neuhaus, which
it
believes are without merit. Trial in this matter is scheduled for September24,2007.
On
January 17, 2007, Rudolf W. Gunnerman filed a lawsuit against four of the
Company’s independent directors, Richard L. Masica, Robert Van Maasdijk, Edward
E. Urquhart, and Lawrence G. Schafran. This case is known as Rudolph
W. Gunnerman v. Robert Van Maasdijk, Richard L. Masica, Larry G. Schafran,
Edward E. Urquhart,
and was
filed in the Second Judicial District Court of the State of Nevada, in and
for
the County of Washoe, Case No Case No. CV07 00103, Dept. No. B6. Gunnerman’s
Complaint seeks declaratory and injunctive relief with respect to the amendments
to the Company’s bylaws made by the Company’s Board of Directors on Wednesday,
January 17, 2007. Gunnerman alleges that the independent directors’ amendment to
the Company’s bylaws which provides that the Board of Directors shall have
exclusive authority to amend the bylaws was invalid and the bylaw amendment
should be declared invalid. The independent directors have counterclaimed for
a
declaration that the amendment was valid and in the Company’s best interest.
Discovery in this case has not begun and no trial date has been
set.
On
January 26, 2007, Thomas Hendrickson filed a shareholder derivative claim
against certain current and former officers and directors or the Company in
the
Second Judicial District Court of the State of Nevada, in and for the County
of
Washoe. The case is known as Thomas
Hendrickson, Derivatively on Behalf of SulphCo, Inc. v. Rudolf W. Gunnerman,
Peter W. Gunnerman, Loren J. Kalmen, Richard L. Masica, Robert Henri Charles
Van
Maasdijk, Hannes Farnleitner, Michael T. Heffner, Edward E. Urquhart, Lawrence
G. Schafran, Alan L. Austin, Jr., Raad Alkadiri and Christoph
Henkel,
Case
No. CV07 00137, Dept. No. B6. The complaint alleges, among other things, that
the defendants breached their fiduciary duty to the Company by failing to act
in
good faith and diligence in the administration of the affairs of the Company
and
in the use and preservation of its property and assets, including the Company’s
credibility and reputation. The Company and the Board intend to file a Motion
for Dismissal with the Court, based upon the Plaintiff’s failure to make a
demand upon the Board.
On
June26, 2006, the Company filed an action, SulphCo,
Inc. v. Cullen,
in the
Second Judicial District Court of the State of Nevada, in and for the County
of
Washoe, Case No. CV06-01490, against Mark Cullen arising out of Mr. Cullen’s
alleged breach of a secrecy agreement that he had executed when employed by
GRD,
Inc., whose claims have accrued to the Company. The lawsuit seeks damages,
a
constructive trust, and an order requiring Mr. Cullen to assign to the Company
certain intellectual property in the form of patent applications (as well as
a
now-issued patent) that he filed following his departure from the Company.
On
October 23, 2006, Mr. Cullen moved to dismiss the Company’s complaint; the
motion was denied. On February 26, 2007, Mr. Cullen filed an amended answer
to
the Company’s complaint. That Answer included counterclaims for breach of
contract, unfair competition, interference with contractual relations, and
interference with prospective economic advantage. The Company views Mr. Cullen’s
counterclaims as without merit and has moved to dismiss them. Discovery in
this
case has not yet begun, and no trial date has been set.
21
ITEM
4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS
Not
applicable.
22
PART
II
ITEM
5. MARKET FOR
REGISTRANT’S
COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Market
Information
On
October 7, 2005, our common stock commenced trading on the American Stock
Exchange under the symbol “SUF.” Prior to October 7, 2005, our common stock had
been quoted on the NASD, Inc. OTC Bulletin Board
under the symbol “SLPH.”
The
following table sets forth the high and low sale prices for our common stock
for
each of the quarterly periods indicated.
High
Low
Fiscal
2006
First
Quarter
19.70
6.02
Second
Quarter
12.49
6.90
Third
Quarter
7.39
4.15
Fourth
Quarter
6.84
4.15
Fiscal
2005
First
Quarter
5.45
2.80
Second
Quarter
6.33
2.96
Third
Quarter
5.35
2.68
Fourth
Quarter
11.68
3.25
There
were 257 holders of record of our common stock on February 28, 2007. This number
does not include stockholders whose shares were held in a "nominee" or "street"
name.
Dividends
We
currently have no contractual restrictions that limit our ability to pay
dividends on common equity. We currently expect that we will retain future
earnings, if any, to finance the growth and development of our business and
we
will dividend to our stockholders amounts in excess of that required for future
growth and development.
Table
of Securities Authorized for Issuance under Equity Compensation Plans at the
End
of 2006
The
following table presents information regarding our securities which are
authorized for issuance under all of our compensation plans as of December31,2006.
23
Plan
Category
Number
of Securities
to
be Issued upon
Exercise
of
Outstanding
Options,
Warrants
and rights
Weighted-average
Exercise
Price of
Outstanding
Options,
Warrants
and Rights
Number
of Securities
Remaining
Available for
Future
Issuance under
Equity
Compensation
Plans
(Excluding Securities
Reflected
at Left)
Equity
Compensation Plans Approved by Security Holders
1,127,000
9.03
873,000
Equity
Compensation Plans Not Approved by Security Holders
152,500
3.96
(1)
(1)
Future
grants are within the discretion of our board of directors and, therefore,
cannot be determined at this time.
Under
compensation plans approved by our security holders, the 1,127,000 securities
relate to outstanding options under the stock option plan approved by the
shareholders at our annual meeting in June 2006. All of these options had been
granted prior to approval of the plan and incorporated therein. The options
include 1,000,000 to Dr. Rudolf Gunnerman which were subsequently terminated
at
the termination of his employment with us in January 2007. The balance consists
of 125,000 to Robert van Maasdijk as reflected below in “Item 11. Executive
Compensation” and 2,000 options to Tom Nardi, a contractor.
Under
compensation plans not approved by our security holders, the 152,500 securities
consist of the following:
Warrants
for 100,000 shares of our common stock were issued to Rubenstein Public
Relations, Inc. in conjunction with a consulting agreement for stockholder
relations executed as of November 11, 2004, which provided for cash compensation
and warrants. One warrant, issued under the agreement, granted the right to
purchase 50,000 shares of unregistered common stock at an exercise price of
$1.93, the closing price of trading common stock at the date of the execution
of
the agreement. Provided the agreement had not been terminated as of May 2005
(which it had not), it provided for an issuance of an additional warrant
granting the right to purchase 50,000 shares of unregistered common stock
at an exercise price equal to the closing price of trading common stock on
May11, 2005, which was $3.85. Each of the warrants will expire in November
2009.
Options
to acquire
52,500 shares of our common stock were issued to Mustang International, L.P.
in
conjunction with a contract executed March 29, 2006 for program management,
engineering, procurement, construction management, and other services. The
option is exercisable at $6.00 per share and expires on April 1,2010.
24
ITEM
6.SELECTED
FINANCIAL DATA
Comparative
Financial Data
The
table
below sets forth a comparison of the financial data specified for the latest
five years. The figures for the 2006 loss include approximately $21.5 million
($30 per share) for the construction of equipment and building related to the
project in Fujairah as discussed under "Business Development During the Past
Year."
As
of
March 30, 2007, we had approximately $ 9.5 million in available cash reserves
which includes approximately $7.9 million received from the March 2007 exercise
of warrants described below. As we have a $5 million note payable to Dr. Rudolf
Gunnerman due by December 31, 2007, described below, we face uncertainty
regarding our ability to operate as a going concern beyond that date. Additional
funding will be necessary. Until that note is due, we anticipate that our
existing capital resources will be sufficient to fund our cash requirements
from
cash presently on hand, based upon our current levels of expenditures and
anticipated needs during this period. We have historically been able to raise
capital to continue with our research and development and it is likely that
we
will need to raise additional funds before we can generate enough revenue to
become profitable.
25
On
March29, 2006, we completed a private placement to a small number of accredited
investors for the sale of 4,000,000 units, each unit consisting of one share
of
the Company’s common stock and one warrant to purchase a share of common stock.
Each unit was sold at a price of $6.805 per share, resulting in gross proceeds
at closing of $27.2million. The warrants were exercisable, in whole or in
part,
at a fixed price equal to $6.805 per share for a period of 18 months following
their issuance.
On
March12, 2007, as an incentive for the March 2006 private placement warrant holders
to exercise half of their warrants for 2,000,000 shares of our common stock,
we
agreed to reduce the exercise price of all such warrants to the current trading
value based on the March 9, 2007 closing price of $2.68 per share of our common
stock. We also agreed to issue additional warrants with rights to acquire the
same number of shares as were acquired by the exercise of those warrants in
March 2007, also at $2.68 per share, to expire in three years. Additional
warrants on the same terms are also to be issued to investors who exercise
any
of their remaining 2006 warrants in 2007. The exercises of these warrants in
March 2007 generated $5,360,000.
In
2004,
we conducted two private placements with institutional and other third party
investors for the sale of units consisting of our common stock, warrants, and
rights to acquire additional stock and warrants, generating net cash proceeds
of
approximately $4.6 million. Additional amounts of approximately $3.8 million
in
2005 and approximately $7.8 million in 2006 were generated from the exercises
of
rights and warrants related to the June 2004 private placements
As
an
incentive for the warrant holders of the 2004 private placement to exercise
their remaining warrants in March 2007, we issued additional warrants with
rights to acquire the same number of shares as were acquired by the exercise
of
warrants in March 2007. These additional warrants have an exercise price of
$2.68 per share and expire in three years. Most of the warrant holders exercised
their remaining warrants whereby we generated approximately $2.5
million.
As
of
December 31, 2006, we were obligated to pay approximately $958,000
in the aggregate to investors in the 2004 private placements as late
registration fees and interest due to the fact that the registration statement
covering the private placement shares was not declared effective by the SEC
by
the time required by the investor agreements. We plan to work with our investors
to issue common stock in lieu of these obligations; however, as of the date
of
this report no formal agreements have been entered into with any investors
regarding such issuances.
In
December 2004, Dr. Gunnerman advanced $7 million to us as a loan. The loan
is
evidenced by a promissory note which bears interest at the rate of 0.5% above
the 30 day “LIBOR” rate, adjusted quarterly and payable annually. In 2006, $2
million of principal was repaid on this loan, and the entire principal amount
is
due and payable December 30, 2007.
Because
of the significant amount of legal proceedings we have experienced, especially
in the last year, we still owed
approximately $2 million for attorney fees and related legal costs at the end
of
2006.On
March29, 2007, we successfully negotiated a reduction in these billings by
approximately $500,000.
The
extent and timing of our future capital requirements will depend primarily
upon
the rate of our progress in the development and commercialization of our
technologies, including the successful implementation of our venture with
Fujairah Oil Technology and other third parties, and the timing of future
customer orders.
26
To
date,
we have generated no material revenues from our business operations. We are
unable to predict when or if we will be able to generate future revenues from
commercial activities or the amounts expected from such activities. These
revenue streams may be generated by us or in conjunction with collaborative
partners or third party licensing arrangements, and may include provisions
for
one-time, lump sum payments in addition to ongoing royalty payments or other
revenue sharing arrangements. We presently have no binding commitments for
any
such revenues. Future revenues and profits from Fujairah Oil Technology are
dependent upon the successful implementation of our Sonocracking
technology.
Other
possible
sources of additional capital include the exercise of the remaining warrants
issued to investors in the March 2006 private placement and of the additional
warrants issued in March 2007, and funding through future collaborative
arrangements, licensing arrangements and debt and equity financings. We do
not
know whether additional financing will be available on commercially acceptable
terms when needed. If we cannot raise funds on acceptable terms when needed,
we
may not be able to successfully commercialize our technologies, take advantage
of future opportunities or respond to unanticipated requirements. If we are
unable to secure such additional financing when needed, we will have to curtail
or suspend all or a portion of our business activities. Further, if we issue
equity securities, our shareholders may experience severe dilution of their
ownership percentage.
Results
of Operations
As
a
development stage company, we have not generated any material revenues since
we
commenced our current line of business in 1999.
In
2005,
we received $550,000 from SulphCo KorAsia (formerly known as OIL-SC, Ltd.),
pursuant to our Equipment Sale and Marketing Agreement. As this amount is fully
refundable if the pilot plant does not ultimately meet the agreed
specifications, no portion of the purchase price has been or will be recorded
as
revenue in our financial statements until the pilot plant meets all agreed
specifications. We do not have an equity interest in SulphCo KorAsia. There
was
no activity in 2006 with regard to the pilot plant.
Research
and Development Expenses
During
2006, we incurred approximately $4 million related to research and development
of our Sonocracking™ technology. This compares to approximately $2.5 million and
$407,000 during 2005 and 2004, respectively. In 2006, approximately $21.5
million was spent on building construction and construction, purchase, and
installation of equipment in Fujairah, UAE. Also in 2006, approximately $1.1
million in construction of a testing unit to be utilized in Austria was
expensed.
During
2006, approximately $331,000 represents amounts paid to our engineers and other
research and development employees as wages and related benefits and for design
and testing of our Sonocracker™ units, and approximately $2.1 million was
incurred for the procurement of control panels, probes, centrifuges, and
generators related to the ongoing research and development of our units. The
remainder of our research and development costs are recurring monthly expenses
related to the maintenance of our warehouse facilities.
We
expect
our research and development expenses to decrease significantly upon successful
transition into generation of sustained revenue. Thereafter, research and
development will continue as needed to enhance our technology.
Selling,
General and Administrative Expenses
During
2006, we incurred approximately $13.5 million in selling, general and
administrative expenses. This compares to approximately $5.7 million and $3.5
million during 2005 and 2004, respectively.
27
Legal
fees were approximately $6.1 million during 2006, reflecting substantial
increases over 2005 and 2004 amounts which were approximately $2.1 million
and
$135,000, respectively. These increases were primarily due to litigation fees
relating to the lawsuits against us. We expect to incur similar legal fees
in
2007, due to the on-going litigation described above in “Item 3. Legal
Proceedings.”
Consulting
fees, payroll and related expenses were approximately $3.7 million in 2006
which
compares to approximately $2.5 million and $1.7 during 2005 and 2004,
respectively. Salaries include grants of 50,000 shares to new officers, $636,000
in the first quarter of 2006 and $204,000 in the first quarter of 2005.
Excluding the stock grants and options, our consulting fees, payroll and related
expenses increased from the prior year 42% in 2006 and 48% in 2005. These
increases reflect the quality of our work force.
Travel
and travel related expenses were approximately $1 million in 2006 which compares
to approximately $552,000 and $114,000 during 2005 and 2004, respectively.
The
percentage increase from the prior year was 81% in 2006 and 384% in 2005. These
increases were due to meetings of the Board of Directors, meetings with the
European manufacturers of our equipment, and meetings with our joint venture
partner in Fujairah, UAE.
Director
fees were approximately $1.6 million in 2006 which compares to approximately
$1.1 million and $21,000 during 2005 and 2004, respectively. Director fees
in
these periods represent grants to each new director of 50,000 shares each and
a
grant of options to Robert van Maasdijk, a director, in the second quarter
of
2006. Specifically, the following grants were issued to the following
directors:
In 2006:
An
option valued at $687,500 to acquire 125,000
shares of common stock was granted to director
Robert van Maasdijk.
150,000
shares of common stock valued at $960,000 were granted to directors
Ed
Urquhart,
Mike Heffner, and Larry Schafran.
In 2005:
200,000
shares of common stock valued at
$$927,000 were granted to directors Hannes
Farnleitner, Robert van Maasdijk, Raad Alkadiri, Christoph
Henkel.
In 2004:
50,000
shares of common stock valued at $21,000
were granted to director, Richard
Masica.
The
remainder of the amounts incurred relate to normal recurring operating expenses
such as lease expense, utilities, marketing, and investor
relations.
Interest
Expense
Interest
expense was approximately $466,000 in 2006, which compares to approximately
$395,000 and $303,000 during 2005 and 2004, respectively. These increases result
from a combination of incurring late registration fees beginning near the end
of
2004 which accrue interest (see “Late Registration” below) and net interest rate
increases in our variable rate debt to Dr. Rudolf Gunnerman. During the second
quarter of 2006, we paid off a $500,000 note to Dr. Gunnerman bearing interest
of 8% and paid $2,000,000 against the $7,000,000 note to Dr. Gunnerman which
has
a variable interest rate (5.34625% during the third quarter of
2006).
28
Late
Registration
In
accordance with the terms of our 2004 private placement, we accrued late fees
of
approximately $760,000 during the first two quarters of 2005, due to a delay
in
the effective date of our registration statement filed with the SEC. Our
registration statement was declared effective by the SEC in June 2005. Interest
of approximately $90,000 ($30,000 per quarter) accrues on the unpaid amount
at
the rate of 18% per annum. However, as of the date of this report no formal
demands have been made by investors to pay these fees.
Depreciation
and Amortization
During
the years 2006, 2005, and 2004, exclusive of the Fujairah test facility, we
expended approximately $3.9 million, $2.5 million and $48,808, respectively,
for
equipment and to maintain exclusivity for the sale and/or licensing of our
Sonocracking™ technology in the United States and abroad. Our depreciation
expense related to current and previously capitalized equipment for 2006, 2005,
and 2004 were approximately $84,927, $198,055, and $104,242, respectively.
Our
amortization expense related to patent and trademark rights, for 2006, 2005,
and
2004 were approximately $0, $ and $0 respectively. We expect to continue our
pursuit of exclusive distribution and licensing of our technology and purchasing
equipment for the manufacture and upgrading of our Sonocracking
technology.
Loss
on Impairment of Asset
In
accordance with SFAS No. 144 Accounting
for the Impairment or Disposal of Long Lived Assets,
we
determined in 2005 that a previously capitalized prototype no longer reflected
the value of our commercially viable technology, resulting in an impairment
loss
of approximately $234,000. There was no comparable item in the other
years.
Net
Loss
We
incurred net losses of approximately $39.1 million in 2006, $9.4 million in
2005, and $4.1 million in 2004. The substantial increase in net loss in 2006
primarily reflects the construction of the Fujairah test facility, which has
been expensed as research and development in 2006, as indicated above under
the
heading “Research and Development.”
As
of
December 31, 2006, we had an accumulated deficit of approximately $70.8 million,
which includes approximately $10.1 million of stock-based compensation expense,
and we incurred a net loss of approximately $39 million for the 12 month period
ending December 31, 2006. These losses are principally associated with the
research and development of our Sonocracking technology, including the
construction of the test facility in Fujairah, as more thoroughly explained
below, the construction of the pilot plant in South Korea, development of
prototypes, and related marketing activity. Although we expect to continue
to
incur expenses in the future for development, commercialization and sales and
marketing activities related to the commercialization of our technologies,
such
expenditures will not include major construction projects until
commercialization can be proven to be profitable.
Operation
and maintenance of the Fujairah test facility is the responsibility of Fujairah
Oil Technology LLC (“FOT”) and SulphCo is responsible for contributing its
Sonocracking units. Our present timetable calls for production to begin by
the
end of 2007. Until FOT generates revenues, additional expenses for
completion of the Sonocracking ® test facility are estimated initially at
$200,000 per month and will be paid by the Company. The Memorandum of
Association of Fujairah Oil Technology, which defines certain rights of the
joint venture
29
partners,
calls for profits and losses to be shared 50/50, with profits being distributed
to the partners, subject to a 10% reserve for legal expenses which may be
waived
by the partners. SulphCo’s 50% share of distributions made by the joint venture
to SulphCo will also be subject to other costs and expenses incurred directly
by
SulphCo from time to time, including commissions payable directly by SulphCo
to
third parties, presently estimated at up to 10% of SulphCo’s net joint venture
profits. We expect that following the successful commissioning of the first
Sonocracking unit and probe test, funding of direct expenditures required
to
start up the 180,000bbl/day facility, such as tank storage and pipelines,
will
be available from financing through the joint venture.
The
present timetable represents management’s best estimate based upon progress to
date and presently known circumstances, and all parties are fully committed
to a
timely rollout of the Fujairah facility. Due to the inherent complexities
involved in the installation of a facility of this magnitude, however, there
may
be unforeseen delays in our current timetable, which will in turn affect the
timing and availability of revenues. In addition, future costs and expenses
are
estimates, and therefore we cannot assure you that our cost estimates will
not
increase.
In
addition to activities related to the Fujairah joint venture, we intend to
continue to incur additional expenditures during the next 12 months for
development and testing of Sonocracker units.
Off-Balance
Sheet Arrangements
We
issued
warrants as part of the private placements of our securities in June 2004 and
March 2006. As of December 31, 2006, the warrants outstanding from those
placements were as follows:
Exercise
Option
Total
Exercise
Price
/ Share
Shares
Amount
From
June 2004 placement
$
1.125
1,182,224
$
1,330,002
From
June 2004 placement
$
1.5625
795,256
1,242,588
From
March 2006 placement
$
6.80*
4,000,000
27,200,000
*The
exercise price for the March 2006 warrants was reduced to $2.68 per share under
an amended agreement of March 12, 2007. See the narrative that
follows.
On
March12, 2007, as described above under “Liquidity and Capital Resources,” we lowered
the exercise price to $2.68 per share for the warrants issued in the March
2006
placement and issued additional warrants as an incentive for warrant holders
to
exercise their warrants. This caused the issuance of approximately an additional
4 million shares of our common stock and a like number of additional warrants
in
exchange for approximately $8 million. Up to 2 million additional shares of
common stock may be issued in 2007 under this agreement for $2.68 per share,
which would also require the issuance of additional warrants with rights to
purchase 2 million shares. After March 12, 2007, if all remaining warrant
holders under this agreement were to exercise all their warrants, we would
issue
approximately an additional 6 million shares in exchange for approximately
$16
million.
30
Contractual
Obligations
Payments
due by period
Total
Less
than 1 year
1
-
3 years
3
-
5 years
More
than 5
years
Related
party loan
$
5,000,000
$
5,000,000
-
-
-
Operating
lease obligations
74.393
74,393
-
-
-
Purchase
obligations
1,405,408
1,405,408
-
-
-
Total
6,479,801
6,479,801
-
-
-
ITEM
7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We
consider our exposure to market risks to be immaterial. Although there is market
risk involving changes in the interest rates which apply to our note payable
and
our cash investments, such risk is minor. Our risk related to foreign currency
fluctuations is not material at this time, as any accounts payable we have
in
foreign denominations are not in themselves material.
Our
note
payable is for $5,000,000 and is due December 30, 2007. Its rate is keyed to
a
LIBOR rate and adjusted quarterly. Were this rate to increase dramatically,
its
impact would terminate at the end of the year when the note is due. The current
rate is 5.82563% and will be adjusted again based on LIBOR rates at March 29,
June 28, and September 27 of this year. Even in the event that the rate
increased 1% per quarter, the impact would be a $75,000 additional outlay for
interest.
As
we
anticipate needing to use the cash we held at year end within a short period,
we
have it invested for the most part in money market accounts. The amount of
fluctuation in interest rates will not expose us to any significant risk due
to
market fluctuation as the interest on our note payable would likely decrease
by
a greater amount.
ITEM
8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
Our
audited financial statements as of December 31, 2006, and December 31, 2005,
and
for the years 2006, 2005, and 2004 are included at the end of this report
following the signature page.
ITEM
9. CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not
applicable.
31
ITEM
9A. CONTROLS
AND PROCEDURES
We
strive
to maintain disclosure controls and procedures designed to ensure that
information required to be disclosed in reports filed under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the specified time periods and that such information is
accumulated and communicated to management to allow timely decisions on required
disclosure.
After
a
thorough reexamination of the events that led to a restatement of the Company’s
quarterly financial statements for the first and second quarters of 2006, the
Chief Executive Officer and Interim Chief Financial Officer believe that the
Company’s disclosure controls and procedures were not effective during 2006.
There were deficiencies in the communications between management to the board
of
directors and the Audit Committee. The Company also lacked personnel with
sufficient financial expertise and experience to
make
appropriate judgments resulting appropriate accounting and financial reporting.
The
Company has attempted to address these issues as it makes transitions to new
management. The Company has hired a new CEO and President and intends to hire
additional personnel with the financial expertise it currently
lacks.
Management's
Annual Report on Internal Control Over Financial Reporting
Management
is responsible for establishing and maintaining adequate internal control
over
financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange
Act of 1934, as amended). Management has concluded that, as of December 31,2006, in light of the deficiencies uncovered by the new management team as
stated in this Section above, the Company’s internal control over financial
reporting was not effective 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.
The
Company’s independent registered public accounting firm, Marc Lumer &
Company, has issued an audit report on the Company’s assessment of the
effectiveness of internal control over financial reporting, which is included
herein.
There
were no changes in the Company’s internal control over financial reporting that
occurred during the Company’s most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.
ITEM
10. DIRECTORS,
EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
Directors
and Executive Officers
As
of
March 1, 2007, our directors and executive officers, their ages, positions
with
SulphCo, and the dates of their initial election or appointment as director
or
executive officer are as follows:
Name
Age
Position
With SulphCo
Served
From
Expiration
Dr.
Larry Ryan
35
Chief
Executive Officer and Director
January
2007
February
2007
N/A
Brian
Savino
52
President
March
2007
Michael
A. Abend
37
Interim
Chief Financial Officer
March
2007
Richard
L. Masica
70
Director
November
2004
Robert
Henri Charles van Maasdijk
62
Director
April
2005
Dr.
Hannes Farnleitner
67
Director
November
2005
Edward
E. Urquhart
39
Director
August
2006
Lawrence
G. Schafran
68
Director
December
2006
Michael
T. Heffner (1)
60
Director
January
2007
____________
1.
On
January24, 2007,
Michael T. Heffner accepted the offer from the Company’s Board of
Directors to serve as a member of the Board of Directors.He
previously served as a Director
from February 6, 2006 until his term expired on June 19,2006.
Business
Experience of Directors and Executive Officers
Dr.
Larry Ryan, Chief
Executive Officer beginning January 2007 and a Director beginning February
2007,
was a senior executive leader at General Electric Company, GE Advanced Materials
Division from 1998 to January, 2007.
His
last role within GE was in the capacity of Business Manager, Elastomers, and
RTV
AMR. Dr.
Ryan
has a Ph.D. in Chemical Engineering from the University of Delaware, a Six-Sigma
Blackbelt certification, and a long history of working with chemical
process-dependent technologies. He is a graduate of the esteemed General
Electric Edison Engineering Development Program, a technical leadership program
focused on process engineering projects and product quality improvements. Dr.
Ryan has a proven track record of delivering results in the area of new
process-technology development, new development, and business leadership.
Brian
Savino,
President beginning March 2007, was Executive Vice President of Pierson Capital
LLC, where he was accountable for all oil energy projects. From 2002 to 2004,
Mr. Savino served as Vice President of Energy for RWE Americas. He has also
held
managerial positions for William Energy, Texaco Oil Trading Company and Avant
Petroleum. Early in his career Mr. Savino served as Senior Chartering Contractor
for Mobil Oil Corporation where he chartered various types of vessels for
petroleum products and crude oil. Mr. Savino earned a B.S. from the US Merchant
Marine Academy, a master's degree in finance from Long Island University and
a
master's degree of transportation from New York University. He also has an
advanced training CSE degree from the Advanced Market Profile
School.
33
Michael
A. Abend
was
appointed our Interim Chief Financial Officer in March 2007, prior to which
he
served as our Controller. Mr. Abend received his bachelor's degree in Business
Administration with an accounting major and computer information systems minor
from the University of Nevada, Reno in 1994. Mr. Abend was employed from 1997
to
2000 as the property accountant for Classic Residence by Hyatt. He was then
employed by CLP Resources, Inc. from 2000 to 2003 as a financial analyst. Mr.
Abend joined us in June 2003 as our Assistant Controller and was appointed
as
our Treasurer and Interim Controller in August 2004.
Richard
L. Masica,
a
Director since November 2004, served as the President of Texaco Chemical, Inc.
from 1994 to 1997. During his 39-year career at Texaco (now ChevronTexaco
Corporation), Mr. Masica also held other positions, including the position
of
Vice-President-Business Management of Texaco Chemical Company from 1992 to
1994,
and Plant Manager of Texaco Refining & Marketing, Inc. from 1985 to 1992.
During his tenure with Texaco, Mr. Masica participated in a leadership role
in
two major divestitures, as well as other domestic and foreign reorganizations,
mergers and startups. Since retiring from Texaco in 1998, Mr. Masica founded
and
is the President of Peak One Consulting, Inc., a private management consulting
firm.
Robert
Henri Charles van Maasdijk,
Chairman of the Board since January 2007 and a Director since April 2005, is
also the Chairman of Mulier Capital, an investment bank. During 2006, he sold
Attica Alternative Investment Fund, Ltd. (AAI), a private investment fund,
of
which he was Chairman and CEO and had headed since 1999. For the previous 16
years, he served as Managing Director and CEO of Lombard Odier Investment
Portfolio Management Ltd., one of the oldest and largest private banks in
Switzerland. Over his 36-year career, he has held executive, portfolio
management and research positions with Ivory & Sime, Edinburgh; Banque
Lambert, Brussels; Pierson Heldring Pierson, Amsterdam; and with Burham and
Company, New York.
Dr.
Hannes Farnleitner,
a
Director since November 2005, is a former federal minister for economic affairs
for the country of Austria. Dr. Farnleitner has served in policy-making roles
in
Austria involving economics and international trade for more than 40 years.
Since 2002, he has served as a member of the Convent of the European Union
and
representative of the Federal Chancellor of Austria. He earned his Juris Doctor
degree at the School of Law of the University of Vienna.
Edward
E. Urquhart, a
Director since August 2006, is the Chief Executive Officer of Ma’rkisches Werk
Halver, GmbH (MHW), Halver, Germany, the world’s leading supplier of components
and systems for large diesel and gas engines operating within the marine
transportation, oil & gas distribution, stationary power generation,
locomotive and cruise industries. Mr. Urquhart has been the CEO of MWH since
July 2003 and is responsible for all aspects of managing the MWH worldwide
family of companies in Germany, USA, Korea, Japan, and China. Prior to his
current position, he was the CEO of Maerkisches Werk of North America Inc.
Mr.
Urquhart received his Master of Business Administration at Boston University,
a
C.D. in Project Management from Worcester Polytechnic Institute and a B.S.
and
M.S. in Mechanical Engineering from Worcester Polytechnic Institute and the
University of Virginia respectively.
Lawrence
G. Schafran
a
Director beginning December 2006, has extensive experience in the financial
markets and, corporate governance and is a member of the Board of Directors
of
several other publicly-traded companies.Mr.
Schafran currently is Managing Director of Providence Capital, Inc., a private
New York City based activist investment firm, and a Co-Managing Partner of
Providence Recovery Partners LLC, which manages a New York based investment
fund. He has filled these positions since July 2003 and March 2003,
respectively. From 1999 through 2002, Mr. Schafran served as Trustee,
Chairman/Interim-CEO/President and Co- Liquidating Trustee of the Special
Liquidating Trust of Banyan Strategic Realty Trust. He also currently serves
in
the following roles: Director and Audit Committee Chairman of RemoteMDx, Inc.,
Tarragon Corporation, and PubliCARD, Inc.; Director and Audit Committee member
of Nat’l Patent Development Corp. and Electro-Energy Inc. In recent years, Mr.
Schafran has served in other capacities, including as a Director of COMSAT,
Inc.
and Shoppers Food Warehouse, Inc., and Chairman of the Executive Committees
of
Dart Group Corporation and its publicly traded subsidiaries.
34
Michael
T. Heffner, a
Director beginning January 2007, retired from an executive position in BP
in 2001 after 20 years with the company. From 1996 to 2001, he was president
of
BP Algeria, responsible for overseeing a $5 billion division comprising a
petroleum-producing property and two natural gas developments in Algeria.
Previously, he served as joint venture manager in Colombia, managing partner
relationships with the Colombian State Oil Company and private partners Total
and Triton for a $2 billion Colombian oil and gas development. During his
career, he also served as British Petroleum's health, safety and environmental
manager for the Western Hemisphere. Prior to working at BP, Mr. Heffner spent
ten years with the Bechtel Corporation, where he served in a variety of cost,
planning and construction roles in that company's petrochemical division in
the
U.S. and Canada. Mr. Heffner earned his BS degree in chemical engineering from
the Georgia Institute of Technology and a master’s degree in business from Rice
University.
Family
Relationships
None.
Audit
Committee Financial Expert
Our
audit
committee consists of Lawrence G. Schafran, Robert Henri Charles van Maasdijk
and Edward E. Urquhart. The Board has determined that Mr. van Maasdijk and
Mr.
Schafran qualify as an “audit committee financial experts,” as defined in
applicable SEC rules. The Board made a qualitative assessment of Mr. van
Maasdijk’s and Mr. Schafran’s level of knowledge and experience based on a
number of factors, including formal education and business experience.
To
our
knowledge the officers, directors and beneficial owners of more than 10% of
our
common stock have filed their initial statements of ownership on Form 3 on
a
timely basis with respect to fiscal 2006, and the officers, directors and
beneficial owners of more than 10% of our common stock have also filed the
required Forms 4 or 5 on a timely basis with respect to fiscal 2005, except
as
follows:
Number
of
Late
Reports
Number
of Transactions Not Reported
Timely
Michael
T. Heffner
1
1
Michael
T. Applegate
1
1
Rudolf
W. Gunnerman
1
1
Code
of Ethics
Our
Board
of Directors has adopted a Code of Ethics applicable to all of its senior
officers, its principal executive officer and principal financial officer.
A
copy of the Code of Ethics is included as an exhibit to this
report.
The
following discussion concerns compensation awarded to, earned by, and paid
to
our executive officers who served in 2006.
The
primary objectives of our compensation program are to acquire and retain
qualified management. We reward experience as well as extra efforts which we
regard as highly valuable to our Company.
As
the
number of executives employed by our Company is very small, the Company has
not
as yet adopted set policies for compensation. It has been able to use its
judgment on a case by case basis. In moving forward to provide better forms
of
incentive, it proposed the stock option plan which was approved by the
shareholders in June 2006. For the time being, it has also taken over the role
of hiring new executives and negotiating their contracts. Prior to 2007,
executive salaries, bonuses, and stock grants were generally determined by
executive officers and approved by the Board of Directors.
Salary
is
a basic element of compensation that we pay. For each new executive, we
negotiate a salary based on what the marketplace conditions dictate while
factoring in any special knowledge, experience, or skill set that the candidate
may possess.
Stock
grants have been issued from time to time as compensation for valuable services
either in lieu of other compensation or as part of the employment contract.
All
stock-based compensation requires approval of the Board of Directors and the
value of the stock is determined by using the closing price of the stock on
the
date the stock was granted.
Although
the compensation paid to Dr. Rudolf W. Gunnerman was arranged from the beginning
of his employment in 2002 as a consulting contract with RWG, Inc., a Nevada
corporation owned by him, we regard it the same as salary for all practical
purposes.
In
2006,
Michael Applegate was awarded 50,000 shares of our common stock as part of
his
employment contract, which included a ninety day vesting period. He fulfilled
his vesting period on April 1, 2006. No other grants of stock were issued to
executive officers in 2006.
The
shareholders of SulphCo,
Inc. approved a stock option plan in June 2006. Under that plan, we have
allocated two million shares of common stock which may be utilized in awarding
options to employees or contractors. In May 2006, Dr. Rudolf W. Gunnerman was
awarded an option to acquire one million shares. This option was issued under
the stock option plan approved by the shareholders the following month. Dr.
Gunnerman’s option provided that he could not exercise it until the Company had
reported at least $50 million in annual revenues or a “change in control” of the
Company occurred as defined in the Plan. The purpose of issuing this option
was
to give Dr. Gunnerman the incentive to complete the test facility in Fujairah
and see that it became fully operational, or otherwise to secure material
revenues for our Company under his direction. As Dr. Gunnerman’s services were
terminated in January 2007, no compensation value is given to this option as
it
not exercisable due to the termination.
Bonuses
may be issued as a reward for accomplishments that we value highly. This is
done
to encourage extra efforts on the part of our executives. We also issue a small
holiday bonus as a gesture we believe our executives and other employees
appreciate.
36
A
living
expense allowance primarily for commuting from out of town was included in
the
contract with Michael Applegate. The amount was estimated based on such
additional expenses he would incur. This kind of allowance is of a type that
would be considered as part of any negotiated employment contract.
Medical
insurance is generally provided for executives as well as other employees.
We
consider this to be a reasonable part of the compensation package.
No
other
material compensation elements are currently provided to
executives.
Each
element of compensation is considered in light of the others when negotiating
employment contracts or making awards, in order to assure that we generate
appropriate incentives to ultimately benefit the Company.
Summary
Compensation Table
The
following table sets forth information about compensation paid or accrued by
us
during the years ended December 31, 2006, 2005 and 2004 to our executive
officers who served in 2006. No executive officers who served during 2006 have
been omitted from the table.
Summary
Compensation Table
Fiscal
Years 2006, 2005 and 2004
All
Other
Stock
Option
Compen-
Name
and
Salary
Bonus
Awards
Awards
sation
Total
Principal
Position
Year
(
$ )
(
$ )
(
$ )
(
$ )
(
$ )
(
$ )
Rudolf
W. Gunnerman
2006
620,000
500
-
-
-
620,500
Chairman
& Chief
2005
360,000
-
-
-
360,000
Executive
Officer
2004
370,000
-
-
-
370,000
Peter
W. Gunnerman
2006
310,000
100,500
-
-
-
418,000
President
2005
132,917
-
-
-
-
132,917
2004
-
-
-
-
-
-
Loren
J. Kalmen
2006
300,000
500
-
-
-
300,500
Chief
Financial
2005
42,100
-
-
-
-
-
Officer
2004
-
-
-
-
-
-
Michael
Applegate
2006
160,000
-
636,000
-
-
796,000
Chief
Operating
2005
-
-
-
-
-
-
Officer
2004
-
-
-
-
-
-
37
Grants
of Plan Based Awards in 2006
The
following table sets forth certain information regarding plan based awards
to
the executives listed in the previous table.
We
procured the full time services of our Chairman of the Board and Chief Executive
Officer Dr. Rudolf W. Gunnerman1
pursuant
to a Consulting Agreement with RWG, Inc., a Nevada corporation owned by him.
As
of July 1, 2004, we were obligated to pay a fee of $480,000 annually as a
consulting payment through July 2006. Effective as of November 1, 2004, this
amount had been reduced by mutual agreement to $30,000 per month until we
received substantial additional funds. In May 2006, our Board of Directors
approved the reinstatement of consulting fees to $40,000 per month effective
April 1, 2006. The agreement terminated on July 1, 2006, and on July 5, 2006
the
Board of Directors approved a new agreement effective July 1, 2006. Dr.
Gunnerman’s services were terminated for cause on January 12, 2007 and it is the
opinion of the company that no further payments are due. Under the new
agreement, RWG, Inc. was also entitled to receive amounts it previously waived
under prior engagement agreements totaling $170,000, which was paid in July
2006.
Dr.
Gunnerman
was
granted an option for one million shares exercisable within three years at
an
exercise price of $9.03 per share. The vesting event for the option agreement
is
defined as when the Company has reported at least $50 million in annual revenues
or there is a “change in control” of the Company as defined in the Plan, and
that his employment continues. This option was valued at $3.72 million under
the
assumption that the revenue would be generated and that Dr. Gunnerman’s
employment would continue. In January 2007, Dr. Gunnerman’s employment with the
Company was terminated, thus the option grant will not be
exercisable.
Peter
Gunnerman2
was
appointed President and Chief Operating Officer in June 2005. In connection
with
his appointment, we executed an employment agreement with him which provided
for
a base salary of $220,000 per annum subject to increases. The agreement was
terminable by either party at any time. Prior to that, from January 2005 through
May 2005, we maintained a monthly consulting arrangement with Global 6, LLC,
a
company owned by Peter Gunnerman, which provided for Global 6 to provide
management consulting services to us on a month-to-month basis, for a monthly
consulting fee of $10,000. Near the end of 2005, Mr. Peter Gunnerman’s salary
was raised to $300,000 per annum.
1
Dr. Gunnerman was dismissed from the offices of Chairman of the Board and Chief
Executive Officer, effective January 12, 2007.
In
April
2006 for extraordinary services provided, Peter Gunnerman received a bonus
of
$100,000 approved by the Board of Directors and ratified at their meeting of
May8, 2006. He also received a salary increase to $360,000 per year beginning
November 2006.
From
January 1, 2006 to July 2006, Peter Gunnerman served as president only, but
subsequent to Mr. Applegate’s termination in July 2006, Mr. Gunnerman acted as
Interim Chief Operating Officer in conjunction with his position as President
until his resignation effective December 31, 2006.
In
November 2005, we appointed Loren J. Kalmen as our Chief Financial Officer.
In
connection with his appointment, we executed an employment agreement with him
which is terminable by either party at any time. Under the terms of the
agreement, Mr. Kalmen is entitled to receive a base salary of $25,000 per month
($300,000 on an annualized basis) and additional bonuses as determined by our
Board of Directors and customary equity compensation and benefits as other
of
our similarly situated senior executives. On March 23, 2007 Mr. Kalmen resigned
from the Company.
In
January 2006, we appointed Michael Applegate our Chief Operating Officer. In
connection with his appointment, we executed an employment agreement with him
which provided for a base salary of $240,000 per annum, effective January 1,2006. He was also granted 50,000 shares of the our common stock valued at
$636,000 or $12.72 per share, the closing value on January 3, 2006, the first
trading day after the effective date of the contract. This grant vested at
the
end of his first 90 days. Mr. Applegate’s employment was terminated in July
2006.
Outstanding
Equity Awards at Year End 2006
The
following table sets forth information on options that were outstanding at
the
end of 2006 for our executive officers.
Name
Equity
Incentive Plan Awards:
Number
of Securities Underlying Unexercised Unearned Options ( #
)
Option
Exercise Price ( $ )
Option
Expiration Date
Rudolf
W. Gunnerman
1,000,000
9.03
per share
5/22/09
As
described above, in January 2007 Dr. Gunnerman’s employment with the Company was
terminated, thus the option grant will not be exercisable. The stock option
agreement provided for a vesting event, which was defined as when the Company
reported gross revenues of $50,000,000 or more in a fiscal year.
39
Option
Exercises and Stock Vested in 2006
The
following table sets forth the stock vested for our executive officers in 2006.
No stock options were exercised by our executive officers in 2006.
Stock
Awards
Name
Number
of Shares
Acquired
on Vesting ( # )
Value
Realized on
Vesting
( $ )
Michael
Applegate
50,000
636,000
Directors
Compensation Table for 2006
The
following table sets forth compensation paid to our Company’s directors in
2006.
The
option award to Robert van Maasdijk was granted to him on May 23, 2006. The
option is for 125,000 shares of our common stock, exercisable immediately at
$9.03 per share, the average value of our common stock on the date the option
was granted. The option has a term of three years and was valued at $687,500
based on the Black-Scholes valuation model using the assumptions described
in
footnotes to our financial statements. This option award was made in recognition
of Mr. van Maasdijk’s extraordinary services as a director. The other
compensation represents consulting contracts we had with Michael Heffner and
Peak One Consulting, Inc. which is owned by Richard Masica. These amounts were
for services other than those of a director. For the consulting contract related
to Rudolf W. Gunnerman, also a director during 2006, see the section above
in
this item labeled “Compensation Narrative Disclosure.”
ITEM
12. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
Table
of Securities Authorized for Issuance under Equity Compensation Plans at the
End
of 2006
The
following table presents information regarding our securities which are
authorized for issuance under all of our compensation plans as of December31,2006.
40
Plan
Category
Number
of Securities
to
be Issued upon
Exercise
of
Outstanding
Options,
Warrants
and rights
Weighted-average
Exercise
Price of
Outstanding
Options,
Warrants
and Rights
Number
of Securities
Remaining
Available for
Future
Issuance under
Equity
Compensation
Plans
(Excluding Securities
Reflected
at Left)
Equity
Compensation Plans Approved by Security Holders
1,127,000
9.03
873,000
Equity
Compensation Plans Not Approved by Security Holders
152,500
3.96
(1)
(1)
Future grants are within the discretion of our board of directors and,
therefore, cannot be determined at this time.
Under
compensation plans approved by our security holders, the 1,127,000 securities
relate to outstanding options under the stock option plan approved by the
shareholders at our annual meeting in June 2006. All of these options had been
granted prior to approval of the plan and incorporated therein. The options
include 1,000,000 to Dr. Rudolf Gunnerman which were subsequently terminated
at
the termination of his employment with us in January 2007. The balance consists
of 125,000 to Robert van Maasdijk as reflected above in “Item 11. Executive
Compensation” and 2,000 to Tom Nardi, a contractor.
Under
compensation plans not approved by our security holders, the 152,500 securities
consist of the following:
Warrants
for 100,000 shares of our common stock were issued to Rubenstein Public
Relations, Inc. in conjunction with a consulting agreement for stockholder
relations executed November 11, 2004, which provided for cash compensation
and
warrants. One warrant, issued at execution of the agreement, evidenced the
right to purchase 50,000 shares of unregistered common stock at an exercise
price of $1.93, the closing price of trading common stock at the date of the
execution of the agreement. Provided the agreement had not been terminated
as of
May 2005 (which it had not), it called for issuing another warrant
evidencing the right to purchase 50,000 shares of unregistered common stock
at an exercise price equal to the closing price of trading common stock on
May11, 2005, which was $3.85. Each of the warrants will expire in November
2009.
Options
to acquire
52,500 shares of our common stock were issued to Mustang International, L.P.
(“Mustang”) in conjunction with a contract executed March 29, 2006 for program
management, engineering, procurement, construction management, and other
services. The option is exercisable at $6.00 per share by April 1,2010.
Security
Ownership of Certain Beneficial Owners
The
following table presents the ownership of beneficial owners known to us who
own
more than five percent of our common stock as of this filing.
1.
The
share ownership of Dr. and Mrs. Gunnerman is reflected pursuant to the
information contained in Schedule 13D as amended, which was filed with the
Commission on January 16, 2007. Of these shares 27,697,913 are subject to shared
voting power between them. The voting power for the remaining 574,300 shares
is
held by Dr. Gunnerman.
2.
Blizzard Capital Ltd. holds 4,000,000 million shares outright and warrants
to
acquire an additional 2,000,000 shares.
Security
Ownership of Management
The
following table presents the ownership of our common stock by directors and
executive officers as of March 30 , 2007.
Title
of Class
Name
of Beneficial Owner
Amount
and Nature of
Beneficial
Ownership (1)
Percent
of
Class
Common
Richard
Masica
50,000
0.1%
Common
Robert
van Maasdijk
175,000(2)
0.2%
Common
Dr.
Hannes Farnleitner
50,000
0.1%
Common
Edward
Urquhart
55,500
0.1%
Common
Lawrence
Schafran
104,000
0.1%
Common
Michael
T. Heffner
50,000
0.1%
Common
Dr.
Larry Ryan
-
0.0%
Common
Brian
Savino
-
0.0%
Common
All
Executive Officers and Directors
as
a Group (8 persons)
484,500
0.7%
1.
In
every
case the shares are held outright with the exception of 125,000 shares of Robert
van Maasdijk as explained in note 2.
2.
Robert
van Maasdijk owns 50,000 outright and an option to acquire 125,000
shares.
42
ITEM
13. CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Certain
Transactions
Exclusive
of transactions reported in Item 11 above, the following are descriptions of
all
material transactions since the beginning of 2006 between us and our directors,
executive officers, or members of their immediate families.
On
May15, 2006,
we
repaid a $500,000 promissory note to Dr. Rudolf Gunnerman which was originally
issued on December 30, 2003. In December 2005, Dr. Gunnerman agreed to a second
extension of the maturity date to December 30, 2006 at an interest rate of
8%
per annum. The extension agreement provided for payment on demand. Also accrued
interest through May 15, 2006 of $15,000 was paid during 2006.
On
May15, 2006, under Board approval, we repaid $2,000,000 in principal on a note
payable to Dr. Rudolf Gunnerman. In December 2004, Dr. Gunnerman had advanced
$7,000,000 to us for a promissory note which bears interest at the rate of
0.5%
above a “LIBOR” rate adjusted quarterly and payable annually. The entire
principal amount is due and payable in December 2007. Also the accrued interest
through May 15, 2006 of $133,809 was paid. Interest accrued through December31,2006 of $172,167 was paid at the end of December 2006. Thus, total interest
for
the year was $305,976. Interest rates on the note ranged from 4.885% per annum
to 5.84625% per annum. Beginning January 1, 2007, the rate was adjusted to
5.32563% per annum for a quarterly interest amount of approximately
$72,000.
For
additional information regarding related party transactions, see Notes 10,
12,
13, and 15 to our audited financial statements which appear elsewhere in this
report.
43
ITEM
14. PRINCIPAL ACCOUNTANT
FEES AND SERVICES
Independent
Auditors' Fees
The
following table represents aggregate fees billed by our independent auditors
for
each of our fiscal years ended December 31, 2006, and December 31,2005.
Fiscal
Year
Independent
Audit Firm
2006
2005
Marc
Lumer & Company
Audit
Fees
$
152,600
$
114,617
Audit-related
Fees
-
-
Tax
Fees
-
-
All
Other Fees
-
-
Total
Fees
$
152,600
$
114,617
Mark
Bailey & Company, Ltd
Audit
Fees
$
-
$
45,975
Audit-related
Fees
-
-
Tax
Fees
-
-
All
Other Fees
-
-
Total
Fees
$
-
$
45,975
Fees
for
audit services included fees associated with the annual audit and reviews of
our
quarterly reports, as well as services performed in conjunction with our filings
of Registration Statements on Form SB-2, Form S-3 and Form S-8. All fees
described above were approved by the Audit Committee.
2003
Non-Officer Limited Stock Appreciation Rights
Plan.
10.2+
Securities
Purchase Agreement dated as of June 1, 2004, by and between SulphCo,
Inc.
and the Purchasers parties thereto.
10.3++
Securities
Purchase Agreement dated as of June 14, 2004, by and between SulphCo,
Inc.
and the Purchasers parties thereto.
10.4#
Engagement
Agreement dated July 1, 2004, by and between SulphCo, Inc. and RWG,
Inc.
10.5#
Promissory
Note dated December 30, 2003, from SulphCo, Inc. to Rudolf W. Gunnerman
and Doris Gunnerman.
10.6#
Promissory
Note dated December 30, 2003, from SulphCo, Inc. to Erika
Herrmann.
10.7#
Letter
dated April 28, 2004, from Rudolf W. Gunnerman to SulphCo,
Inc.
10.8#
Promissory
Note dated April 28, 2004, from SulphCo, Inc. to Rudolf W.
Gunnerman.
10.9#
Finder’s
Fee Agreement made as of May 11, 2004 between SulphCo, Inc. and Vantage
Investments Group, Inc.
10.10#
Letter
Agreement dated May 28, 2004 between SulphCo, Inc. and Olympus Securities,
LLC.
45
10.11#
Engagement
Agreement dated July 1, 2004, by and between SulphCo, Inc. and RWG,
Inc.
10.12#
Consulting
Agreement dated July 15, 2004, by and between SulphCo, Inc. and InteSec
Group LLC.
10.13#
Collaboration
Agreement dated August 6, 2004, by and between SulphCo, Inc. and
ChevronTexaco Energy Technology
Company.
10.14#
Contract
for Establishment of a Limited Liability Company (SulphCo Oil Technologies
Kuwait).
10.15#
Loan
Extension Agreement, dated for reference the 12th
day of December, 2004, between Rudolf W. Gunnerman and SulphCo,
Inc.
10.16#
Loan
Extension Agreement, dated for reference the 12th
day of December, 2004, between Erika Herrmann and SulphCo,
Inc.
10.17(1)
Separation
Agreement and General Release dated as of December 28, 2004, by and
between SulphCo, Inc. and Kirk S.
Schumacher.
10.18(2)
Letter
Agreement dated as of January 6, 2005, by and between SulphCo, Inc.
and
Alan L. Austin, Jr.
10.19(3)
Promissory
Note from SulphCo, Inc. to Rudolf W. Gunnerman dated December 31,2004.
10.20#
Letter
Agreement dated February 4, 2005, by and between SulphCo, Inc. and
ChevronTexaco Energy Technology
Company.
10.21(4)
Agreement
dated February 22, 2005, by and between SulphCo, Inc. and OIL-SC,
Ltd.
10.22(5)
Letter
Agreement dated April 27, 2005, by and between SulphCo, Inc. and
ChevronTexaco Energy Technology
Company.
10.23(6)
Employment
Agreement dated as of June 1, 2005, by and between SulphCo, Inc.
and Peter
Gunnerman.
10.24(7)
Test
Agreement by and between SulphCo, Inc. and Total France entered into
on
October 10, 2005.
10.25(8)
Employment
agreement with Loren J. Kalmen dated November 10,2005.
10.26(9)
Letter Agreement by and between SulphCo and OIL-SC
and
dated as of November 9, 2005.
10.27(10)
Memorandum of Association dated November 29, 2005,
by and
between SulphCo, Inc. and Trans Gulf Petroleum Co., a Government of
Fujairah company.
10.28(11)
Employment Agreement, dated as of January 1, 2006,
by and
between SulphCo, Inc. and Michael
Applegate.
46
10.29(12)
2nd
Loan Extension and Modification Agreement by and between SulphCo,
Inc. and
Dr. Rudolf W. Gunnerman and Doris Gunnerman entered into on January30,2006.
10.30(13)
Securities
Purchase Agreement dated as of March 29, 2006, by and between SulphCo,
Inc. and the Purchasers parties thereto, including form of Warrant
as
Exhibit “A” thereto.
10.31(14)
SulphCo, Inc. 2006 Stock Option
Plan
approved by stockholders June 19, 2006.
10.32(15)
Engagement Agreement with RWG,
Inc. dated
July 1, 2006.
10.33(16)
Test Agreement between SK Corporation
and
SulphCo, Inc. dated July 20, 2006.
10.34(17)
Memorandum of Understanding with
Pierson
Capital International, Ltd. dated August 1,2006.
10.35(18)
Memorandum of Understanding with
Petrobras
dated August 31, 2006.
Pursuant
to the requirements of Section 13 of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on
the
dates indicated.
REPORT
OF
MARC LUMER & COMPANY, INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
The
Board
of Directors and Stockholders
Sulphco,
Inc.
We
have
audited the accompanying balance sheet of SulphCo, Inc. as of December31, 2006
and 2005 and the related statements of operations, stockholders' equity,
and
cash flows for the year then ended. These financial statements and the
schedule
are the responsibility of the Company's management. Our responsibility
is to
express an opinion on these financial statements and schedule based on
our
audit.
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 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 opinions.
A
company’s internal control over financial reporting is a process designed by,
or
under the supervision of, the company’s principal executive and principal
financial officers, or persons performing similar functions, and effected
by the
company’s board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override
of
controls, material misstatements due to error or fraud may not be prevented
or
detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future
periods
are subject to the risk that the 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 significant deficiency, or combination of significant
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 resulting from deficiencies in the design or
operation of the respective controls:
(1) The
Corporation lacked the technical expertise and processes to ensure compliance
with Statement of Financial Accounting Standards (SFAS) No. 2, Accounting
for research and development costs. This material weakness resulted in
a
restatement of prior financial statements, quarterly financial statements
and,
if not remediated, could result in a material misstatement in the future.
(2) The
Corporation did not maintain a sufficient complement of personnel with
an
appropriate level of accounting knowledge, experience, and training in
the
application of generally accepted accounting principles commensurate
with the
Corporation’s complex financial accounting and reporting requirements. This
material weakness contributed to the restatement of prior financial statements.
This report does not affect our report on such consolidated financial
statements
and financial statement schedule.
In
our
opinion, management’s assessment that the Corporation did not maintain effective
internal control over financial reporting as of December 31, 2006, is
fairly stated, in all material respects, based on the criteria established
in
Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion,
because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, the Corporation
has not
maintained effective internal control over financial reporting as of
December 31, 2006, based on the criteria established in Internal
Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
The
accompanying financial statements have been prepared assuming that the
Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has suffered recurring losses from operations
that
raise substantial doubt about its ability to continue as a going concern.
Management's
plans in regard to these matters are also described in Note 1. The financial
statements do not include any adjustments that might result from the
outcome
of this uncertainty.
In
our
opinion, the financial statements referred to above present fairly, in
all
material respects, the financial position of SulphCo, Inc. at December31, 2006
and 2005, and the results of its operations and its cash flows for the
year then
ended, in conformity with accounting principles generally accepted in
the United
States of America.
We
have
audited the accompanying balance sheet of SulphCo, Inc., (a company in
the
development stage) as of December 31, 2004, and the related statements
of
operations, shareholders’ deficit and cash flows for the years ended December31, 2004 and 2003. 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 standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our
audits provide a reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in
all
material respects, the financial position of SulphCo, Inc., (a company
in the
development stage), as of December 31, 2004, and the results of its operations
and its cash flows for the years ended December 31, 2004 and 2003, in conformity
with accounting principles generally accepted in the United States.
1.Organization
and Significant Accounting Policies
Business
The
Company is considered a developmental stage company as defined by Statement
of
Financial Accounting Standards (“FAS”) No. 7, as the Company has not recognized
significant revenue and is continuing to develop and market processes for
the
upgrading of crude oil by reducing its relative density, viscosity, and sulfur
content.
SulphCo,
Inc. (the Company), formerly FilmWorld, Inc., was originally organized under
the
laws of the State of Nevada on December 23, 1986 under the name Hair Life
Inc.
The Company became inactive during 1987 and remained inactive until September
1994. In September 1994, through a reverse acquisition agreement, the Patterson
Group became a wholly owned subsidiary of Hair Life, Inc. Operations were
conducted via two subsidiaries until 1998, at which time all operations were
discontinued, and the Company remained dormant until January 1999.
In
July
1999 the Company acquired film rights and changed the corporate name to
FilmWorld, Inc. In December 2000 the Company discontinued its film operations
and distributed all assets and liabilities related to that business to certain
shareholders in exchange for their stock.
In
December 2000 the Company entered into an exchange agreement with GRD, Inc.
(DBA
SulphCo) and issued 1,200,000 shares in exchange for all of the outstanding
shares of GRD, Inc. Because the shareholders of GRD, Inc. controlled the
Company
after the exchange, the merger was accounted for as a reverse acquisition
of
FilmWorld, Inc. The Company’s name was changed to SulphCo, Inc.
On
October 7, 2005, the Company’s stock began trading on the American Stock
Exchange under the symbol “SUF.” Previously the Company’s common stock had been
quoted on the NASD, Inc. OTC Bulletin Board under the symbol “SLPH.”
In
2006,
the Company continued to make progress towards the completion of a test facility
in Fujairah, United Arab Emirates. This test facility will be instrumental
in
the validation of the SonocrackingÔ
process
and allowing the Company to continue to its transition towards
commercialization.
Going
Concern
The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. As reflected in the
accompanying financial statements, as of December 31, 2006, the Company had
cash
on hand of approximately $6.0 million, negative working capital of approximately
$3.6 million, and an accumulated deficit of approximately $70.9 million.
These factors raise substantial doubt about its ability to continue as a
going
concern. In March 2007, the Company received approximately $8 million from
the exercise of warrants as explained in Note 19, however, the ability of
the
Company to continue as a going concern is dependent on the Company’s ability to
implement its business plan and raise additional funds.
Use
of Estimates in the Preparation of Financial
Statements
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements
and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The markets for the Company’s
potential products and services will be impacted by the price of oil,
competition, rapid technological development, regulatory changes, and new
product introductions, all of which may impact the future value of the Company’s
assets.
F-13
Cash
and Cash Equivalents
All
highly liquid investments with maturities of three months or less are considered
to be cash equivalents. The Company maintains amounts in three U.S. accounts,
two checking accounts and a money market account, on deposit with two financial
institutions. These exceed federally insured limits by approximately $5.8
million at December 31, 2006.
Foreign
Currency Translation and Transactions
The
financial position and results of operations of the Company's equity ownership
is determined using local currency as the functional currency. Assets and
liabilities of the equity ownership in Fujairah Oil Technology LLC (see Note
6)
are translated at the prevailing exchange rate in effect at each year end.
Contributed capital is translated using the historical rate of exchange when
capital is injected. Income statement accounts are translated at the average
rate of exchange during the year. Translation adjustments arising from the
use
of different exchange rates from period to period are included in the cumulative
translation adjustment account in stockholders' equity. Gains and losses
resulting from foreign currency transactions are included in
operations.
Accounts
Receivable and Allowance for Doubtful Accounts
The
Company evaluates the collectibility of accounts receivable on a case-by-case
basis. Based on such evaluation, the Company records allowances for accounts
at
such time as they are considered doubtful of collection.
Fair
Value of Financial Instruments
The
carrying amounts of financial instruments held by the Company, which include
cash, accounts receivable, accounts payable, and accrued liabilities,
approximate fair values due to their short maturity. The carrying value of
the
payable to related party and loan receivable reasonably approximate
their fair value as the stated interest rates approximate current
market interest rates.
Property
and Equipment
Property
and equipment are recorded at cost, less accumulated depreciation. In accordance
with FAS No. 144, the Company reviews its long-lived assets for impairment.
Whenever events or changes in circumstances indicate that the carrying amount
of
the assets might not be recovered through undiscounted future cash flows,
such
impairment losses are recognized in the statement of operations.
The
cost
of property, plant, and equipment is depreciated over the remaining estimated
useful lives of the assets ranging from 3 to 7 years. Leasehold improvements
are
depreciated over the lesser of the terms of the lease or the estimated useful
lives of the assets. Depreciation is computed using the straight line method.
Expenditures for maintenance and repairs are expensed when incurred, while
betterments are capitalized. Gains and losses on the sale of property and
equipment are reflected in the statement of operations.
Equity
method
Investments
in joint ventures and other entities over which the Company does not have
control, but does have the ability to exercise significant influence over
the
operating and financial policies, are carried under the equity
method.
The
Investment in Fujairah Oil Technology LLC, in which the Company owns a 50%
interest, is carried at cost and adjusted for the Company's 50% share of
undistributed earnings or losses.
There
was no activity in the entity prior to 2006. See Note 6 for activity in
2006.
F-14
Research
and Development
The
Company expenses research and development as incurred.
Income
Taxes
The
Company provides for income taxes under the provisions of FAS No. 109
“Accounting for Income Taxes,” which requires an asset and liability based
approach in accounting for income taxes.
Deferred
income tax assets and liabilities are recorded to reflect the tax consequences
in future years of temporary differences between revenue and expense items
for
financial statement and income tax purposes. Valuation allowances are provided
against assets that are not likely to be realized. Deferred tax assets and
liabilities are measured using the enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to
be recovered or settled. The effect on deferred tax assets and liabilities
of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Loss
Per Share
The
computations of basic and diluted loss per common share are based upon the
weighted average number of common shares outstanding and potentially dilutive
securities. Potentially dilutive securities include stock options and unvested
shares of restricted stock. Computations of diluted net loss per share for
the
years ended December 31, 2006, 2005, and 2004 did not include options to
purchase 7,256,980, 7,806,237, and 13,794,798 shares of common stock,
respectively, because inclusion of such shares would have an anti-dilutive
effect on net loss per share.
Concentrations
The
Company has generally been able to obtain component parts from multiple sources
without difficulty. Nevertheless, because of price and quality considerations,
in 2005 the Company lined up three manufacturers to supply virtually all
its
needs, as the Company's results could be adversely affected if manufacturing
were delayed or curtailed. The Company has also established two test sites
overseas, in Fujairah, UAE (Note 6) and in Austria.
Reclassification
For
comparative purposes, certain amounts previously included in selling, general
and administrative expenses have been reclassified to research and development
expenses 2005. The reclassifications do not require any adjustments to assets,
liabilities, equity, or income.
The
following summarizes the reclassifications made:
2005
Sales,
general, & administrative expenses
Original
filing
$
6,790,998
Reclassifications
-1,075,919
Reclassified
$
5,715,079
Research
& development
Original
filing
$
1,442,096
Reclassifications
1,075,919
Reclassified
$
2,518,015
Additionally,
deposits of $140,000 were reclassified to prepaid expenses in 2005.
F-15
2.Loans
Receivable and Accrued Interest
On
February 16, 2006the Company committed to a loan agreement with SulphCo
KorAsia
(formerly known as OIL-SC, Ltd.) of South Korea. The agreement called for
advances of $50,000 per month through May 15, 2006. A total of $150,000 was
advanced through May, 2006. An additional $50,000 was advanced June 6, 2006
under the same terms as the original note and in November 2006, an additional
$75,000 was advanced, with a revision to the loan agreement that the full
$275,000 in advances and related interest would be immediately repaid from
revenues or from proceeds of any equity financings. Interest accrues at prime
rate plus 1%. Although SulphCo KorAsia has never had material revenue streams,
the Company believes that the full amounts of principal and interest will
be
collected and that no allowance for doubtful collection is necessary. Also
the
Company holds a refundable deposit of SulphCo KorAsia as summarized in Note
8.
In
July
2006 the Company advanced $191,352 (690,000 Dirhams) to Fujairah Oil Technology,
LLC (the “LLC”) to more easily pay for Company expenditures in Fujairah. See
Note 6. Funds totaling 338,674 Dirhams have been expended by the LLC on behalf
of the Company. The net amount of 351,326 Dirhams is reflected as a related
party loan receivable. The dollar amount has been adjusted to $95,627 which
includes a foreign currency transaction loss of $3,554. As the LLC holds
this
amount in cash on behalf of the Company, no allowance has been taken for
collectibility.
3.Property
and Equipment
The
following is a summary of property, plant, and equipment - at cost, less
accumulated depreciation:
2006
2005
Equipment
$
772,385
$
911,438
Computers
199,582
176,226
Office
furniture
57,116
54,517
Leasehold
improvements
90,941
83,375
1,120,024
1,225,556
Less:
Accumulated depreciation
(913,067
)
(828,140
)
Total
$
206,957
$
397,416
Depreciation
expense was $194,029 in 2006, $198,056 in 2005, and $104,242 in 2004. In
2006
assets with accumulated depreciation totaling $109,102 were sold or
abandoned.
4.Loss
On Impairment of Asset
The
Company had a desulfurization unit (“unit”) consisting of a trailer containing
equipment to be used to remove sulfur from crude oil. The Company spent $3,787
in the year ended December 31, 2004, upgrading the unit. At December 31,2004
the cost of the unit was $431,417. No depreciation expense related to the
unit
was recognized in 2004 as it was considered work in process.
In
March
2005 the unit was determined to be obsolete based on the Company’s current
technological improvements. The estimated value of the reusable components
as of
March 31, 2005 was $197,517, resulting in an impairment loss of $233,900.
The
Company included the $197,517 in equipment and began depreciating it in 2005.
In
2006 the equipment was sold.
5.Intangibles
Assets
The
Company has five U.S. patents, six U.S. patents pending, five foreign patents,
several foreign patents pending, and six U.S. trademarks pending. At December31, 2006the Company had capitalized $552,908 in costs that were incurred
in
connection with filing patents and trademarks related to its internally
developed technology in accordance with Accounting Principles Board Opinion
No.
17 - Intangible
Assets.
Amounts
of $185,503, $200,011, and $172,629 were capitalized in 2006, 2005, and 2004,
respectively. In 2006 $5,235 of costs net of accumulated amortization of
$679
were expensed for abandoned trademarks.
F-16
Patents
and trademarks are amortized using the straight-line method over their estimated
period of benefit, ranging from 10 to 20 years with a weighted average of
16.5
years. Due to the majority of the 2004 capitalized costs being incurred near
the
end of the year, no amortization expense was recognized in 2004. Amortization
expense related to patents and trademarks for the years ended December 31,2006,
2005, and 2004, and from inception was $27,949, $17,422, $-0-, and $45,371,
respectively. Maintenance costs totaling $36,261 and $28,972 were expensed
throughout 2006 and 2005, respectively.
The
following table reflects management’s estimate for amortization expense, using
the straight-line method, for the next five years based on current capitalized
amounts and estimated lives:
Year
Estimated
Amortization Expense
2007
$
33,500
2008
33,500
2009
33,500
2010
33,500
2011
33,500
Thereafter
340,716
Total
$
508,216
6.Investment
in Joint Venture
In
November 2005 the Company and Trans Gulf Petroleum Co., a Government of Fujairah
company, formed Fujairah Oil Technology LLC (“LLC”), a United Arab Emirates
limited liability company, to implement SulphCo’s Sonocracking™ desulfurization
technology. The LLC is 50% owned by Trans Gulf Petroleum and 50% owned by
SulphCo, Inc. Fujairah is one of the seven Emirates of the United Arab
Emirates.
The
formation agreement called for each shareholder to contribute 500,000 Dirhams
for 500 shares for the 50% ownership in the LLC.
The
LLC
had no operations in 2005.
The
LLC’s
operations began in 2006. For the year ended December 31, 2006 its financial
activities consisted primarily of leasing office space and acquiring leasehold
improvements and office furniture and equipment. The lease commenced March15,2006. There was a loss of 237,171 Dirhams of which 50% (US $32,278) has been
reflected by the Company.
The
Company entered into an agreement to construct a test facility for $1,600,000
for the LLC operations. Subsequently the building plans were expanded to
require
additional amounts of $600,000 and $350,000 for construction. The Company
paid
$1,900,000 to the construction company for building construction and $875,000
for pipeline.
The
test
facility constructed by the Company for use in Fujairah will be owned by
the
Company, and the Company anticipates that it will lease the equipment to
the
LLC. The Facility is on land owned by the Government of Fujairah and the
Government has leased the land to the LLC.
As
of
December 31, 2006, and for the year then ended, the LLC had the following
condensed balance sheet and operating statement converted to US
dollars:
F-17
December
31,
December
31,
Condensed
Balance Sheet
2006
2005
Current
assets
Cash
and cash equivalents
$
217,169
$
279,100
Total
current assets
$
217,169
$
279,100
Depreciable
assets (net)
100,567
-
Other
assets
1,633
-
Total
assets
$
319,369
$
279,100
Current
Liabilities
Advance
- related party
$
95,647
$
-0-
Other
Current liabilities
16,088
-0-
Total
current liabilities
Members’
equity
207,634
279,100
Total
liabilities and members’ equity
$
319,369
$
279,100
Operating
Statement for the Year Ended:
Revenue
$
-0-
$
-0-
Operating
expenses
(61,159
)
-
Non-operating
expense
(3,397
)
-
Net
loss
$
(64,556
)
$
-0-
A
foreign
currency translation loss of $3,455 has also been recognized as other
comprehensive loss relative to this investment for 2006.
Of
the
$111,735 in current liabilities, $95,647 is due to SulphCo, Inc.
The
Company’s 50% share of distributions made by the joint venture will also be
subject to other costs and expenses incurred directly by the Company from
time
to time, including commissions payable directly by the Company to third parties,
presently estimated at up to 10% of the Company’s net joint venture profits. The
Company is uncertain that it will be able to recover it’s investment in the LLC.
Accordingly, the carrying value of the investment has been reduced to
$0.
7.Income
Taxes
The
deferred tax assets computed prior to the valuation allowances and the valuation
allowances were overstated in earlier periods through September 30, 2005.
The
valuation allowance has always been set equal to the deferred tax asset prior
to
such allowance, and the Company has never reflected an income tax benefit.
The
adjustments of the overstatements did not, therefore, require any adjustments
to
assets, liabilities, equity, or income. Also, tax credit carryforwards had
been
omitted from disclosures in those earlier periods. In 2005 the Company made
adjustments for previous years to properly recognize net operating losses,
the
net effect of which was to reduce the deferred tax assets and the valuation
allowance by $3,574,419.
F-18
The
Company is currently subject to income taxation only in the jurisdiction
of the
United States. The state of Nevada has no income tax. Foreign jurisdiction
will
impose income taxes if and when income is generated subject to their laws,
but
there is currently no such related income. The significant components of
the
Company’s deferred tax assets and liabilities at December 31, 2006 and 2005 were
as follows:
Deferred
tax liabilities relative to the following:
Patent
costs
(172,793
)
(120,774
)
Depreciable
assets
(5,282
)
(14,998
)
Total
deferred tax liabilities (all non-current)
(178,075
)
(135,772
)
Current
portion
13,053,051
6,943,506
Non-current
portion
7,140,164
172,822
Total
deferred tax assets prior to offsets
20,193,215
7,116,328
Valuation
allowance
(20,193,215
)
(7,116,368
)
Net
deferred tax assets
$
-
$
-
For
the
years ended December 31, 2006 and 2005, the valuation allowance was increased
by
$13,076,847 and $3,106,598, respectively due to the uncertainties surrounding
the realization of the deferred tax assets resulting from the Company’s net
losses of $39,122,412 and $9,428,370 in 2006 and 2005, respectively, and
accumulated deficits of $70,856,288 and $31,740,128 at December 31, 2006
and
2005, respectively.
F-19
The
provision (benefit) for income taxes differs from the provision (benefit)
amount
computed by applying the statutory federal tax rate (34%) to the loss before
taxes due to the following:
Tax
related deductions not expensed on financial statements:
Patent
costs
(52,019
)
(68,004
)
Depreciation
(24,458
)
(31,691
)
Increase
in benefit from net operating loss
(5,200,895
)
(2,672,701
)
(Increase)
decrease in other deferred tax assets
(7,918,255
)
(458,424
)
Increase
(decrease) in deferred tax liabilities
42,303
24,527
Increase
in valuation allowance
13,076,847
3,106,598
Provision
(benefit) for income taxes
$
-
$
-
As
of
December 31, 2006 and 2005, the Company had net operating loss carryforwards
for
federal income tax purposes of $35,196,126 and $19,899,378, respectively,
and
tax credit carryforwards of $502,077 and $233,401, respectively, for incremental
research expenses. Both the carryforwards for net operating loss and tax
credit
will expire beginning in 2019, fully expiring in 2026.
The
valuation allowance for each year has been estimated in an amount equal to
the
projected future benefit of the deferred tax asset net of the deferred tax
liability as it is not certain that the Company will generate sufficient
income
to utilize the future tax benefits, due to the lack of earnings in the Company’s
history.
8.Refundable
Deposit
In
2005
the Company received $550,000 from SulphCo KorAsia (formerly known as OIL-SC,
Ltd.), pursuant to our Equipment Sale and Marketing Agreement. As this amount
is
fully refundable if the pilot plant does not ultimately meet the agreed
specifications, no portion of the purchase price has been or will be recorded
as
revenue in the Company’s financial statements until the pilot plant meets all
agreed specifications. The Company does not have an equity interest in SulphCo
KorAsia.
9.Accrued
Fees and Interest
As
of
December 31, 2006, the Company had accrued late registration fees of $760,240
and interest thereon of $197,588 in conjunction with the private placements
in
2004, as more fully described in Note 12. As of December 31, 2005the Company
had accrued late registration fees of $760,240, accrued interest thereon
of
$60,745, and additional offering fees of $214,587 in conjunction with the
same
private placements. In 2006 and 2005, interest expense associated with accrued
late fees were $136,843 and $60,745 respectively.
F-20
10.Notes
Payable - Related Party
The
Company’s notes payable consist of the following as of December 31,2006:
On
December 30, 2003, the Company issued a $500,000 note to Dr. Gunnerman, the
Chairman and CEO, and a $500,000 note to Erika Herrmann, sister-in-law of
the
Dr. Gunnerman. From each of these notes, $250,000 was obtained before year
end,
2003. The balance of $250,000 for each note was obtained during 2004. The
notes
were originally issued on December 30, 2003 at an interest rate of 29.6%,
which
was paid via the issuance of 1,000,000 shares of restricted stock on January1,2004 for total consideration of $296,000 or $0.296 per share. On December30,2004 the notes were renewed at 8% per annum with the interest and principal
due
December 30, 2005. The note to Erika Herrmann was paid off December 30, 2005.
Effective December 30, 2005, the note to Dr. Gunnerman was again renewed
for
another year at 8% per annum with interest payable quarterly and principal
due
on demand or on December 30, 2006. The note was paid in full including accrued
interest on May 15, 2006.
On
December 31, 2004, under the approval of its Board of Directors, the Company
borrowed $7,000,000 in the form of a long-term note from Dr. Rudolf Gunnerman,
the Chairman and CEO. Interest on the note is adjusted quarterly based on
a
3-month London Inter-Bank Offering Rate (“LIBOR”) plus 0.5% per annum, with
interest only payments due on December 31, 2005 and 2006 and the remaining
accrued interest and principal due on December 31, 2007 when the note matures.
On May 15, 2006, under Board approval, the Company paid $2,000,000 in principal
on the note and the accrued interest through May 15, 2006. At December 31,2006,
interest on the note was paid through January 8, 2007. $6,250 is included
in
prepaid expenses. Beginning January 1, 2007 the rate was adjusted to
5.82563%.
The
annual payment obligations related to this note based on the current 2007
interest rates, assuming no early retirements of principal, are as
follows:
Principal
Interest
Total
2007:
Principal
due
$
5,000,000
$
5,000,000
Interest
due
$
291,282
291,282
Totals
$
5,000,000
$
291,282
$
5,291,282
Thereafter
None
None
None
Totals
$
5,000,000
$
291,282
$
5,291,282
Interest
expense of $334,954, $333,917, and $302,786 was incurred on the above notes
during 2006, 2005, and 2004, respectively.
11.Commitments
and Contingencies
The
Company has agreed to a commission for ten percent of the net income to be
received by the Company from the operations in Fujairah if an oil contract
is
secured.
The
Company entered into an agency agreement with Atlas Commercial Holdings,
LLC on
July 25, 2006 to advise and assist the company with establishing and
implementing an ongoing business venture with Petrobras (Brazil). The
Company shall pay to Atlas a transaction fee equal to ten percent of the
net
income received by the company from any transaction with Petrobras in respect
of
net income which accrues to the company through and including December 31,2016.
In
October 2006 the Company advanced $875,000 to its building contractor in
Fujairah for pipeline and related infrastructure. By December 31, 2006, it
was
not clear how much value would be received from this advance. As the Company
had
agreed to pay an additional $350,000 toward construction of the test facility
in
Fujairah, the Company has allocated the full $875,000 payment to research
and
development expense relating to construction of the test facility which includes
the building, infrastructure and equipment (see Note 6).
F-21
Financial
instruments, which potentially subject the Company to concentrations of credit
risk, consist mainly of cash and cash equivalents. The Company maintains
amounts
in three U.S. accounts, two checking accounts and a money market account
on
deposit with two financial institutions, which exceed federally insured limits
by approximately $5.8 million at December 31, 2006. The Company has not
experienced any significant losses in such accounts, nor does management
believe
it is exposed to any significant credit risk.
At
December 31, 2006the Company has a $550,000 refundable deposit in connection
with an agreement with KorAsia (formerly OIL-SC) for a pilot plant in South
Korea. Until KorAsia accepts in writing the results of the pilot plant, the
$550,000 is refundable at their option. The Company has agreed to receive
the
remaining payment of $450,000 within seven days after the first commercial
license agreement for the Sonocracking™ technology between the Company and a
Korean refining company, provided that KorAsia uses the funds for continued
marketing activities regarding the Sonocracking technology in
Korea.
There
are
various claims and lawsuits pending against the Company arising in the normal
course of the Company’s business. Although the amount of liability at December31, 2006, cannot be ascertained, management is of the opinion that these
claims
and lawsuits will not materially affect the Company’s financial position. We
have and will continue to devote significant resources to our defense, as
necessary. The following paragraphs set forth the current status of
litigation.
On
January 5, 2004, the Company filed a lawsuit in the Second Judicial District
Court of the State of Nevada, in and for the County of Washoe, Case No. CV04
00013, Dept. No. 9, against Alexander H. Walker, Jr., the Company’s former
general counsel and director, and Nevada Agency & Trust Company, the
Company’s former transfer agent. The lawsuit alleges breaches of fiduciary duty,
contract violations, conversion, and other related claims, in connection
with
the sale of shares of the Company’s common stock to Coldwater Capital, LLC and
Mark Neuhaus in 2001. The Company claims it did not receive approximately
$737,000 of the purchase price for the shares sold. The Defendants have answered
the Complaint, generally denying the allegations and raising affirmative
defenses, and cross-complaining against Coldwater Capital, LLC and Mark Neuhaus
for the payment of the funds owed to the Company. The Company subsequently
obtained a pre-judgment writ of attachment requiring Mr. Walker to deposit
the
proceeds of the sale of the Company stock he owned with the court, pending
trial. Discovery has been completed and trial in this matter is presently
scheduled for April 23, 2007.
In
Clean
Fuels Technology v. Rudolf W. Gunnerman, Peter Gunnerman, RWG, Inc. and SulphCo,
Inc.,
the
Company, Rudolf Gunnerman, Peter Gunnerman, and RWG, Inc., were named as
defendants in a legal action commenced in Reno, Nevada. The Plaintiff alleged
claims relating to “sulfur removal technology” originally developed by Professor
Teh Fu Yen and Dr. Gunnerman with financial assistance provided by Dr.
Gunnerman, and subsequently assigned to the Company. On December 18, 2006,
following a trial, the jury found in the Company’s favor on both claims asserted
against the Company by the Plaintiff. The Plaintiff has since requested
equitable relief, including the imposition of a constructive trust, from
the
Judge who presided over the trial. The Company views the request for any
equitable relief as against the Company as without merit. Oral argument on
the
request for equitable relief took place on February 22, 2007, and the Company
is
awaiting a decision.
In
Talisman
Capital Talon Fund, Ltd. v. Rudolf Gunnerman and SulphCo, Inc.,
the
Company and Rudolf Gunnerman were named as Defendants in a legal action
commenced in federal court in Reno, Nevada. The Plaintiff alleged claims
relating to the Company’s rights to develop its “sulfur removal technology.” The
Company regards these claims as without merit. Discovery in this case formally
concluded on May 24, 2006. Motions to compel additional discovery and summary
judgment motions by both parties are still pending, and no trial date has
yet
been set.
F-22
In
The
Matter of the Arbitration between Stan L. McLelland v. SulphCo,
Inc.,
Mr.
McLelland, who was the Company's president from August 13, 2001, until he
resigned on September 12, 2001, is seeking to exercise options to purchase
two
million (2,000,000) shares of the Company’s common stock at 50 cents per share.
It is the Company’s position that those options had not vested prior to Mr.
McLelland's resignation. Mr. McLelland also seeks salary for the six months
following his resignation and $20,000 of alleged unpaid commuting expenses,
as
well as attorneys' fees and costs. Discovery is closed, and the arbitrator
recently denied the parties’ cross-motions for summary judgment on the options
issue. The arbitration hearing has been set for April 19 and 20, 2007 in
Reno,
Nevada.
On
October 20, 2006, Mark Neuhaus filed a lawsuit against the Company and Rudolph
W. Gunnerman, Mark
Neuhaus v. SulphCo, Inc., Rudolph W. Gunnerman,
in the
Second Judicial District Court, in and for the County of Washoe, Case No.
CV06
02502, Dept. No. 1. The lawsuit is based on a purported Non-Qualified Stock
Option Agreement and related Consulting Agreement between Mark Neuhaus and
the
Company dated March of 2002. Mark Neuhaus claims that according to the terms
of
the Non-Qualified Stock Option Agreement, he was granted an option to purchase
three million (3,000,000) shares of the Company’s common stock at the exercise
price per share of $0.01. On or about February of 2006, Mark Neuhaus attempted
to exercise the option allegedly provided to him under the Non-Qualified
Stock
Option Agreement. At that time, the Company rejected Mr. Neuhaus’s attempt to
exercise the option. Thereafter, Mr. Neuhaus filed this lawsuit seeking to
enforce the Non-qualified Stock Option Agreement. In his suit, Mr. Neuhaus
includes claims for specific performance, breach of contract, contractual
breach
of the covenant of good faith and fair dealing, and tortious breach of the
covenant of good faith and fair dealing. He requests the Court to compel
the
Company to issue the shares or alternatively to award him damages equal to
the
fair market value of the three million (3,000,000) shares of stock when he
purported to exercise the options, minus the exercise price. On December7,2006, the Company moved to dismiss the lawsuit. On January 4, 2007, the Court
issued an Order denying the motion on the ground that there were factual
issues
to be resolved which prevented dismissal at that time. The Company is now
in the
process of preparing an Answer to the Complaint. The Company intends to
vigorously defend the claims made by Mr. Neuhaus, which it believes are without
merit. Trial in this matter is scheduled for September 24, 2007.
On
January 17, 2007, Rudolf W. Gunnerman filed a lawsuit against four of the
Company’s independent directors, Richard L. Masica, Robert Van Maasdijk, Edward
E. Urquhart, and Lawrence G. Schafran. This case is known as Rudolph
W. Gunnerman v. Robert Van Maasdijk, Richard L. Masica, Larry G. Schafran,
Edward E. Urquhart,
and was
filed in the Second Judicial District Court of the State of Nevada, in and
for
the County of Washoe, Case No Case No. CV07 00103, Dept. No. B6. Gunnerman’s
Complaint seeks declaratory and injunctive relief with respect to the amendments
to the Company’s bylaws made by the Company’s Board of Directors on Wednesday,
January 17, 2007. Gunnerman alleges that the independent directors’ amendment to
the Company’s bylaws which provides that the Board of Directors shall have
exclusive authority to amend the bylaws was invalid and the bylaw amendment
should be declared invalid. The independent directors have counterclaimed
for a
declaration that the amendment was valid and in the Company’s best interest.
Discovery in this case has not begun and no trial date has been
set.
On
January 26, 2007, Thomas Hendrickson filed a shareholder derivative claim
against certain current and former officers and directors or the Company
in the
Second Judicial District Court of the State of Nevada, in and for the County
of
Washoe. The case is known as Thomas
Hendrickson, Derivatively on Behalf of SulphCo, Inc. v. Rudolf W. Gunnerman,
Peter W. Gunnerman, Loren J. Kalmen, Richard L. Masica, Robert Henri Charles
Van
Maasdijk, Hannes Farnleitner, Michael T. Heffner, Edward E. Urquhart, Lawrence
G. Schafran, Alan L. Austin, Jr., Raad Alkadiri and Christoph
Henkel,
Case
No. CV07 00137, Dept. No. B6. The complaint alleges, among other things,
that
the defendants breached their fiduciary duty to the Company by failing to
act in
good faith and diligence in the administration of the affairs of the Company
and
in the use and preservation of its property and assets, including the Company’s
credibility and reputation. The Company and the Board intend to file a Motion
for Dismissal with the Court, based upon the Plaintiff’s failure to make a
demand upon the Board.
On
June26, 2006, the Company filed an action, SulphCo,
Inc. v. Cullen,
in the
Second Judicial District Court of the State of Nevada, in and for the County
of
Washoe, Case No. CV06-01490, against Mark Cullen arising out of Mr. Cullen’s
alleged breach of a secrecy agreement that he had executed when employed
by GRD,
Inc., whose claims have accrued to the Company. The lawsuit seeks damages,
a
constructive trust, and an order requiring Mr. Cullen to assign to the Company
certain intellectual property in the form of patent applications
(as well as a now-issued patent) that he filed following his departure from
the
Company. On October 23, 2006, Mr. Cullen moved to dismiss the Company’s
complaint; the
F-23
motion
was denied. On February 26, 2007, Mr. Cullen filed an amended answer to the
Company’s complaint. That Answer included counterclaims for breach of contract,
unfair competition, interference with contractual relations, and interference
with prospective economic advantage. The Company views Mr. Cullen’s
counterclaims as without merit and has moved to dismiss them. Discovery in
this
case has not yet begun, and no trial date has been set.
12.Common
Stock
Other
than stock based compensation disclosed in Note 13 and related party
transactions disclosed in Note 15, the Company had the following transactions
related to its common stock during the years ended December 31, 2006, 2005,
and
2004:
In
January 2004 the Company issued 100,000 shares of common stock at $0.85 per
share, the closing value on the date issued, for the services of a consultant
valued at $85,000.
In
June
2004 the Company entered into two private placements. The first private
placement was to sell 2,978,342 shares of common stock at $0.90 per share,
warrants exercisable at $1.125 per share for 1,073,690 shares of common stock,
additional investment rights (“AIR’s”) entitling the purchaser to purchase up to
6,135,357 shares of common stock at a purchase price of $0.90, and upon exercise
of AIR’s, additional warrants to purchase up to 2,147,379 shares of common stock
at $1.125 per share. The additional warrants are issued for shares equal
to 35%
of shares issued when the AIR’s are exercised. The AIR’s were exercisable by
investors for 180 trading days following the date the registration statement
was
first declared effective by the Securities and Exchange Commission. That
occurred June 27, 2005, which caused the expiration date to be March 15,2006.
The warrants are exercisable for up to 30 months after the later of the June27,2005 effective date or the date of their issuance. All 2,978,342 shares were
issued for net cash proceeds totaling $2,342,985 during 2004. During 2005
AIR’s
for 2,280,229 shares and warrants for 410,403 shares were exercised for proceeds
of $2,513,909. Additional warrants for 798,080 were issued. At December 31,2005
AIR’s for 3,855,137 shares and warrants for 1,461,368 were outstanding from this
placement. During 2006, the balance of AIR’s for 3,855,137 shares were
exercised, resulting in the issuance of additional warrants for 1,349,295shares.
Warrants for 1,628,438 shares were exercised with adjustments for cashless
exercises requiring 3,967 fewer shares to be issued. Gross proceeds for 2006
were $5,235,003. At December 31, 2006 warrants for 1,182,224 shares were
outstanding from this placement. See Note 19 regarding a subsequent transaction
relating to this placement.
The
second private placement was to sell 2,030,960 shares of common stock at
$1.25
per share, warrants exercisable at $1.5625 per share for 732,161 shares of
common stock, AIR’s entitling the purchaser to purchase up to 2,091,889 shares
of common stock at $1.25 per share, and upon exercise of AIR’s, additional
warrants to purchase up to 1,464,322 shares of common stock at $1.5625 per
share. The additional warrants are issued for shares equal to 70% of shares
issued when the AIR’s are exercised. The AIR’s were exercisable by investors for
180 trading days following the date the registration statement was first
declared effective by the Securities and Exchange Commission. As registration
for both 2004 placements were combined, the expiration date was March 15,2006.
The warrants are exercisable for up to 30 months after the later of the June27,2005 effective date or the date of their issuance. All 2,030,960 shares were
issued during 2004 for net cash proceeds totaling $2,236,466. During 2005
AIR’s
for 810,656 shares and warrants for 291,121 shares were exercised for proceeds
of $1,468,198. Additional warrants for 567,460 shares were issued. At December31, 2005 AIR’s for 1,281,232 shares and warrants for 1,008,500 were outstanding
from this placement. During 2006, the balance of AIR’s for 1,281,232 shares were
exercised, resulting in the issuance of additional warrants for 896,862 shares.
Warrants for 1,110,105 shares were exercised with adjustments for cashless
exercises requiring 3,967 fewer shares to be issued. Gross proceeds for 2006
were $ 3,277,679. At December 31, 2006 warrants for 795,256 shares were
outstanding from this placement. See Note 19 regarding a subsequent transaction
relating to this placement.
For
both
placements additional fees equal to 7% of proceeds from the exercise of AIR’s
was payable to Olympus Securities, LLC pursuant to the agreement. At December31, 2005 this amount was $214,587 and unpaid. The total fee of $214,587 was
paid
in 2006. The fees are accounted for as a charge to Paid-In-Capital.
F-24
The
Company is obligated to pay $760,240 in late registration fees due to the
registration statement related to the private placements in June of 2004
not
having become effective on time, as provided in the agreement with the
investors. The agreement requires the Company to pay late registration fees
to
the selling security holders at the rate of 2% per month of the invested
amount
if the registration covering the placement shares were not declared effective
by
the SEC within 90 days of the date of the investment. As of December 31,2006,
accrued interest on these fees totaled $181,243. Additional fees may accrue
in
2006 for investors still holding restricted shares due to the registration
statement becoming inactive and may continue to accrue until the registration
is
reactivated. As very few of the shares are still held, the amount involved
is
immaterial.
In
August
2004 the Company issued 45,000 shares at $2.86 per share, the closing value
on
the date issued, for the services of a consultant valued at
$128,700.
In
September 2004 the Company received 45,000 subscribed shares which were returned
to cancel part of a subscription receivable at $1.50 per share or
$67,500.
In
April
2005 fifteen thousand shares of common stock were issued at $5.91 per share,
the
closing value on the date issued, in exchange for consulting services valued
at
$88,650.
During
August through December of 2005, additional investment rights and warrants,
issued in the two private placements of 2004, were exercised for 3,792,410
shares for net proceeds of $3,767,518. Additional warrants for 1,365,543
shares
of Common stock were issued pursuant to the agreements as a result of exercises
of additional investment rights.
On
March29, 2006, the Company completed a private placement to a small number of
accredited investors for the sale of 4,000,000 units, each unit consisting
of
one share of the Company’s common stock and one warrant to purchase a share of
common stock. Each unit was sold at a price of $6.805 per share, resulting
in
gross proceeds at closing of $27.2million. The warrants are exercisable,
in
whole or in part, at a fixed price equal to $6.805 per share, and are
exercisable for a period of 18 months following their issuance. The Company
filed a registration statement with the SEC covering the resale of the shares
of
common stock issued at closing and shares issuable upon exercise of warrants.
The registration statement was declared effective by the SEC on June 23,2006.
See Note 19 regarding a subsequent transaction relating to this
placement.
The
Company granted 217,500 shares of its common stock during 2006, all of which
were vested during the year. The weighted-average grant-date fair value of
those
shares was $7.94 per share.
A
fee of
$100,000 was paid to an unrelated third party in consideration of introducing
an
investor to the Company relative to the March 29, 2006 placement. This amount
was reflected as a reduction of the proceeds.
All
AIR’s
and warrants are valued at exercise price when exercised net of any offering
fees payable.
13.Stock
Plans and Share-Based Compensation
Beginning
in 2006, the Company records compensation in the form of grants of common
stock
and options for common stock at fair value in accordance with FAS No. 123(R),
which requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on
their
fair values.
Prior
to
2006, the Company had adopted the disclosure provision for stock-based
compensation of FAS No. 123, “Accounting for Stock-Based Compensation,” and FAS
No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,”
but continued to account for such items using the intrinsic value method
as
outlined under APB Opinion No. 25, “Accounting for Stock Issued to Employees.”
Under APB 25, if the exercise price of the Company’s employee stock options
equaled or exceeded the fair market value of the underlying stock on the
date of
grant, no compensation expense was recognized.
F-25
For
purposes of required pro forma disclosures for periods prior to 2006, the
estimated fair value of employee options was amortized to expense over the
vesting period of the options. No employee held options at the end of 2004
and
2005. No employee stock options were issued in 2005. Kirk Schumacher, whose
employment had terminated before the end of 2004, held fully vested options
until February 2006 when he exercised them. The options exercised for employee
compensation during the year ended December 31, 2004 were included in the
net
loss for 2004. Thus the pro forma disclosure applies only to 2004 and is
presented below under the detailed description of the related
options.
The
following sets forth share-based compensation during the years 2004, 2005,
and
2006:
In
February 2003 the Company agreed to issue 50,000 shares of common stock to
Kirk
Schumacher, a Director, at $0.42 per share for director services of $21,000.
These shares were issued in March 2004.
In
February 2003 the Company entered into an Executive Employment Agreement
with
its then President Kirk S. Schumacher who served as President and Secretary
from
February 2004 through December 2004. The agreement included a grant of stock
options for 1,000,000 shares of the Company’s common stock, fully vested, at an
exercise price of $.55 per share, the value of the stock at grant date, expiring
February 14, 2006.
In
July
2004, the Company issued to Kirk Schumacher, President, Secretary, and Director,
200,000 shares of common stock at $0.55 per share in connection with the
exercise of stock options granted in 2003 for cash in the amount of
$110,000.
In
July
2004, the company issued to Patrick Lacy, Controller and Director, 100,000
shares of common stock at $0.35 per share in connection with the exercise
of
stock options granted in 2003 for cash in the amount of $35,000.
In
November 2004 the Company entered into a stockholders relations consulting
agreement with Rubenstein Public Relations, Inc. providing for cash compensation
of $10,000 per month. Pursuant to this agreement the Company also agreed
to
issue: (i) one warrant evidencing the right to purchase 50,000 shares of
unregistered common stock at an exercise price of $1.93, the closing price
of
trading common stock at the date of the execution of the agreement; and (ii)
provided the agreement had not been terminated as of May 2005 (which it had
not), one warrant evidencing the right to purchase 50,000 shares of
unregistered common stock at an exercise price equal to the closing price
of
trading common stock on May 11, 2005, which was $3.85. Each of the warrants
will
expire in November 2009. No value was given to these warrants as the intrinsic
value was zero on the dates of grant and the Company was paying a fair value
charge in cash for the services it received.
Effective
December 28, 2004 Kirk Schumacher resigned as President and Secretary. In
connection with Mr. Schumacher's resignation, the Company and Mr. Schumacher
entered into a Separation Agreement and General Release, dated and effective
December 28, 2004, which provided for cancellation of 500,000 of the 1,000,000
million options previously granted to him under his Executive Employment
Agreement, of which 200,000 had been exercised, and to receive a separation
payment of $165,000 upon resignation in lieu of the $600,000 severance payment
provided for under the Executive Employment Agreement. The remaining 500,000
options previously granted under the Executive Employment Agreement were
cancelled pursuant to the separation payment. The separation agreement was
used
to exercise the remaining 300,000 options.
In
addition, on December 28, 2004, Dr. Rudolf Gunnerman personally granted to
Mr.
Schumacher an option to acquire 100,000 shares of the Company’s Common Stock
owned by Dr. Gunnerman at an exercise price of $0.55. This option was exercised
in February 2006 prior to expiration. The proceeds were paid to Dr.
Gunnerman.
F-26
The
estimated fair value of the options issued at termination of employment of
Mr.
Schumacher were $567,000, based on the Black-Scholes option valuation model
using a volatility of 172%, an interest rate of 3.5%, and assuming no discount
for restricted shares. The intrinsic value used for recording those options
was
$555,000. The pro forma amounts for 2004 are as follows:
2004
Net
loss - as reported
$
(4,146,453
)
Net
loss - pro forma
$
(4,158,453
)
Loss
per share - as reported
$
(0.08
)
Loss
per share - pro forma
$
(0.08
)
In
January 2005 fifty thousand restricted shares of common stock were issued
at
$4.08 per share, the closing value on his effective date of appointment,
to the
CFO Alan Austin, Jr. for compensation expense valued at $204,000.
In
April
2005 fifty thousand restricted shares of common stock were issued at $4.99
per
share, the closing value on April 13, 2005, the effective date of his
appointment to the Board of Directors, to Robert Van Maasdijk, a Director,
for
services valued at $249,500.
In
May
2005 fifty thousand restricted shares of common stock were issued at $3.54
per
share, the closing value on May 17, 2005, the effective date of his appointment
to the Board of Directors, to Dr. Raad Alkadiri, a Director, for services
valued
at $177,000.
In
December 2005 fifty thousand restricted shares of common stock were issued
at
$3.61 per share, the closing value on November 10, 2005, the effective date
of
his appointment to the Board of Directors, to Dr. Hannes Farnleitner, a
Director, for services valued at $180,500.
In
December 2005 fifty thousand restricted shares of common stock were issued
at
$6.40 per share, the closing value on December 8, 2005, the effective date
of
his appointment to the Board of Directors, to Christoph Henkel, a Director,
for
services valued at $320,000.
Effective
January 1, 2006 in consideration of Michael Applegate’s agreement to join the
Company as Chief Operating Officer, he was granted 50,000 restricted shares
of
the Company’s common stock valued at approximately $636,000 or $12.72 per share,
the closing value on January 3, 2006, the first trading day after the effective
date of the contract. This grant vested April 1, 2006.
In
February 2006 the Company granted to Michael Heffner 50,000 restricted shares
of
common stock valued at $8.80 per share, the closing price on February 6,2006,
the effective date of his appointment to the Board of Directors, for services
valued at approximately $440,000.
Effective
February 1, 2006, the Company entered into a consulting agreement with Thomas
J.
Nardi to provide engineering-construction consulting services on a
month-to-month basis. The consulting agreement provides that for each
month the consulting agreement is in effect, Mr. Nardi will receive options
to
purchase 1,000 shares of our common stock, exercisable within one year, at
an
exercise price of $7.00 per share. During the quarter ended March 31, 2006,
Mr.
Nardi earned options to purchase 2,000 shares at $7.00 per share under this
agreement. The fair value of these options totaled $8,050 based on the
Black-Scholes valuation model using the assumptions described below.
On
March29, 2006the Company entered into a contract with Mustang International,
L.P.
(“Mustang”) for program management, engineering, procurement, construction
management, and other services to be performed. Initially it oversaw engineering
and construction for the project in Fujairah, United Arab Emirates. The fee
for
these services includes grants of stock and options as follows: (i) 17,500
of
the Company’s shares of common stock, with a provision for reimbursement to the
Company by Mustang of the value of the grant if the contract
is terminated by Mustang, and (ii) options to acquire 52,500 shares of the
Company’s common stock at $6.00 per share and are fully vested at project
completion, exercisable by
F-27
April1,2010. This agreement was amended on September 13, 2006 which made it clear
that
the grants were fully vested by September 29, 2006. The value of these services
is included in research and development expense as it relates to plant and
equipment construction-in-progress. The 17,500 shares were valued at the
$7.44
closing price on March 29, 2006, or approximately $130,200. The options were
valued at $357,525 based on the Black-Scholes valuation model using the
assumptions described below.
On
June19, 2006 the stockholders of the Company approved the 2006 Stock Option Plan
(“Plan”), which authorizes the granting of options for up to 2,000,000 shares of
the Company’s common stock. The Plan is administered by an Option Committee
comprised of three independent directors. Effective May 23, 2006, subject
to
stockholder approval of the Plan, the Option Committee granted an option
for
125,000 shares to Vice Chairman of the Board Robert van Maasdijk and an option
for 1,000,000 shares to Chairman and CEO Rudolf Gunnerman. Each option has
a
term of three years and an exercise price of $9.03 per share.
Robert
van Maasdijk’s option was valued at $687,500 based on the Black-Scholes
valuation model using the assumptions described below. It was fully vested
when
issued and expensed.
Dr.
Gunnerman’s option provides that he may not exercise it until the Company has
reported at least $50 million in annual revenues or there is a “change in
control” of the Company as defined in the Plan. This option was valued at $3.72
million based on the Black-Scholes valuation model using the assumptions
described below.
For
purposes of determining the period over which Dr. Gunnerman’s option was to be
expensed, the Company had made the assumption in the second quarter of 2006
that
it would generate at least $50 million in revenue by the end of the first
quarter of 2007. The Company assumed at the end of the third quarter 2006
that
such revenue would be generated by the end of the second quarter of 2007.
The
option value began being expensed pro-rata over implicit vesting periods
from
the effective grant date of June 19, 2006. For the second and third quarters
of
2006, $1,045,000 had been expensed for these options. At December 31, 2006,
such
compensation cost was charged to expense pursuant to Financial Accounting
Standard No. 123R (Share-Based Payment) as the employment of Dr. Gunnerman
was
terminated in January, 2007, which terminated his right to exercise the
option.
The
tables below describe the assumptions used in the Black-Scholes calculations
for
valuing options granted in 2006. In every case expected volatility is based
upon
calculated historical volatility of Company stock over the same term or expected
term used to calculate the option value.
For
options fully vested in 2006:
Nardi
Mustang
van
Maasdijk
Dates
of options
2/28/06
& 3/31/06
3/29/06
6/19/06
Term
One
year
to
4/1/10
to
5/22/09
Expected
volatility
129%
- 131%
162%
147%
Expected
dividends
None
None
None
Risk-free
interest rate
5%
5%
5.2%
Discount
for post-vesting restrictions
None
None
None
For
Dr.
Gunnerman’s option:
Date
of option
6/19/2006
Term
to
5/22/09
Expected
term used to calculate value
646
Days
Expected
volatility
117%
Expected
dividends
None
Risk-free
interest rate
5.2%
Discount
for post-vesting restrictions
None
F-28
On
August16, 2006the Company granted to Edward E. Urquhart 50,000 restricted shares
of
common stock valued at $5.53 per share, the closing price that day, the
effective date of his appointment to the Board of Directors, for services
valued
at $276,500.
On
December 5, 2006the Company granted to Lawrence G. Schafran 50,000 restricted
shares of common stock valued at $4.87 per share, the closing price that
day,
the effective date of his appointment to the Board of Directors, for services
valued at $243,500.
Other
than the additional investment rights and warrants related to the private
placements of 2004 and 2006, the following table summarizes the above
information about stock options related to employees and non-employees which
were outstanding during 2006, 2005, and 2004:
2006
2005
2004
Shares
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Outstanding,
beginning
200,000
$
1.72
150,000
$
1.01
1,100,000
$
0.53
Options
exercised
(100,000
)
0.55
-
-
(600,000
)
0.52
Options
forfeited
-
-
-
-
(500,000
)
0.55
Option
granted
1,179,500
8.89
50,000
3.85
150,000
1.01
Outstanding,
ending
1,279,500
$
8.42
200,000
$
1.72
150,000
$
1.01
Exercisable
12/31/06
279,500
$
6.25
In
2006
the Company granted options to acquire 1,179,500 shares of its common stock.
The
weighted-average grant-date fair value of stock options issued in 2006 was
$8.89
per option share. Options for 100,000 shares were exercised during 2006.
The
total fair value of the 179,500 option shares vested during 2006 was
$1,457,750.
For
option shares fully vested during 2006, which were both outstanding and
currently exercisable at December 31, 2006, the weighted average exercise
price
was $8.42 per share, the aggregate intrinsic value was zero, and
weighted-average remaining contractual term of the options was 31
months.
Total
compensation cost for share-based payments for each year 2006, 2005, and
2004
was $2,779.275, $1,568,225, and $138,625, respectively.
The
Company has a Non-Officer Limited Stock Appreciation Rights Plan. In August
2003
ten employees were granted awards for 2,500 limited stock appreciation rights,
each with a multiplier of eighteen, at a base price of $0.24, with a maximum
value of $450,000 per employee. The limited stock appreciation rights are
exercisable only upon the following two conditions being met: First, the
closing
price of the Company’s common stock must have exceeded $10 for at least three
consecutive trading days, or the stock price in a proposed acquisition must
exceed $10. Second, the Company must have engaged in an acquisition after
the
first condition is met. Under the plan, “acquisition” means that the Company is
merged or consolidated with another company wherein over 20% of voting control
is lost by Company shareholders; or that over 50% of the Company is acquired
by
an entity owning 20% or less of the Company prior to acquisition; or any
other
acquisition determined by the Board of Directors. Rights to awards end upon
termination of employment. As of December 31, 2006, five of the ten employees
originally granted rights are still employed and covered under the plan.
No
values can be ascribed to these awards unless and until the Company engages
in
an acquisition.
F-29
14.Stock
Subscriptions
As
of
December 31, 2005, the Company had stock subscriptions receivable of $744,500.
In January 2004 the Company filed suit to collect $737,000 for a stock
subscription receivable that is being disputed (see Note 11). At December31,2006, the Company reversed the receivable against paid in capital due to
continued uncertainty of collecting it based on the determination of legal
counsel.
15.Related
Party Transactions
Other
than share-based compensation as detailed in Note 13, the following sets
forth
related party transactions occurring in the years 2004, 2005, and
2006.
The
Company paid to RWG, Inc., a corporation wholly owned by Dr. Rudolf Gunnerman
the Chairman and CEO, consulting fees of $620,000, $360,000 and $370,000
in
2006, 2005, and 2004 respectively. The consulting agreement, was set to
terminate on July 1, 2005, and was renewed until July 1, 2006. It was renewed
again until July 1, 2007. The agreements called for $480,000 per year; however,
RWG, Inc. had agreed to take $30,000 per month until the private placement
financing in March, 2006, whereupon the Company began paying $40,000 per
month.
As part of the renewal of the contract in July, 2006, RWG, Inc. was also
paid
amounts previously waived, totaling $170,000. The Company did not pay a salary
to Dr. Gunnerman.
As
discussed in Note 13, Dr. Rudolf Gunnerman personally granted to Mr. Kirk
Schumacher, upon his termination December 28, 2004, an option to acquire
100,000
shares of the Company’s Common Stock owned by Dr. Gunnerman at an exercise price
of $0.55 per share. That option was exercised in February 2006. As Dr. Gunnerman
was the Chairman, CEO, and controlling shareholder of the Company, the Company
recognized an expense in 2004 of $555,000, the difference between the exercise
price of the option and the market price on the date of grant on December28,2004. Mr. Schumacher takes the position that the options received in 2004
were
not for compensation for tax purposes. The Company is maintaining an
accrued liability for payroll taxes until it is reasonably certain of its
position.
In
2005
the Company had a consulting agreement with Peter Gunnerman’s wholly owned
company Global 6 LLC prior to him becoming the Company’s COO and President.
Global 6 LLC was paid $50,000 in consulting fees and reimbursed $50,015 in
travel related expenses.
Beginning
in 2005, the Company had a consulting agreement with Peak One Consulting,
Inc.,
a company owned 100% by a Director, Richard Masica, which was paid $29,711
and
$57,313 in fees for management and technical consulting and reimbursed $2,784
and $18,683 in travel related expenses in 2006 and 2005,
respectively.
The
Company had a consulting arrangement with a Director Michael Heffner who
was
paid $48,871 in technical consulting fees and $5,216 in travel related expense
reimbursements in 2006.
Total
related party expenses were $4,163,920, $1,539,018, and $1,771,887 in 2006,
2005, and 2004, respectively. Total related party cash payments were $1,880,420,
$1,277,018, and $755,101 in 2006, 2005, and 2004 respectively. Included in
these
figures are amounts disclosed in Notes 10 and 13.
In
September 2006, the Company advanced approximately $137,000 to the joint
venture, Fujairah Oil Technology, to be used for expenses relating to
construction of the Fujairah test facility. Of the funds advanced, approximately
$96,000 remain for future expenses related to the construction of the test
facility.
16.Operating
Lease
The
Company leases office and warehouse space in Sparks, Nevada. In February
2004
the Company extended its lease term for one additional year through March3,2005, and in February of 2005, the lease was again extended for two years
to
February 28, 2007, and subsequently extended through May 2007. Dr. Rudolf
Gunnerman, the Chairman and CEO guaranteed the lease.
F-30
Following
is a schedule of payments required under the rental lease
agreement:
2007
$
74,393
After
2007
-0-
Total
minimum lease payments
$
74,393
The
Company incurred $439,373, $434,635, and $443,007 for rent expense in 2006,
2005, and 2004, respectively.
17.Quarterly
Financial Information (Unaudited)
Summarized
unaudited quarterly financial information for the years ended December 31,2006,
2005 and 2004 is noted below (in thousands, except for per share
amounts):
2006
Mar.
31
Jun.
30
Sep.
30
Dec.
31
(restated)
(restated)
(restated)
Net
revenues
$
-
$
-
$
-
$
-
Gross
profit
$
-
$
-
$
-
$
-
Net
(loss)
$
(9,180
)
$
(18,452
)
$
(5,724
)
$
(5,760
)
Net
(loss) per share - basic and diluted
$
(0.14
)
$
(0.25
)
$
(0.08
)
$
(0.08
)
2005
Mar.
31
Jun.
30
Sep.
30
Dec.
31
Net
revenues
$
-
$
-
$
-
$
-
Gross
profit
$
-
$
-
$
-
$
-
Net
(loss)
$
(2,325
)
$
(2,357
)
$
(1,840
)
$
(2,906
)
Net
(loss) per share - basic and diluted
$
(0.04
)
$
(0.04
)
$
(0.03
)
$
(0.05
)
2004
Mar.
31
Jun.
30
Sep.
30
Dec.
31
Net
revenues
$
-
$
-
$
-
$
-
Gross
profit
$
-
$
-
$
-
$
-
Net
loss
$
(803
)
$
(736
)
$
(915
)
$
(1,692
)
Net
loss per share - basic and diluted
$
(0.02
)
$
(0.02
)
$
(0.02
)
$
(0.02
)
F-31
18.New
Accounting Pronouncements
In
June
2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation
No. 48, Accounting
for Uncertainty in Income Taxes — an Interpretation of FASB Statement
No. 109 (FIN 48).
This interpretation clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with
FAS No. 109, Accounting
for Income Taxes
and will
require that companies determine whether it is more-likely-than-not that
a tax
positions taken or expected to be taken in tax returns would be sustained
based
on their technical merits. FIN 48 is effective for the Company
beginning January 1, 2007. The
adoption of this Interpretation is not expected to have a material impact
on the
Company’s financial position, results of operations, or cash flows.
In
September 2006, the SEC issued SAB No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements.
SAB No.
108 provides guidance on how prior year misstatements should be considered
when
quantifying misstatements in current year financial statements for purposes
of
determining whether the current year’s financial statements are materially
misstated. SAB No. 108 is effective for fiscal years ending after November15,2006. The application of SAB No. 108 did not have a material impact on the
Company’s results of operations or financial position.
In
July
2006, the FASB issued FASB Interpretation No. 48, Accounting
for Uncertainty in Income Taxes
(“FIN
48”). The interpretation clarifies the accounting for uncertainty in income
taxes recognized in a company’s financial statements in accordance with SFAS No.
109, Accounting for Income Taxes. Specifically, the pronouncement prescribes
a
recognition threshold and a measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken
in a
tax return. The interpretation also provides guidance on the related
derecognition, classification, interest and penalties, accounting for interim
periods, disclosure and transition of uncertain tax positions. This
interpretation was effective for the Company on January 1, 2007. The Company
is
currently evaluating the impact this new standard will have on its future
results of operations and financial position.
In
September 2006, the FASB issued SFAS No. 157, Fair
Value Measurements
(“SFAS
157”), which defines fair value, establishes a framework for measuring fair
value in accordance with GAAP, and expands disclosures about fair value
measurements. SFAS 157 applies where other accounting pronouncements require
or
permit fair value measurements; it does not require any new fair value
measurements under GAAP. SFAS 157 is effective for the Company on January1,2007. The effects of adoption will be determined by the types of instruments
carried at fair value in the Company’s financial statements at the time of
adoption as well as the method utilized to determine their fair values prior
to
adoption. Based on the Company’s current use of fair value measurements, SFAS
157 is not expected to have a material effect on the results of operations
or
financial position of the Company.
The
FASB
has issued several new standards which have effective dates subsequent to
the
Company’s year end. Management does not believe that any of these new
standards will have a material impact on the Company’s financial position,
results of operations or cash flows in the near future.
19.Subsequent
Events
On
January 12, 2007, the former CEO, Dr. Rudolf Gunnerman, was dismissed as
Chief
Executive Officer and Chairman of the Board. Larry Ryan was named the new
Chief
Executive Officer and Robert van Maasdijk was appointed Chairman of the
Board.
On
January 24, 2007, a former director, who had previously served on the Board
of
Directors in 2005, rejoined the board.
Effective
March 12, 2007, the Company raised $7,899,689 through an exercise of outstanding
warrants. Warrants for 1,952,068 shares were exercised at their stated exercise
prices of $1.125 and $1.5625 pursuant to the Securities Purchase Agreements
dated as of June 1, 2004 and June 14, 2004, respectively. Half of the warrants
issued pursuant to the Securities Purchase Agreement, dated as of March 29,2006
(the “2006 Warrants”) were exercised at $2.68, which was a reduction from the
original exercise price of $6.805. The warrant holders received additional
warrants (the “Additional Warrants”) to replace all of the warrants that were
exercised on a one to one basis. Each Additional Warrant expires three years
from the date of issuance and entitles the holder to purchase one share of
common stock at $2.68. The issuance of the Additional Warrants is exempt
from
registration under the Securities Act of 1933, as amended (the “Securities Act”)
pursuant to Section 4(2) of the Securities Act, as a transaction by an issuer
not involving a public offering.
F-32
Dates Referenced Herein and Documents Incorporated by Reference
