UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended ___December 31, 2002_______________
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________________ to ___________________
Commission file number _______0-20333_______________________________________
Nocopi Technologies, Inc.
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(Name of small business issuer in its charter)
Maryland 87-0406496
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
537 Apple Street, West Conshohocken, PA 19428
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (610) 834-9600
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Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
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None Not Applicable
Securities registered under section 12(g) of the Exchange Act:
Common Stock $.01 par value
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(Title of class)
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(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 _.
Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year. $736,800.
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the issuer. $1,450,000 at March 31, 2003.
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date. 45,972,241 shares of Common
Stock, $.01 par value at March 31, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
None
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
PART I
ITEM 1. BUSINESS
Background
Nocopi Technologies, Inc. (hereinafter "Nocopi", "Registrant" or the "Company")
was organized in 1983 to exploit a technology developed by its founders for
impeding the reproduction of documents on office copiers. In its early stages of
development, Nocopi's business consisted primarily of selling copy resistant
paper to protect corporate documents and information. More recently, Registrant
has increasingly focused on developing and marketing technologies for document
and product authentication which can reduce losses caused by fraudulent document
reproduction and by product counterfeiting and/or diversion. Registrant derives
revenues by licensing its technologies, both to end-users and to value-added
resellers, and by selling products incorporating its technologies and technical
support services.
The decline in Registrant's financial condition has not stabilized or been
reversed. By the end of 2002, this decline had led to a severe working capital
deficiency and adverse liquidity that threatened and continues to threaten to
require the imminent cessation of Registrant's operations. During 2002,
Registrant received new capital investments totaling $411,000 from a variety of
sources including existing and new stockholders and received $160,400 in loans
from three individuals including the Company's Chairman of the Board. The funds
invested have permitted Registrant to continue in operation in the near term.
However, Registrant believes that, to continue to conduct business operation in
the immediate future, it must obtain additional capital immediately to fund
continuing operating deficits. Additional capital is also needed to fund
programs and activities designed to increase Registrant's operating revenues to
levels that will sustain its operations.
Registrant is currently involved in a substantial dispute with Euro-Nocopi,
S.A., its former European licensee, the cost of which has contributed
substantially to Registrant's continuing losses, working capital deficit and
adverse liquidity. Expenses associated with this dispute increased during 2002.
It remains highly uncertain whether Registrant can achieve positive cash flow
before its adverse liquidity forces it to cease or suspend operations.
Registrant's management intends to seek additional capital, if possible, and may
continue to explore possible business combination opportunities if such
opportunities are presented.
Anti-Counterfeiting and Anti-Diversion Technologies and Products
Continuing developments in copying and printing technologies have made it ever
easier to counterfeit a wide variety of documents. Lottery tickets, gift
certificates, event and transportation tickets, travelers' checks and the like
are all susceptible to counterfeiting, and Registrant believes that losses from
such counterfeiting have increased substantially with improvements in these
technologies. Product counterfeiting has long caused losses to manufacturers of
brand name products, and Registrant believes these losses have also increased as
the counterfeiting of labeling and packaging has become easier.
Registrant's document authentication technologies are useful to businesses
desiring to authenticate a wide variety of printed materials and products. These
include a technology with the ability to print invisibly on certain areas of a
document. The invisible printing can be activated or revealed by use of a
special highlighter pen when authentication is required. This technology is
marketed under the trademark COPIMARK(TM). Other variations of the COPIMARK(TM)
technology involve multiple color responses from a common pen, visible marks of
one color that turn another color with the pen or visible and invisible marks
that turn into a multicolored image. A related technology is Nocopi's RUB &
REVEAL(R) system, which permits the invisible printing of an authenticating
symbol or code that can be revealed by rubbing a fingernail over the printed
area. These technologies provide users with the ability to authenticate
documents and detect counterfeit documents. Applications include the
authentication of documents having intrinsic value, such as merchandise
receipts, checks, travelers' checks, gift certificates and event tickets, and
the authentication of product labeling and packaging. When applied to product
labels and packaging, such technologies can be used to detect counterfeit
products whose labels and packaging would not contain the authenticating marks
invisibly printed on the packaging or labels of the legitimate product, as well
as to combat product diversion (i.e. sale of legitimate products through
unauthorized distribution channels or in unauthorized markets). Registrant's
1
related invisible inkjet technology permits manufacturers and distributors to
track the movement of products from production to ultimate consumption when
coupled with proprietary software. Management believes that the "track and
trace" capability provided by this technology should be attractive to brand
owners and marketers.
Document Security Products
Registrant continues to offer a line of burgundy colored papers that deter
photocopying and transmission by facsimile. This colored paper inhibits
photocopier reproduction at the cost of loss of easy legibility to the reader.
Registrant currently offers its copy resistant papers in three grades, each
balancing improved copy resistance against diminished legibility. Registrant
also sells user defined, pre-printed forms on which selected areas are colored
to inhibit reproduction. An example is a doctor's prescription form with the
signature area protected. This product line is called SELECTIVE NOCOPI(TM).
Registrant also offers several inks that impede photocopying by color copiers.
This technology is called COLORBLOC(R).
Since late 1999, Registrant has, in addition to marketing its own technologies
and products, acted as a distributor for a line of Pantograph security paper.
This patented product, complementary to the Registrant's line of security paper,
produces a message, such as "unauthorized copy", when a copy of an original
document that was printed or typed on the Pantograph paper, is reproduced on a
photocopier. This product line is called COPI-ALERT.
The following table illustrates the approximate percentage of Registrant's
revenues accounted for by each type of its products for each of the two last
fiscal years:
Year Ended December 31,
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Product Type 2002 2001
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Anti-Counterfeiting & Anti-Diversion Technologies and Products 79% 83%
Document Security Products 21% 17%
Marketing
The marketing approach of Registrant is to offer sufficient flexibility in its
products and technologies so as to provide cost effective solutions to a wide
variety of counterfeiting, diversion and copier fraud problems. As a technology
company, Registrant generates revenues primarily by collecting license fees from
market-specific manufacturers who incorporate Registrant's technologies into
their manufacturing process and their products. Registrant also licenses its
technologies directly to end-users.
Registrant has identified a number of major markets for its technologies and
products, including security printers, manufacturers of labels and packaging
materials and distributors of brand name products. Within each market, key
potential users have been identified, and several have been licensed. Within
North America, sales efforts include direct selling by company personnel to
create end user demand and selling through licensee sales forces and sales
agents with support from company personnel. Registrant has determined that
technical sales support by its personnel is of great importance to increasing
its licensees' sales of products incorporating Registrant's technologies and,
therefore, seeks to maintain, to the extent permitted by its limited resources,
its commitment to providing such support.
Since 1999, Registrant's management has refocused the company's marketing
efforts somewhat in view of the limited resources available to the Company for
marketing and the need to improve the Registrant's cash flow. Current marketing
efforts are focused on Registrant's more mature technologies that can be
utilized by customers with relatively less development efforts.
As continued improvements in color copier and desktop publishing technology make
counterfeiting and fraud opportunities less expensive and more available,
Registrant intends, to the extent feasible, to maintain an interactive product
development and enhancement program with the combined efforts of marketing,
applications engineering and research and development. Registrant's objective is
to concentrate its efforts on developing market-ready products with the most
beneficial ratios of market potential to development time and cost.
2
Except in Europe, Registrant has historically sought to market its technologies
through its own employees and through independent sales representatives. In
1994, the Registrant formed a European company, Euro-Nocopi, S.A., to market the
Company's technologies in Europe under an exclusive licensing arrangement. The
Registrant owns approximately an 18% interest in Euro-Nocopi, S.A. In December
2000, Registrant terminated its licensing arrangement with Euro-Nocopi, S.A. due
to its commencement of proceedings to liquidate and dissolve and to its failure
to pay license fees and other amounts due to Registrant under the licensing
arrangement. Registrant currently is seeking to exploit the European market for
its technologies directly and through its association with another licensee.
Registrant has taken several steps to improve the marketing of its technologies.
These include the implementation of a new web site and online store designed
both to more effectively promote the Company's products and to provide for
smoother online ordering of certain products, and the establishment of programs
to expand its network of authorized dealers and sales agents.
Major Customers
During 2002, Registrant made sales or obtained revenues equal to 10% or more of
Registrant's 2002 total revenues from one non-affiliated customer, Nashua
Corporation, which accounted for approximately 16% of 2002 revenues.
Outside Sales Agents
Registrant has engaged outside sales agents who are paid commissions on sales to
various customers of Registrant and may also receive retainers and reimbursement
for certain expenses. During 2001 the total payments to outside sales agents was
approximately $26,000. No commissions were paid to outside sales agents in 2002.
Manufacturing
Registrant has a small facility for the manufacture of its security inks. Except
for this facility, Registrant does not maintain manufacturing facilities.
Registrant presently subcontracts the manufacture of its applications (mainly
printing and coating) to third party manufacturers and expects to continue such
subcontracting. Because some of the processes that Nocopi uses in its
applications are based on relatively common manufacturing technologies, there
appears to be no technical or economic reason for Registrant to invest capital
in its own manufacturing facilities.
Registrant has established a quality control program that currently entails
laboratory analysis of developed technologies. When warranted, Registrant's
specially trained technicians travel to third party production facilities to
install equipment, train client staff and monitor the manufacturing process.
Patents
Nocopi has received various patents and/or has patents pending in the United
States, Canada, South Africa, Saudi Arabia, Australia, New Zealand, Japan,
France, the United Kingdom, Belgium, the Netherlands, Germany, Austria, Italy,
Sweden, Switzerland, Luxembourg, and Liechtenstein. Patent applications for
Registrant's technology (including improvements in the technology) have also
been filed in numerous other jurisdictions where commercial usage is foreseen,
including other countries in Europe, Japan, Australia, and New Zealand, and the
rights under such applications have been assigned to Registrant. Registrant's
patent counsel, which conducted the appropriate searches in Canada and the
United States, has reviewed the results of searches conducted in Europe and
advised management that effective patent protection for Registrant's technology
should be obtainable in all countries in which the patent applications have been
filed. There can be no assurance, however, that such protection will be
obtained.
When a new product or process is developed, the developer may seek to preserve
for itself the economic benefit of the product or process by applying for a
patent in each jurisdiction in which the product or process is likely to be
exploited. Generally speaking, in order for a patent to be granted, the product
or process must be new and be inventively different from what has been
previously patented or otherwise known anywhere in the world. Patents generally
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have a duration of 17 years from the date of grant or 20 years from the date of
application depending on the jurisdiction concerned, after which time any person
is free to exploit the product or process covered by a patent. A person who is
the owner of a patent has, within the jurisdiction in which the patent is
granted, the exclusive right to exploit the patent either directly or through
licensees, and is entitled to prevent any person from infringing on the patent.
The granting of a patent does not prevent a third party from seeking a judicial
determination that the patent is invalid. Such challenges to the validity of a
patent are not uncommon and are occasionally successful. There can be no
assurance that a challenge will not be filed to one or more of Registrant's
patents and that, if filed, such challenge(s) will not be successful.
In the United States and Canada, the details of the product or process that is
the subject of a patent application are not publicly disclosed until a patent is
granted. However, in some other countries, patent applications are automatically
published at a specified time after filing.
Research and Development
Nocopi has been involved in research and development since its inception.
Although Registrant's deteriorating financial condition has forced it to reduce
funding for research and development in recent years, it intends to continue its
research and development activities in three areas, to the extent feasible.
First, Registrant will seek to continue to refine its present family of
products. Second, Registrant will seek to develop specific customer
applications. Finally, Registrant will seek to expand its technology into new
areas of implementation. There can be no assurances that Registrant will be able
to obtain funds necessary to continue its research and development activities.
During the years ended December 31, 2002, and 2001, Nocopi expended
approximately $254,100 and $251,600 respectively, on research and development.
Competition
In the area of document and product authentication and serialization, Registrant
is aware of other technologies, both covert and overt surface marking
techniques, requiring decoding implements or analytical methods to reveal the
relevant information. These technologies are offered by other companies for the
same anti-counterfeiting and anti-diversion purposes the Registrant markets its
covert technologies. These include, among others, biological DNA codes,
microtaggants, thermochronic, UV and infrared inks as well as encryption, 2D
symbology and laser engraving. Registrant believes its patented and proprietary
technologies provide a unique and cost-effective solution to the problem of
counterfeiting and gray marketing in the document and product authentication
markets it has traditionally sought to exploit. Registrant knows of one large
company that recently began to offer an expanding portfolio of product security
solutions, some of which may be competitive with Registrant's authentication
technologies. In order both to minimize the adverse effect of this new
competition and to participate in the competitor's success, it has entered into
a license agreement with this competitor so that products incorporating
Registrant's technologies can be offered as part of this portfolio.
Registrant is not aware of any competitors that market paper which functions in
the same way as Nocopi security papers, although management is aware of a
limited number of competitors which are attempting different approaches to the
same problems which Registrant's products address. Registrant is aware of a
Japanese company that has developed a film overlay that is advertised as
providing protection from photocopying. Registrant has examined the film overlay
and believes that it has a limited number of applications. Nocopi security paper
is also considerably less expensive than the film overlay.
Other indirect competitors are marketing products utilizing the hologram and
copy void technologies. The hologram, which has been incorporated into credit
cards to foil counterfeiting, is considerably more costly than Registrant's
technology. Copy void is a security device that has been developed to indicate
whether a document has been photocopied. Registrant also markets a product that
has similar features to the copy void technology.
4
Registrant currently has extremely limited resources, and there can be no
assurance that other businesses with greater resources than Registrant will not
enter Registrant's markets and compete successfully with Registrant.
Euro-Nocopi, S.A.
Registrant formed Euro-Nocopi, S.A. in 1994, to market the Company's
technologies in Europe under an exclusive licensing arrangement. Registrant
currently owns approximately an 18% interest in Euro-Nocopi, S.A. During 2000,
there arose between Registrant and Euro-Nocopi, S.A. a number of areas of
conflict and dispute, leading each party to the licensing arrangement to assert
informally that the other was in breach of its obligations under that
arrangement. The parties initially sought to resolve their differences by
negotiating a transaction in which Euro-Nocopi, S.A. would have purchased from
Registrant its entire equity interest as well as the paid-up European rights to
Registrant's technologies. These negotiations terminated without agreement early
in December 2000.
Following the termination of the transaction negotiations, Registrant was
informed by Euro-Nocopi, S.A. that it had adopted resolutions to liquidate and
dissolve. In December 2000, Registrant terminated its license agreement with
Euro-Nocopi, S.A. in accordance with its terms and discontinued the provision of
support (including the sale of proprietary inks) to Euro Nocopi, S.A. and its
customers. Euro-Nocopi S.A. responded by denying that Registrant's termination
of the licensing agreement was permissible or effective, and by asserting a
claim that, as a result of alleged breaches of the licensing arrangement by
Registrant, it was entitled to a royalty-free license to exploit Registrant's
technologies in Europe.
Promptly thereafter, Euro-Nocopi, S.A. commenced an action before a court in
Paris, France in which it sought the entry of an order, in the nature of a
preliminary injunction, to compel Registrant to honor the license agreement
pending judicial or arbitral resolution of the dispute between the parties under
the license agreement. Notably, in the French litigation, Euro-Nocopi S.A. did
not seek an adjudication on the merits of the underlying dispute. In March 2001,
the Emergency Judge hearing the action issued a decision denying the relief
requested by Euro-Nocopi, S.A. and the shareholders. The decision, which does
not purport to be a final adjudication of the merits of the controversy but only
of Euro-Nocopi's request for preliminary relief, held that Euro-Nocopi S.A. was
not entitled to the requested order because Registrant had validly terminated
the licensing arrangement in mid-December, and also ordered Euro-Nocopi, S.A. to
pay into escrow the approximately $125,000 that Registrant claimed was due and
owing under the licensing arrangement.
In March 2001, Euro-Nocopi, S.A. commenced an arbitration proceeding before the
American Arbitration Association in New York, NY against Registrant. In this
proceeding, Euro-Nocopi, S.A. has not asserted a claim for damages but has
asserted a claim for an award in the nature of a declaratory judgment to the
effect that, because Registrant has (allegedly) breached the license agreement,
Euro-Nocopi, S.A. is entitled to a perpetual royalty-free license to exploit
Registrant's technologies in Europe. These proceedings are described below under
the heading "Legal Proceedings."
Following its termination of the licensing arrangement with Euro-Nocopi, S.A.,
Registrant moved to directly exploit the European marketplace for its
technologies.
Employees
At March 31, 2003, Registrant had four full-time and three part-time employees.
Registrant believes that its relations with its employees are good.
Financial Information about Foreign and Domestic Operations
Certain information concerning Registrant's foreign and domestic operations is
contained in Note 9 to Registrant's Financial Statements included elsewhere in
this Annual Report on Form 10-KSB.
ITEM 2. PROPERTIES
Registrant's corporate headquarters, research and ink production facilities are
currently located at 537 Apple Street, West Conshohocken, Pennsylvania 19428.
Its telephone number at that location is (610) 834-9600. These premises consist
of approximately 14,800 square feet of space leased from an unaffiliated third
party under a lease that expired in February 2003. Registrant is renting the
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premises on a month-to-month basis until it relocates to new premises.
Registrant currently plans to complete this relocation during the second quarter
of 2003. Current monthly rent under this lease is $9,000. Registrant is also
responsible for the operating costs of the building.
In March 2003 Registrant negotiated a five year lease with an unaffiliated third
party, commencing in April 2003, for 5,000 square feet of space in a
multi-tenant building at 9 Portland Road, West Conshohocken, Pennsylvania 19428.
Initial monthly rent at this location is $2,813 escalating four percent on each
anniversary date of the lease. Registrant is also responsible for its pro-rata
share of the operating costs of the building. Registrant anticipates that it
will incur leasehold improvement expenditures of approximately $20,000 before
occupying the space in the second quarter of 2003. Registrant believes that the
newly leased space will be adequate for its current needs due to the loss of
customers over the past years and the reduction in its number of employees and
that its operating expenses will be lowered as a result.
ITEM 3. LEGAL PROCEEDINGS
Except as set forth below, Registrant is not aware of any material pending
litigation (other than ordinary routine litigation incidental to its business
where, in management's view, the amount involved is less than 10% of
Registrant's current assets) to which Registrant is or may be a party, or to
which any of its properties is or may be subject, nor is it aware of any pending
or contemplated proceedings against it by any governmental authority. Registrant
knows of no material legal proceedings pending or threatened, or judgments
entered against, any director or officer of Registrant in his capacity as such.
In December 2000, Euro-Nocopi, S.A, Registrant's former European licensee,
commenced proceedings against Registrant in a court in Paris, France. These
proceedings are described above under the heading "Euro-Nocopi, S.A." In March
2001, Euro-Nocopi, S.A. commenced arbitration proceedings against Registrant
before the American Arbitration Association in New York, NY. In these
proceedings, Euro-Nocopi, S.A. has sought an award in the nature of a
declaratory judgment to the effect that, due to alleged breaches by Registrant
of the licensing arrangement between Registrant and Euro-Nocopi. S.A., it is
entitled to a royalty-free license to exploit Registrant's technologies in
Europe. Euro-Nocopi, S.A. has not sought an award of money damages.
Euro-Nocopi's demand appears to allege that Registrant has committed numerous
breaches of the licensing arrangement between the parties, notably by failing to
disclose certain technical information, by failing to provide technical support,
services and products to Euro-Nocopi, S.A. and by entering into a licensing
agreement with a third party allegedly violating the exclusivity provisions of
the Euro-Nocopi, S.A. licensing arrangement.
Registrant has filed a response to Euro-Nocopi's demand denying that Euro-Nocopi
is entitled to the relief requested and has filed a counter-demand contending
that it has validly terminated the Euro-Nocopi licensing arrangement and seeking
to recover in excess of $125,000 owed to it by Euro-Nocopi, S.A. under the
terminated licensing arrangement. Registrant intends to defend itself against
Euro-Nocopi's claims and to assert its counterclaim vigorously. The parties are
currently engaged in discussions relating to the settlement of the arbitration,
and all related matters, and the arbitration hearing on the merits has been
postponed pending such discussions.
In March 2001 certain shareholders of Euro-Nocopi, S.A. filed suit in a court in
Paris, France against certain current and former officers and directors of
Registrant, and against a licensee of Registrant. Registrant is not named as a
defendant in the suit. The suit seeks damages in excess of $7 million from the
defendants for various alleged acts of oppression, self-dealing and fraud in
connection with the organization and capitalization of Euro-Nocopi, S.A., the
management of that company and Registrant's management of its relationship with
that company. The defendants in this litigation have denied any liability to the
plaintiffs and have claimed indemnification from the Company in connection with
the lawsuit, and Registrant has advanced certain funds toward payment of the
costs of defense.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended December 31, 2002, no matters
were submitted to a vote of Registrant's security holders.
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PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Registrant's Common Stock is traded on the over-the-counter market and quoted on
the NASD over-the-counter Bulletin Board under the symbol "NNUP". The table
below presents the range of high and low bid quotations of Registrant's Common
Stock by calendar quarter for the last two full fiscal years and for a recent
date, as reported by the National Quotation Bureau, Inc. The quotations
represent prices between dealers and do not include retail markup, markdown, or
commissions; hence, such quotations do not represent actual transactions.
High Bid Low Bid
-------- -------
January 1, 2001 to March 31, 2001 $.20 $.11
April 1, 2001 to June 30, 2001 $.15 $.08
July 1, 2001 to September 30, 2001 $.15 $.06
October 1, 2001 to December 31, 2001 $.14 $.05
January 1, 2002 to March 31, 2002 $.16 $.10
April 1, 2002 to June 30, 2002 $.11 $.07
July 1, 2002 to September 30, 2002 $.08 $.05
October 1, 2002 to December 31, 2002 $.08 $.05
January 1, 2003 to March 31, 2003 $.07 $.03
As of March 31, 2003, 45,972,241 shares of Registrant's Common Stock were
outstanding. The number of holders of record of Registrant's Common Stock was
approximately 1,100. However, Registrant estimates that it has a significantly
greater number of Common Stockholders because a number of shares of Registrant's
Common Stock are held of record by broker-dealers for their customers in street
name. In addition to the 45,972,241 shares of Common Stock which are
outstanding, Registrant, at March 31, 2003, has reserved for issuance 2,700,000
shares of its Common Stock which underlie outstanding options to purchase Common
Stock of the Registrant. Under the terms of a Subscription Agreement under which
3,333,333 shares of Registrant's common stock were purchased from the Registrant
by an investment partnership in late 2002, one of whose partners is a director
of Registrant, Registrant has agreed to issue 40,000,000 warrants, at varying
prices ranging from $.10 per share to $.25 per share, exercisable during various
periods through year-end 2003 through year-end 2006, subject to partial rollover
and extension, to the partnership. The issuance of the warrants are subject to
the negotiation and agreement of the Registrant and the investors on the
definitive terms thereof and also to the approval by the Registrant's common
stockholders of an amendment to the Registrant's charter to increase its
authorized capital to a number of shares sufficient to permit exercise of the
warrants.
Registrant has paid no cash dividends on its Common Stock and does not
anticipate paying any such dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Forward-Looking Information
The information in this Management's Discussion and Analysis of Results of
Operations and Financial Condition contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors, which may cause our actual results, performance or achievements
or industry results to be materially different from any future results,
performance or achievements expressed or implied by these forward-looking
statements. Such factors include those described in "Uncertainties That May
Affect the Company, its Operating Results and Stock Price." The forward-looking
statements included in this report may prove to be inaccurate. In light of the
7
significant uncertainties inherent in these forward-looking statements, you
should not consider this information to be a guarantee by us or any other person
that our objectives and plans will be achieved. The Company does not undertake
to publicly update or revise its forward-looking statements even if experience
or future changes make it clear that any projected results (expressed or
implied) will not be realized.
Results of Operations
The Company's revenues are derived from royalties paid by licensees of the
Company's technologies, fees for the provision of technical services to
licensees and from the direct sale of products incorporating the Company's
technologies, such as inks, security paper and pressure sensitive labels, and
equipment used to support the application of the Company's technologies, such as
ink-jet printing systems. Royalties consist of guaranteed minimum royalties
payable by the Company's licensees in certain cases and additional royalties
which typically vary with the licensee's sales or production of products
incorporating the licensed technology. Service fee and sales revenues vary
directly with the number of units of service or product provided.
Because the Company has a relatively high level of fixed costs, its operating
results are substantially dependent on revenue levels. Because revenues derived
from licenses and royalties carry a much higher gross profit margin than other
revenues, operating results are also significantly affected by changes in
revenue mix.
Both the absolute amounts of the Company's revenues and the mix among the
various sources of revenue are subject to substantial fluctuation. The Company
has a relatively small number of substantial customers rather than a large
number of small customers. Accordingly, changes in the revenue received from a
significant customer can have a substantial effect on the Company's total
revenue and on its revenue mix and overall financial performance. Such changes
may result from a customer's product development delays, engineering changes,
changes in product marketing strategies and the like. In addition, certain
customers have, from time to time, sought to renegotiate certain provisions of
their license agreements and, when the Company agrees to revise terms, revenues
from the customer may be affected.
Revenues for 2002 were $736,800, a decline of 5%, or $35,300, from $772,100 in
2001. Licenses, royalties and fees declined in 2002 by 11% to $441,100 from
$498,300 in 2001. The reduction in licenses, royalties and fees is due primarily
to the termination or non-renewal of license arrangements with three licensees,
including the Company's largest 2001 customer, during 2002 offset in part by the
addition of two new licensees. Product and other sales increased by $21,900, or
8% to $295,700 in 2002 from $273,800 in 2001. The increase in product sales
reflects higher level of sales of the Company's line of security papers in 2002
compared to 2001.
Gross profit declined to $358,000 or 49% of revenues in 2002 from $405,900 or
53% of revenues in 2001. Licenses, royalties and fees have historically carried
a higher gross profit than product sales, which generally consist of supplies or
other manufactured products which incorporate the Company's technologies or
equipment used to support the application of its technologies. These items
(except for inks which are manufactured by the Company) are generally purchased
from third-party vendors and resold to the end-user or licensee and carry a
lower gross profit than licenses, royalties and fees. The 2002 gross profit and
gross profit percentage was negatively impacted by the decline in revenues from
licenses, royalties and fees as well higher expenditures for paper purchased for
resale and higher production costs incurred in the manufacture of the Company's
line of security inks.
Research and development expenses of $254,100 in 2002 approximated the $251,600
incurred in 2001.
Sales and marketing expenses increased to $269,900 in 2002 from $251,700 in
2001. The increase reflects the hiring of a sales executive in the fourth
quarter of 2001 offset in part by a reduction in fees paid to sales agents and
consultants and lower travel expenses during 2002.
General and administrative expenses (exclusive of legal expenses) decreased to
$269,600 in 2002 from $376,400 in 2001 as the Company was forced to strictly
limit its expenditures to conserve its cash resources. The decline in 2002
compared to 2001 relates to lower audit fees, consulting fees and costs involved
in the acquisition of new patents and the maintenance of existing patents in
2002 compared to 2001.
8
Legal expenses increased to $479,600 in 2002 from $313,900 in 2001. Significant
legal expenses have been incurred since early 2001 as a result of the
arbitration proceedings and other litigation in both the United States and
France between the Company and Euro-Nocopi, S.A., its former European licensee.
The increase 2002 compared to 2001 results primarily from higher arbitration
related expenses as the arbitration proceedings accelerated during the year.
While the arbitration was scheduled to be heard by the arbitrators in December
2002, the arbitration has been suspended at the request of the parties as
attorneys seek to negotiate a settlement. There can be no assurances that a
settlement acceptable to both parties will be concluded.
Related party expenses of $42,500 in 2001 consisted of consulting services
provided by a firm employing an officer of the Company. There were no such
expenses incurred in 2002.
Other income (expense) includes interest income on funds invested and, in 2002,
interest expense on the Demand Loans. The decline in interest income to $300 in
2002 compared to $3,400 in 2001 resulted from lower levels of cash invested.
The net loss increased to $924,500 in 2002 from $828,600 in 2001. The $95,600
increase in the net loss in 2002 from the prior year resulted primarily from
reductions in revenue and gross profit as the Company's business has continued
to contract and higher legal fees incurred in litigation and arbitration
proceedings with this former licensee.
Plan of Operation, Liquidity and Capital Resources
The Company's cash and cash equivalents increased to $139,000 at December 31,
2002 from $100 at December 31, 2001. During 2002, the Company sold 6,850,000
shares of its common stock to affiliated and non-affiliated individual investors
for $411,000, received loans of $160,400 from three individuals, including
$48,400 from the Chairman of the Board of the Company and used $432,500 to fund
operations.
The loss of a number of customers during the past three years and the
termination of the Company's exclusive European licensee in 2000 has had a
material adverse effect on the Company's results of operations and upon its
liquidity and capital resources. The Company believes that the conditions
arising from these circumstances will make it impossible for the Company to
continue in operation as a going concern unless it receives substantial new
capital investment in the immediate future. During 2002, the receipt of funds in
conjunction with the sale of approximately 18% of the Company's common stock as
was outstanding at December 31, 2001 and loans of $160,400 has permitted the
Company to continue in operation. The Company's illiquidity has forced it to
follow a policy of deferring payment to its vendors, even where such deferral
has not been agreed to by the vendors. As a result, the Company's trade payables
have increased to $649,200 at December 31, 2002 from $237,400 at December 31,
2001. Accordingly, the Company is currently in default of the payment terms
extended by certain of its professional service providers and other vendors,
some of which have suspended providing services and/or credit to the Company and
may require payment in advance. Management of the Company believes that, to
survive, it must obtain additional capital immediately to reduce its substantial
obligations, fund continuing operating deficits and fund investment needed to
increase its operating revenues to levels that will sustain its operations. If
the Company fails to significantly increase its cash balances through further
equity investment, for which it has no commitments and only very limited
prospects, it will be forced to cease operations due to a lack of cash early in
the second quarter of 2003. There can be no assurances that the Company will be
able to secure additional equity investment before it is forced to cease
operations.
The Company, in response to the ongoing adverse liquidity situation, has
maintained a cost reduction program including staff reductions, where possible,
and curtailment of discretionary research and development and sales and
marketing expenses.
The Company plans to spend approximately $20,000 in leasehold improvements at
its newly leased premises during the second quarter of 2003.
9
Uncertainties That May Affect the Company, its Operating Results and Stock Price
The Company's operating results and stock price are dependent upon a number of
factors, some of which are beyond the Company's control. These include:
Inability to Continue in Operation Without Immediate New Capital Investment. The
Company had a negative working capital of $994,700 at December 31, 2002 and
experienced negative cash flow from operations of $432,500 in the year ended
December 31, 2002. The Company currently has insufficient cash to conduct its
business operations in the ordinary course without substantial regard for the
effect of a contemplated activity or transaction on its liquidity. Cash received
from the sale of common stock and the issuance of demand loans during 2002 have
allowed the Company to continue in operation to the current date but have not
been sufficient to offset the Company's ongoing cash deficits resulting in the
continuing deterioration of the Company's financial condition. Management does
not believe the Company can significantly improve its negative cash flow in the
near future. If it does not obtain a substantial cash infusion, (through capital
investment or otherwise) in the very near term, it will be forced to cease
operations due to a lack of cash by early in the second quarter of 2003. It is
uncertain whether the Company's assets will retain any value if the Company
ceases operations. There are no assurances that the Company will be able to
secure additional capital investment before it is forced to cease operations.
Continuing Euro-Nocopi Litigation. The Company is currently expending sums
representing a substantial portion of it revenues for professional fees and
costs relating to legal disputes between the Company and its former affiliate,
Euro-Nocopi, S.A. as described under the heading "Litigation". Management
believes that successful resolution of the disputes between it and Euro-Nocopi
is necessary for the Company to be able to license its technologies to European
users. If Euro-Nocopi succeeds in asserting its rights to a paid-up European
license, it will be entitled to license European end users of the Company's
technologies with no payment of license fees (by Euro-Nocopi or such users) to
the Company, and the Company will not be entitled to grant licenses or collect
license fees from European users or to grant worldwide licenses. The Company
cannot continue to pay the costs of this dispute unless it can obtain
substantial new capital investment, of which there can be no assurances, and the
Company will not prevail in this dispute if it cannot continue to pay such
costs. Even if the Company is able to continue its dispute with Euro-Nocopi
through resolution, or complete the settlement discussions currently underway,
there can be no assurance that the resolution will be a successful one for the
Company or that it will have a material positive effect on the financial
condition of the Company.
Possible Inability to Develop New Business. Even if the Company is able to raise
cash through additional capital investment or otherwise, it must quickly improve
its operating cash flow. Because the Company has already significantly reduced
its operating expenses, Management believes that any significant improvement in
the Company's cash flow must result from increases in its revenues from
traditional sources and from new revenue sources. The Company's ability to
develop new revenues may depend on the extent of both its marketing activities
and its research and development activities. There are no assurances that the
resources the Company, even with additional investment, can devote to marketing
and to research and development will be sufficient to increase the Company's
revenues to levels resulting in positive cash flow.
Inability to Obtain Raw Materials and Products for Resale. The Company's adverse
financial condition has required it to significantly defer payments due vendors
who supply raw materials and other components of the Company's security inks,
security paper that the Company purchases for resale and professional and other
services. As a result, the Company is on credit hold with certain of its
suppliers and is required to pay cash in advance of shipment to others. Delays
in shipments to customers caused by the Company's inability to obtain materials
on a timely basis and the possibility that certain current vendors may
permanently discontinue to supply the Company with needed products could impact
the Company's ability to service its customers and adversely affect its customer
and licensee relationships. Management of the Company believes that, without
significant capital investment in the very near term, the Company will not be
able to maintain acceptable relationships with its vendors and professional
service providers. There are no assurances that the Company will be able to
secure sufficient capital investment to maintain its vendor accounts on
satisfactory terms.
10
Uneven Pattern of Quarterly and Annual Operating Results. The Company's
revenues, which are derived primarily from licensing and royalties, are
difficult to forecast due to the long sales cycle of the Company's technologies,
the potential for customer delay or deferral of implementation of the Company's
technologies, the size and timing of inception of individual license agreements,
the success of the Company's licensees and strategic partners in exploiting the
market for the licensed products, modifications of customer budgets, and uneven
patterns of royalty revenue and product orders. As the Company's revenue base is
not substantial, delays in finalizing license contracts, implementing the
technology to initiate the revenue stream and customer ordering decisions can
have a material adverse effect on the Company's quarterly and annual revenue
expectations and, as the Company's operating expenses are substantially fixed,
income expectations will be subject to a similar adverse outcome.
Volatility of Stock Price. The market price for the Company's common stock has
historically experienced significant fluctuations and may continue to do so. The
Company has, since its inception, operated at a loss and has not produced
revenue levels traditionally associated with publicly traded companies. The
Company's common stock is not listed on a national or regional securities
exchange and, consequently, the Company receives limited publicity regarding its
business achievements and prospects, nor do securities analysts and traders
extensively follow it. The market price may be affected by announcements of new
relationships or modifications to existing relationships. The stock prices of
many developing public companies, particularly those with small capitalizations,
have experienced wide fluctuations not necessarily related to operating
performance. Such fluctuations may adversely affect the market price of the
Company's common stock.
Intellectual Property. The Company relies on a combination of protections
provided under applicable international patent, trademark and trade secret laws.
It also relies on confidentiality, non-analysis and licensing agreements to
establish and protect its rights in its proprietary technologies. While the
Company actively attempts to protect these rights, the Company's technologies
could possibly be compromised through reverse engineering or other means. In
addition, the Company's ability to enforce its intellectual property rights
through appropriate legal action has been and will continue to be limited by the
Company's adverse liquidity. There can be no assurances that the Company will be
able to protect the basis of its technologies from discovery by unauthorized
third parties or to preclude unauthorized persons from conducting activities
that infringe on the Company's rights. The Company's adverse liquidity situation
has also impacted its ability to obtain patent protection on its intellectual
property and to maintain protection on previously issued patents. The Company
has been advised by its patent counsel that patent maintenance fees
approximating $20,000 will be due during 2003. The Company has not yet made a
decision on keeping any or all of these patents in force. There can be no
assurances that the Company will be able to continue to prosecute new patents
and maintain issued patents. As a result, the Company's customer and licensee
relationships could be adversely affected and the value of the Company's
technologies and intellectual property (including their value upon a liquidation
of the Company) could be substantially diminished.
Recently Issued Accounting Standards
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("Statement
144"), effective in fiscal years beginning after December 15, 2001, with early
adoption permitted, and in general are to be applied prospectively. Statement
144 establishes a single accounting model for the impairment or disposal of
long-lived assets, including discontinued operations. Statement 144 superseded
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," and APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The Company adopted SFAS No. 144 effective January 1, 2002. The
adoption of this standard had no effect on the Company's financial statements.
The following recently issued accounting pronouncements are currently not
applicable to the Company.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Correction." This Statement eliminates extraordinary accounting treatment for
reporting gain or loss on debt extinguishment, and amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions.
11
In November 2002, the FASB issued Interpretation 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This Interpretation expands the disclosures to be made
by a guarantor about its obligations under certain guarantees and requires that,
at the inception of a guarantee, a guarantor recognize a liability for the fair
value of the obligation undertaken in issuing the guarantee. The disclosure
requirements are effective immediately. The initial recognition and measurement
provisions of this Interpretation are effective for guarantees issued or
modified after December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation - Transition and Disclosure - an Amendment to SFAS 123". SFAS No.
148 provides two additional transition methods for entities that adopt the
preferable method of accounting for stock based compensation. Further, the
statement requires disclosure of comparable information for all companies
regardless of whether, when, or how an entity adopts the preferable, fair value
based method of accounting. These disclosures are now required for interim
periods in addition to the traditional annual disclosure. The amendments to SFAS
No. 123, which provides for additional transition methods are effective for
periods ending after December 15, 2002, although earlier application is
permitted. The amendments to the disclosure requirements are required for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements of Registrant meeting the requirements of Regulation S-B
(except section 228.310 and Article 11 of Regulation S-X thereof) are included
herein beginning at page F-1 of this Annual Report on Form 10-KSB.
For information required with respect to this Item 7, see "Financial Statements
and Schedules on pages F-1 through F-13 of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On March 23, 2002, Registrant engaged the accounting firm Cogen Sklar, LLP to
audit Registrant's financial statements for the year ended December 31, 2001.
The engagement of BDO Seidman, LLP which had been engaged by Registrant to audit
its financial statements for prior years was not renewed. Such firm had not
submitted a resignation, nor had it formally declined to stand for re-election
as Registrant's auditor. This event is more fully described in 8-K and 8-K/A
filings dated March 23, 2002 and April 3, 2002, respectively, which are
incorporated herein by reference.
PART III
The information required by Part III, items 9 through 12 inclusive, of
Form 10-KSB either (a) is incorporated by reference to Registrant's Definitive
Proxy Statement for the Annual Meeting of Stockholders if filed by April 30,
2003 or (b) will be furnished by amendment to this Form 10-KSB to be filed by
that date.
12
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following Financial Statements are filed as part of this Annual Report
on Form 10-KSB
PAGE
----
Report of Independent Certified Public Accountants F-1
Balance Sheet as of December 31, 2002 F-2
Statements of Operations for the Years ended
December 31, 2002 and 2001 F-3
Statements of Stockholders' Equity (Deficiency) for
the Years ended December 31, 2002 and 2001 F-4
Statements of Cash Flows for the Years ended
December 31, 2002 and 2001 F-5
Notes to Financial Statements F-6 to F-13
(b) The Exhibit Index begins on Page 15 of this Annual Report on Form 10-KSB.
No Current Reports on Form 8-K have been filed by the Registrant during the
quarter ended December 31, 2002.
ITEM 14. CONTROLS AND PROCEDURES
Within 90 days prior to the filing date of this report, we carried out an
evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures provide reasonable
assurance that material information required to be included in our periodic SEC
reports is recorded, processed, summarized and reported within the time periods
specified in the relevant SEC rules and forms.
In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could
significantly affect those controls subsequent to the date of their last
evaluation.
13
SIGNATURES
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.
NOCOPI TECHNOLOGIES, INC.
Registrant
Dated: April 11, 2003 By: /s/ Michael A. Feinstein, M.D.
-------------------------------------
Michael A. Feinstein, M.D.
Chairman of the Board
Dated: April 11, 2003 By: /s/ Rudolph A. Lutterschmidt
--------------------------------------
Rudolph A. Lutterschmidt
Vice President, Chief Financial Officer
and Chief Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Date: April 11, 2003 /s/ Michael A. Feinstein, M.D.
--------------------------------
Michael A. Feinstein, M.D.,
Chairman of the Board
Date: April 11, 2003 --------------------------------
Franco Harris, Director
Date: April 11, 2003 /s/ Stanley G. Hart
--------------------------------
Stanley G. Hart, Director
Date: April 11, 2003 /s/ Richard Levitt
--------------------------------
Richard Levitt, Director
Date: April 11, 2003 /s/ Waldemar Maya, Jr.
--------------------------------
Waldemar Maya, Jr., Director
Date: April 11, 2003 /s/ Claude Nash
--------------------------------
Claude Nash, Director
Date: April 11, 2003 --------------------------------
John F. O'Brien III, Director
Date: April 11, 2003 --------------------------------
Alan Rihm, Director
Date: April 11, 2003 /s/ Michael Solomon
-------------------------------
Michael Solomon, Director
14
The following Exhibits are filed as part of this Annual Report on Form 10-KSB:
Exhibit
Number Description
------ -----------
3.1 Articles of Incorporation (1)
3.2 Bylaws (1)
3.3 Articles of Amendment to Articles of Incorporation (3)
3.4 Article of Amendment to Articles of Incorporation (5)
3.5 Amendments to Bylaws (6)
10.1 Summary Plan Description for Nocopi Technologies, Inc. 401(k) Profit
Sharing Plan (2)
10.2 Nocopi Technologies, Inc. 1996 Stock Option Plan (3)
10.3 Employment Agreement between Registrant and Dr. A. Gundjian (4)
10.4 Form of Common Stock Purchase Warrant (4)
10.5 Lease Agreement dated February 17, 1998 relating to premises at 537
Apple Street, West Conshohocken, PA 19428 (4)
10.6 Nocopi Technologies, Inc. 1999 Stock Option Plan (5)
10.7 Amended Summary Plan Description for Nocopi Technologies, Inc. 401(k)
Profit Sharing Plan (5)
10.8 Director Indemnification Agreement (6)
10.9 Officer Indemnification Agreement (6)
10.10 License Agreement with Westvaco Brand Security, Inc. (7)
10.11 Amendment to Westvaco License Agreement (7)
10.12 Amendment (No. 2) to Westvaco License Agreement (7)
10.13 Stock Purchase Agreement with Westvaco Brand Security, Inc. (7)
10.14 Registration Rights Agreement with Westvaco Brand Security, Inc. (7)
10.15 Collateral Assignment of Patent Rights to Westvaco Brand Security, Inc.
(7)
10.16 Escrow Agreement with Westvaco Brand Security, Inc. (7)
10.17 Amendment (No. 3) to Westvaco License Agreement
10.18 Subscription Agreement with Entrevest I Associates
10.19 Lease Agreement dated March 19, 2003 relating to premises at 9 Portland
Road, West Conshohocken, PA 19428
16.1 Letter dated March 27, 2002 from BDO Seidman, LLP re: Change in
Certifying Accountant (8)
99.1 Certificates of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
15
(1) Incorporated by reference to Registrant's Registration Statement on
Form 10, as filed with the Commission on or about August 19, 1992
(2) Incorporated by reference to Registrant's Annual Report on Form 10-K
for the Year Ended December 31, 1993
(3) Incorporated by reference to Registrant's Annual Report on Form 10-K
for the Year Ended December 31, 1996
(4) Incorporated by reference to Registrant's Annual Report on Form 10-K
for the Year Ended December 31, 1997
(5) Incorporated by reference to Registrant's Annual Report on Form 10-KSB
for the Year Ended December 31, 1998
(6) Incorporated by reference to Registrant's Quarterly Report on Form
10-QSB for the Three Months Ended September 30, 1999
(7) Incorporated by reference to Registrant's Annual Report on Form 10-KSB
for the Year Ended December 31, 2000
(8) Incorporated by reference to Registrant's Current Report on Form 8-K/A
dated April 3, 2002
16
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
of Nocopi Technologies, Inc.
West Conshohocken, Pennsylvania
We have audited the accompanying balance sheet of Nocopi Technologies, Inc. as
of December 31, 2002 and the related statements of operations, stockholders'
equity, and cash flows for each of the two years in the period ended December
31, 2002. The 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. 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 presentation of the
financial statements. 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 Nocopi Technologies, Inc. at
December 31, 2002, and the results of its operations and its cash flows for each
of the two years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 11 to the
financial statements, the Company has suffered recurring losses from operations
that raises substantial doubt about its ability to continue as a going concern.
Management's plans in regard to this matter are also described in Note 11. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
COGEN SKLAR, LLP
Bala Cynwyd, Pennsylvania
February 25, 2003
F-1
Nocopi Technologies, Inc.
Balance Sheet
December 31
2002
------------
Assets
Current assets
Cash and cash equivalents $139,000
Accounts receivable less $15,000 allowance
for doubtful accounts 39,100
Prepaid and other 31,000
-----------
Total current assets 209,100
Fixed assets
Leasehold improvements 39,500
Furniture, fixtures and equipment 476,200
-----------
515,700
Less: accumulated depreciation and amortization 501,700
-----------
14,000
Other assets
Investment in unconsolidated affiliate - net 110,600
-----------
$333,700
===========
Liabilities and Stockholders' Deficiency
Current liabilities
Demand loans $160,400
Accounts payable 649,200
Accrued expenses 273,500
Deferred revenue 120,700
-----------
Total current liabilities 1,203,800
Commitments and contingencies
Stockholders' deficiency
Series A preferred stock $1.00 par value
Authorized - 300,000 shares
Issued and outstanding - none
Common stock, $.01 par value
Authorized - 75,000,000 shares
Issued and outstanding - 45,972,241 shares 459,700
Paid-in capital 11,141,100
Accumulated deficit (12,470,900)
-----------
(870,100)
-----------
$333,700
===========
The accompanying notes are an integral part of these financial statements.
F-2
Nocopi Technologies, Inc.
Statements of Operations
Years ended December 31
2002 2001
------------ ------------
Revenues
Licenses, royalties and fees $441,100 $498,300
Product and other sales 295,700 273,800
----------- -----------
736,800 772,100
----------- -----------
Cost of sales
Licenses, royalties and fees 187,700 215,800
Product and other sales 191,100 150,400
----------- -----------
378,800 366,200
----------- -----------
Gross profit 358,000 405,900
----------- -----------
Operating expenses
Research and development 254,100 251,600
Sales and marketing 269,900 251,700
General and administrative
(exclusive of legal expenses) 269,600 376,400
Legal expenses 479,600 313,900
Related party expenses 42,500
----------- -----------
1,273,200 1,236,100
----------- -----------
Loss from operations (915,200) (830,200)
----------- -----------
Other income (expenses)
Interest income 300 3,400
Interest and bank charges (9,600) (1,800)
----------- -----------
(9,300) 1,600
----------- -----------
Net loss ($924,500) ($828,600)
=========== ===========
Basic and diluted loss per common share
($.02) ($.02)
Weighted average common shares outstanding 42,516,686 37,386,574
The accompanying notes are an integral part of these financial statements.
F-3
Nocopi Technologies, Inc.
Statements of Stockholders' Equity (Deficit)
For the Period January 1, 2001 through December 31, 2002
Common stock Paid-in Accumulated
Shares Amount Capital Deficit
------ ------ ------- ------------
Balance - January 1, 2001 33,817,332 $338,200 $10,434,600 $(10,717,800)
Sales of common stock, net of
expenses 5,304,909 53,000 364,000
Net loss (828,600)
--------------------------------------------------
Balance - December 31, 2001 39,122,241 391,200 10,798,600 (11,546,400)
Sales of common stock 6,850,000 68,500 342,500
Net loss (924,500)
--------------------------------------------------
Balance - December 31, 2002 45,972,241 $459,700 $11,141,100 ($12,470,900)
=========== ======== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-4
Nocopi Technologies, Inc.
Statements of Cash Flows
Years ended December 31
2002 2001
------------ -------------
Operating Activities
Net loss ($924,500) ($828,600)
Adjustments to reconcile net loss to
cash used in operating activities
Depreciation 18,700 23,500
Allowance for doubtful accounts, net (6,200) (1,300)
---------- ----------
(912,000) (806,400)
(Increase) decrease in assets
Accounts receivable 6,700 33,700
Prepaid and other (8,300) 16,400
Increase in liabilities
Accounts payable and accrued expenses 423,400 133,600
Deferred revenue 57,700 18,900
---------- ----------
479,500 202,600
---------- ----------
Cash used in operating activities (432,500) (603,800)
Financing Activities
Issuance of common stock, net 411,000 417,000
Demand loans 160,400
---------- ----------
Cash provided by financing activities 571,400 417,000
---------- ----------
Increase (decrease) in cash and cash equivalents 138,900 (186,800)
Cash and cash equivalents
Beginning of year 100 186,900
---------- ----------
End of year $139,000 $100
========== ==========
The accompanying notes are an integral part of these financial statements.
F-5
NOCOPI TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 2002 and 2001
1. Organization of the Company
Nocopi Technologies, Inc. (the Company) is organized under the laws of the
State of Maryland. Its main business activities are the development and
distribution of document security products and the licensing of its
patented authentication technologies in the United States and foreign
countries. The Company operates in one principal industry segment.
2. Significant Accounting Policies
Estimates - The preparation of the financial statements in conformity with
Accounting Principles Generally Accepted in the United States requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent liabilities
at the dates of financial statements and the reported amounts of revenues
and expenses during the reported periods. Actual results could differ from
those estimates.
Cash and cash equivalents - Cash equivalents consist principally of time
deposits and highly liquid investments with an original maturity of three
months or less placed with major banks and financial institutions. Cash
equivalents are carried at the lower of cost, plus accrued interest, or
market value and are held in money market accounts at a local bank. At
December 31, 2002, Nocopi's investments in money market accounts amounted
to $124,200.
Concentration of credit risk involving cash - At December 31, 2002, the
Company has deposits with a major financial institution that exceed
Federal Deposit Insurance limits. This financial institution has a strong
credit rating, and Management believes that credit risk related to these
deposits is minimal.
Fixed assets are carried at cost less accumulated depreciation and
amortization. Furniture, fixtures and equipment are generally depreciated
on the straight-line method over their estimated service lives. Leasehold
improvements are amortized on a straight-line basis over the shorter of
five years or the term of the lease. Major renovations and betterments are
capitalized. Maintenance, repairs and minor items are expensed as
incurred. Upon disposal, assets and related depreciation are removed from
the accounts and the net amount, less proceeds from disposal, is charged
or credited to income.
Investment in Affiliate - The Company's investment, approximately 18%, in
Euro-Nocopi, S.A. (Euro) was accounted for under the equity method through
September 30, 2000 due to the technical dependence of Euro on the Company.
The Company changed its method of accounting for its investment in Euro to
the cost method effective October 1, 2000 and recorded the carrying value
at that date as the cost of its investment. During the fourth quarter of
2000, the Company wrote down its investment in Euro by $110,000 due to the
uncertainty of its recoverability. (See note 9).
Patent costs are charged to expense as incurred due to the uncertainty of
their recoverability as a result of the Company's adverse liquidity
situation.
F-6
Revenues, consisting primarily of license fees and royalties, are recorded
as earned over the license term. Product sales are recognized upon
shipment of products.
Income taxes - Deferred income taxes are provided for all temporary
differences and net operating loss and tax credit carryforwards. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion or all of the
deferred tax assets will not be realized.
Fair value - The carrying amounts reflected in the balance sheets for
cash, cash equivalents, accounts receivable, and accounts payable
approximate fair value due to the short maturities of these instruments.
The fair values represent estimates of possible value that may not be
realized in the future. The carrying value of the Demand Loans
approximates the fair market value since the interest rate associated with
the debt approximates the current market interest rate.
Loss per share - The Company follows Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" resulting in the presentation of
basic and diluted earnings per share. Because the Company reported a net
loss in 2002 and 2001, common stock equivalents, including stock options
and warrants were anti-dilutive.
Comprehensive income (loss) - The Company follows Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income". Since the
Company has no items of comprehensive income (loss), Comprehensive income
(loss) is equal to net income (loss).
Recently Issued Accounting Standards
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("Statement 144"), effective in fiscal years beginning after December 15,
2001, with early adoption permitted, and in general are to be applied
prospectively. Statement 144 establishes a single accounting model for the
impairment or disposal of long-lived assets, including discontinued
operations. Statement 144 superseded Statement No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of," and APB Opinion No. 30, "Reporting the Results of Operations
- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The adoption of this standard had no effect on the
Company's financial statements.
The following recently issued accounting pronouncements are currently not
applicable to the Company.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Correction." This Statement eliminates extraordinary accounting
treatment for reporting gain or loss on debt extinguishment, and amends
other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under
changed conditions.
F-7
In November 2002, the FASB issued Interpretation 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This Interpretation expands the
disclosures to be made by a guarantor about its obligations under certain
guarantees and requires that, at the inception of a guarantee, a guarantor
recognize a liability for the fair value of the obligation undertaken in
issuing the guarantee. The disclosure requirements are effective
immediately. The initial recognition and measurement provisions of this
Interpretation are effective for guarantees issued or modified after
December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock
Based Compensation - Transition and Disclosure - an Amendment to SFAS
123". SFAS No. 148 provides two additional transition methods for entities
that adopt the preferable method of accounting for stock based
compensation. Further, the statement requires disclosure of comparable
information for all companies regardless of whether, when, or how an
entity adopts the preferable, fair value based method of accounting. These
disclosures are now required for interim periods in addition to the
traditional annual disclosure. The amendments to SFAS No. 123, which
provides for additional transition methods are effective for periods
ending after December 15, 2002, although earlier application is permitted.
The amendments to the disclosure requirements are required for financial
reports containing condensed financial statements for interim periods
beginning after December 15, 2002.
3. Demand Loans
During 2002, the Company received unsecured loans from three individuals,
including $48,400 from the Company's Chairman of the Board, totaling
$160,400. The loans bear interest at seven per cent per year and are
payable on demand. The loans were used to finance the Company's working
capital requirements.
4. Stockholders' Equity
During January 2002, the Company sold 2,316,667 shares of its common stock
to investors, including affiliates of the Company, for $139,000. In May
2002, the Company sold 1,200,000 shares of its common stock to
non-affiliated investors for $72,000. One of the individuals who invested
in May 2002 was later appointed to the Company's Board of Directors in
late May 2002.
In mid-November, 2002, the Company entered into a subscription agreement
with a partnership composed of Michael Solomon, a director of the Company,
and three other persons pursuant to which the partnership agreed to
acquire, in return for a subscription payment of $200,000, a total of
3,333,333 shares of the Company's common stock, together with warrants to
purchase an additional 40,000,000 shares of common stock in the aggregate
at exercise prices ranging from $0.10 to $0.25 per share, during various
periods through year-end 2003 through year-end 2006, subject to partial
rollover and extension. The warrants are subject to the negotiation and
agreement of the Company and the investors on the definitive terms thereof
and also to the approval by the Company's common stockholders of an
amendment to the Company's charter to increase its authorized capital to a
number of shares sufficient to permit exercise of the warrants. This
transaction was approved by the Company's board of directors with Mr.
Solomon abstaining. The Company received the partnership's $200,000
subscription payment in early December 2002.
F-8
5. Income Taxes
At December 31, 2002, the Company had net operating loss carryforwards
("NOL's") approximating $12,000,000. These operating losses are available
to offset future taxable income through the year 2022. As a result of the
sale of the Company's common stock in an equity offering in late 1997 and
the issuance of additional shares, the amount of the NOL's carryforwards
may be limited. Additionally, the utilization of these NOL's if available,
to reduce the future income taxes will depend on the generation of
sufficient taxable income prior to their expiration. There were no
temporary differences for the years ended December 31, 2002 and 2001. The
Company has established a 100% valuation allowance of approximately
$4,900,000 at December 31, 2002 for the deferred tax assets due to the
uncertainty of their realization.
6. Related Party Transactions
Expenses aggregating $42,500 in 2001 were incurred by the Company for
consulting services provided by a firm employing an officer of the
Company. There were no such expenses incurred in 2002.
7. Commitments and Contingencies
The Company conducts its operations in leased facilities and leases
equipment under non-cancelable operating leases expiring at various dates
to 2008.
Future minimum lease payments under non-cancelable operating leases with
initial or remaining terms of one year or more at December 31, 2002 are:
$43,700 - 2003; $34,800 - 2004; $36,100 - 2005; $37,600 - 2006 and $39,100
- 2007.
Total rental expense under operating leases was $104,500 and $103,600 in
2002 and 2001, respectively.
The Company had a consulting agreement with a former executive officer and
director, the term of which expired at December 31, 2002. The Board of
Directors of the Company, in mid-2000, suspended cash payments to the
consultant as a potential offset to certain payments made to the
consultant by a licensee of the Company. All other provisions of the
agreement remained in force throughout the term of the agreement. At
December 31, 2002, unpaid consulting fees totaling $166,300 were included
in Accrued Expenses on the Balance Sheet.
From time to time, the Company may be subject to legal proceedings and
claims that arise in the ordinary course of its business. During late 2000
and early 2001, as described in Note 9, several legal and arbitration
proceedings were commenced by the Company's former European exclusive
licensee and certain of its shareholders against the Company, certain
former and present directors of the Company and against a licensee of the
Company.
8. Stock Options and 401(k) Savings Plan
The 1996 and 1999 Stock Option Plans provide for the granting of up to
2,700,000 incentive and non-qualified stock options to employees,
non-employee directors, consultants and advisors to the Company. In the
case of options designated as incentive stock options, the exercise price
of the options granted must be not less than the fair market value of such
shares on the date of grant. Non-qualified stock options may be granted at
any amount established by the Stock Option Committee or, in the case of
Discounted Options issued to non-employee directors in lieu of any portion
of an Annual Retainer, in accordance with a formula designated in the
Plan.
F-9
A summary of stock options under the Company's stock option plans follows:
Exercise Weighted
Number of Price Range Average
Shares Per Share Exercise Price
--------- -------------- ---------------
Outstanding at December 31, 2000 647,000 $.30 to $4.35 $.45
Options canceled during 2001 (122,000) .30 to 4.35 .83
-------- ------------- -----
Outstanding at December 31, 2001 and 2002 525,000 $.30 and $.45 $.36
======== ============= =====
Exercise Weighted
Option Price Range Average
Shares Per Share Exercise Price
---------- --------------- ---------------
Exercisable at year end:
2001and 2002 525,000 $.30 and $.45 $.36
Options available for future grant under all plans:
2001 and 2002 2,175,000
The following table summarizes information about stock options outstanding at
December 31, 2002:
Range of exercise prices $.30 to $.45
------------
Number outstanding at
December 31, 2002 525,000
-------
Weighted average remaining contractual life
(years) 3.09
----
Weighted average exercise price $.36
----
Exercisable options:
Number outstanding at
December 31, 2002 525,000
-------
Weighted average remaining
Contractual life (years) 3.09
----
Weighted average exercise price $.36
----
F-10
No options were granted in 2002 or 2001.
The Company continues to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees". Compensation cost for
stock options, if any, is measured as the excess of the quoted market
price of the Company's stock at the date of grant over the amount an
employee must pay to acquire the stock. Compensation costs for shares
issued under performance share plans are recorded based upon the current
market value of the Company's stock at the end of each period. The Company
has adopted the disclosure-only provisions of Statement of Financial
accounting Standards ("SFAS") No. 123, "Accounting for Stock Based
Compensation" for employees and employee-directors as defined in SFAS No.
123. Compensation costs for grants to employees and directors would be
determined based on the fair value at the date of grant in accordance with
SFAS No. 123 and would be amortized over the vesting period of the option,
which is generally two years. Had compensation cost for the Company's
stock option grants to employees and employee-directors been determined
based on the fair value at the date of grants in accordance with the
provisions of SFAS No. 123, the Company would have amortized the cost over
the vesting period of the option. There was no pro forma effect on the
Company's net loss or the net loss per share applicable to common shares
for 2002 and 2001, since no options were granted during these periods.
At December 31, 2002, the Company has reserved 2,700,000 shares of common
stock for possible future issuance upon exercise of stock options. The
Company sponsors a 401(k) savings plan, covering substantially all
employees, providing for employee and employer contributions. Employer
contributions are made at the discretion of the Company. There were no
contributions charged to expense during 2002 or 2001.
9. Affiliate
The Company organized Euro-Nocopi, S.A. (Euro) in 1994 to market the
Company's technologies in Europe under an exclusive license arrangement.
Euro was capitalized through a European private placement. The Company
holds an approximately 18% interest in Euro. During 2000, there arose
between Euro and the Company a number of areas of conflict and dispute,
leading each party to the licensing arrangement to assert informally that
the other was in breach of its obligations under that arrangement. The
parties initially sought to resolve their differences by negotiating a
transaction in which Euro would have purchased from the Company its entire
equity interest as well as the paid-up European rights to the Company's
technologies. These negotiations terminated without agreement early in
December 2000. Following the termination of the transaction negotiations,
the Company was informed by Euro that it had adopted resolutions to
liquidate and dissolve. In mid-December 2000, the Company terminated its
license agreement with Euro in accordance with its terms and discontinued
the provision of support (including the sale of proprietary inks) to Euro
and its customers. As a result of the license termination the
technological dependency of Euro on the Company ceased and the Company was
no longer permitted to account for its investment in Euro on the equity
method. Accordingly, the Company, effective October 1, 2000, changed its
method of accounting for its investment in Euro to the cost method and
recorded the carrying value at that date as the cost of its investment.
During the fourth quarter of 2000, the Company wrote down its investment
in Euro by $110,000 due to the uncertainty of its recoverability and
recorded a charge of $68,600 resulting from the transfer of foreign
currency translation adjustments to net income.
F-11
Euro responded to the license termination by denying that the Company's
action was permissible, or effective, and by asserting a claim that, as a
result of alleged breaches of the licensing agreement by the Company, it
was entitled to a royalty-free license to exploit the Company's
technologies in Europe.
Promptly thereafter, Euro commenced an action before a court in Paris,
France in which it sought the entry of an order, in the nature of a
preliminary injunction, to compel the Company to honor the license
agreement pending judicial or arbitral resolution of the dispute between
the parties under the license agreement. In the French litigation, Euro
did not seek an adjudication on the merits of the underlying dispute.
Certain shareholders of Euro subsequently joined in the proceedings
commenced by Euro. In March 2001, the Emergency Judge hearing the action
issued a decision denying the relief requested by Euro and the
shareholders. The decision, which does not purport to be a final
adjudication of the merits of the controversy but only of Euro's request
for preliminary relief, held that Euro was not entitled to the requested
order because the Company had validly terminated the licensing arrangement
in mid-December, and also ordered Euro to pay into escrow the
approximately $125,000 that the Company claimed was due and owing under
the licensing arrangement.
In March 2001, Euro commenced an arbitration proceeding before the
American Arbitration Association in New York, NY against the Company. In
this proceeding, Euro has not asserted a claim for damages but has
asserted a claim for an award in the nature of a declaratory judgment to
the effect that, because the Company has (allegedly) breached the license
agreement, Euro is entitled to a royalty-free license to exploit the
Company's technologies in Europe. The Company has filed a response denying
that Euro is entitled to the relief requested, asserting that it has
validly terminated Euro's license agreement, and seeking damages for
Euro's breaches of the licensing agreement. The parties are currently
engaged in discussions relating to the settlement of the arbitration, and
all related matters, and the arbitration hearing on the merits has been
postponed pending such discussions.
In March 2001 certain shareholders of Euro filed suit in a court in Paris,
France against certain current and former officers and directors of the
Company and against a licensee of the Company. The Company is not named as
a defendant in the suit. The suit seeks damages in excess of $7 million
from the defendants for various alleged acts of oppression, self-dealing
and fraud in connection with the organization and capitalization of Euro,
the management of that company and the Company's management of its
relationship with that company. The defendants have denied any liability
to the plaintiffs and have sought indemnification from the Company in
connection with the lawsuit. The Company has advanced certain costs of
defense for the benefit of the named defendants.
10. Major Customer Information
The Company's largest non-affiliate customers accounted for approximately
16% of revenues in both 2002 and 2001 and 34% of accounts receivable at
December 31, 2002. The Company performs ongoing credit evaluations of its
customers and generally does not require collateral. The Company also
maintains allowances for potential credit losses.
F-12
11. Going Concern
Since its inception, the Company has incurred significant losses and, as
of December 31, 2002, had accumulated losses of $12,470,900. For the years
ended December 31, 2002 and 2001, the Company's net losses were $924,500
and $828,600, respectively. In addition, the Company had negative working
capital of $994,700 at December 31, 2002 and experienced negative cash
flow from operations of $432,500 and $603,800, respectively, for the years
ended December 31, 2002 and 2001. The Company may incur further operating
losses and experience negative cash flow in the future. Achieving
profitability and positive cash flow depends on the Company's ability to
generate and sustain significant increases in revenues and gross profits
from its traditional business. There can be no assurances that the Company
will be able to generate sufficient revenues and gross profits to achieve
and sustain profitability and positive cash flow in the future.
During 2002, the Company sold 6,850,000 shares of its common stock to
affiliated and non-affiliated individual investors for $411,000, received
loans of $160,400 from three individuals, including $48,400 from the
Chairman of the Board of the Company and used $432,500 to fund operations.
The reciept of these funds has permitted the Company to continue in
operation to the current date. Management of the Company believes that, to
survive, it must obtain additional capital immediately both to fund
continuing operating deficits and to fund investments needed to increase
its operating revenues to levels that will sustain its operations. There
can be no assurances that the Company will be successful in obtaining
sufficient additional capital, or if it does, that the additional capital
will enable the Company to improve its business so as to have a material
positive effect on the Company's operations and cash flow. The Company
believes that without substantial immediate investment, it will be forced
to cease operations early in the second quarter of 2003. Further, the
Company requires investment to fund the ongoing arbitration with
Euro-Nocopi, S.A. There are no assurances that, even if funding, for which
the Company has no commitments and only limited prospects, is arranged,
the Company will prevail in the arbitration.
The Company's independent certified public accountants have included a
"going concern" explanatory paragraph in their audit report accompanying
the 2002 financial statements. The paragraph states that the Company's
recurring losses from operations raise substantial doubt about the
Company's ability to continue as a going concern and cautions that the
financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
F-13