-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AEDCFQJCvljz+pyDeF8e8uRG+QhrbQPmmkY6xmwpB4z7yyL3R2bayCmgeU8Q81xR md3cUYIxWdifs86DfqhTag== 0001214659-06-001841.txt : 20060913 0001214659-06-001841.hdr.sgml : 20060913 20060913112814 ACCESSION NUMBER: 0001214659-06-001841 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20060731 FILED AS OF DATE: 20060913 DATE AS OF CHANGE: 20060913 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CDEX INC CENTRAL INDEX KEY: 0001173738 STANDARD INDUSTRIAL CLASSIFICATION: MEASURING & CONTROLLING DEVICES, NEC [3829] IRS NUMBER: 522336836 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-49845 FILM NUMBER: 061087888 BUSINESS ADDRESS: STREET 1: 1700 ROCKVILLE PIKE STREET 2: STE 400 CITY: ROCKVILLE STATE: MD ZIP: 20852 BUSINESS PHONE: 301-881-0080 MAIL ADDRESS: STREET 1: 1700 ROCKVILLE PIKE STREET 2: STE 400 CITY: ROCKVILLE STATE: MD ZIP: 20852 10QSB 1 f9116110q.txt FOR THE QUARTERLY PERIOD ENDED JULY 31, 2006 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended July 31, 2006 |_| 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 000-49845 CDEX INC. (Exact name of small business issuer in its charter) Nevada 52-2336836 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1700 Rockville Pike, Suite 400 Rockville, Maryland, 20852 301-881-0080 (Address of principal executive offices and registrant's phone number) 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 [_] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes [_] No [X] Indicate the number of shares outstanding of each of the issuer's classes or common stock, as of the last practicable date. Class A Common Stock: 37,045,409 shares as of September 1, 2006 Transitional Small Business Disclosure Format. Yes [_] No [X] - -------------------------------------------------------------------------------- CDEX INC. FORM 10-QSB For the Quarterly Period Ended July 31, 2006 INDEX Page Part I Financial Information Item 1. Financial Statements Condensed Balance Sheet as of July 31, 2006.....................3 Condensed Statements of Operations for the Three and Nine Months ended July 31, 2006 and 2005....................4 Condensed Statements of Cash Flow for the Nine Months ended July 31, 2006 and 2005........................5 Notes to Condensed Financial Statements.........................6 Item 2. Management's Discussion and Analysis of Financial Condition or Plan of Operation......................................9 Item 3. Controls and Procedures............................................18 Part II Other Information Item 1. Legal Proceedings..................................................19 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........19 Item 3. Defaults Under Senior Securities...................................19 Item 4. Submission of Matters to a Vote of Security Holders................19 Item 5. Other Information..................................................19 Item 6. Exhibits...........................................................19 Signatures....................................................................20 Cautionary Note Regarding Forward-Looking Statements This document contains forward-looking statements as that term is defined in the federal securities laws. Forward-looking statements can be identified by the use of words such as "expects," "plans," "may," "anticipates," "believes," "should," "intends," "estimates," and other words of similar meaning. These statements are subject to risks and uncertainties that cannot be predicted or quantified and, consequently, actual results may differ materially from those expressed or implied by such forward-looking statements. Such risks and uncertainties include, without limitation, the ability of the Company to raise capital to finance the development of its chemical detection products, the effectiveness, profitability and the marketability of those products, the ability of the Company to protect its proprietary information, the establishment of an efficient corporate operating structure as the Company grows and, other risks detailed from time-to-time in our filings with the Securities and Exchange Commission. The Company undertakes no obligation to publicly update any forward-looking statements. 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CDEX Inc. Balance Sheet as of July 31, 2006 (unaudited) Assets Current assets Cash and cash equivalents $ 10,028 Accounts receivable 16,520 Unbilled revenue 112,000 Finished goods inventory 95,173 Raw materials inventory 48,038 Prepaid expenses 2,768 ------------ Total current assets 284,527 Property and equipment Laboratory and computer equipment 639,437 Furniture and fixtures 1,666 Building improvements 1,265 ------------ Total property and equipment 642,368 Less: Accumulated depreciation (587,962) ------------ Net property and equipment 54,406 Other assets 2,499 ------------ Total Assets $ 341,432 ============ Liabilities and Stockholders' Equity Current Liabilities Accounts payable and accrued expenses $ 686,232 Note payable 92,192 Deferred stock compensation 52,000 Advance payments 37,934 Deferred revenue 10,000 Deferred rent 8,567 ------------ Total Current Liabilties 886,925 Stockholders' Deficit Preferred Stock - $.005 par value per share,500,000 shares authorized and 6,675 outstanding 33 Class A common stock - $.005 par value per share, 50,200,000 shares authorized and 37,045,409 outstanding 185,232 Additional paid in capital 21,445,550 Deferred stock compensation (20,413) Accumulated deficit (22,155,895) ------------ Total Stockholders' Deficit (545,493) ------------ Total Liabilities and Stockholders' Deficit $ 341,432 ============ The accompanying Notes to Financial Statements are an integral part of these financial statements. 3 CDEX Inc. Statements of Operations (unaudited)
Three Months Ended Nine Months Ended July 31 July 31 2005 2006 2005 2006 ---- ---- ---- ---- Revenue $ 54,489 $ 181,316 $ 162,149 $ 622,730 Cost of Revenue 15,324 65,599 83,782 294,038 ------------ ------------ ------------ ------------ Gross Profit 39,165 115,717 78,367 328,692 Operating Expenses Development costs 986,087 280,518 1,943,216 1,010,789 General and administrative expenses 860,467 560,577 1,978,993 1,703,860 ------------ ------------ ------------ ------------ Total Operating Expenses 1,846,553 841,095 3,922,209 2,714,649 Loss From Operations (1,807,389) (725,378) (3,843,842) (2,385,957) Other Income (Expense) Interest income 2,464 -- 3,139 7,201 Related party interest expense (483) (483) -- Interest expense -- (3,107) -- (3,107) ------------ ------------ ------------ ------------ Total Other (Expense) Income 1,981 (3,107) 2,656 4,094 ------------ ------------ ------------ ------------ Net Loss $ (1,805,408) $ (728,485) $ (3,841,186) $ (2,381,863) ============ ============ ============ ============ Basic and diluted net loss per common share: $ (0.05) $ (0.02) $ (0.12) $ (0.07) Basic and diluted weighted average common shares oustanding 33,201,118 36,810,353 31,232,627 36,399,748
The accompanying Notes to Financial Statements are an integral part of these financial statements. 4 CDEX Inc. Statements of Cash Flows (unaudited)
Nine Months Ended July 31 2005 2006 ---- ---- Cash Flows from Operating Activities Net loss $(3,841,186) $(2,381,863) Adjustments to reconcile net loss to cash used by operating activities Depreciation 12,569 16,588 Stock compensation 2,048,031 286,767 Noncash interest -- 3,107 Changes in operating assets and liabilities Inventory (143,460) 108,252 Accounts receivable (69,899) (108,891) Prepaid expenses 1,148 78 Other assets (1,100) -- Current liabilities 46,135 337,410 ----------- ----------- Net cash used by operating activities (1,947,764) (1,738,552) Cash Flows from Investing Activities Purchase of property and equipment (2,108) (36,162) ----------- ----------- Net cash used by investing activities (2,108) (36,162) Cash Flows from Financing Activities Proceeds from sale of preferred stock -- 133,500 Proceeds from sale of common stock 1,726,250 89,000 Proceeds from note payable -- 90,000 Proceeds from convertible notes payable 89,000 -- Proceeds from related party convertible notes payable 62,000 -- Repayment of related party convertible notes payable (62,000) -- ----------- ----------- Net cash provided by financing activities 1,815,250 312,500 ----------- ----------- Net decrease in cash (134,622) (1,462,214) Cash and cash equivalents, beginning of the period 471,485 1,472,242 ----------- ----------- Cash and cash equivalents, end of the period $ 336,863 $ 10,028 =========== =========== Supplemental Cash Flow Information Actual cash payments for interest $ 483 $ -- Conversion of convertible notes payable to common stock $ 89,000 $ -- Common stock issued in non-cash transactions $ 215,000 $ -- Conversion of Class B to Class A common stock $ -- $ 18,250
The accompanying Notes to Financial Statements are an integral part of these financial statements. 5 CDEX INC. NOTES TO THE UNAUDITED FINANCIAL STATEMENTS JULY 31, 2006 1. General The financial statements included herein have been prepared, without audit, pursuant to the regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto contained in CDEX Inc.'s Audited Financial Statements for the year ended October 31, 2005. In the opinion of CDEX Inc.'s management, the accompanying unaudited financial statements contain all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the financial position as of July 31, 2006, results of operations for the three and nine month periods ended July 31, 2006 and 2005, and cash flows for the nine month periods ended July 31, 2006 and 2005. Interim results are not necessarily indicative of results for an entire year. 2. Basis of Presentation USE OF ACCOUNTING ESTIMATES: The preparation of 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 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. REVENUE: Revenue recognized represents amounts earned for products and services. Revenue is recognized at contractually agreed upon rates in the fiscal period in which products are delivered to customers and services are performed. Revenue is not recognized for amounts pending customer acceptance of the product. UNBILLED REVENUE: Unbilled revenue represents amounts recognized as revenue but not invoiced by July 31, 2006. DEFERRED REVENUE: Deferred revenue represents amounts invoiced but not recognized as revenue if collectibility is uncertain. RESEARCH AND DEVELOPMENT: Total research and development costs include labor for employees and contractors, rent, professional services, materials, lab equipment and disposals. These costs are expensed on the accompanying Statement of Operations as development costs. 3. Stock Based Compensation All stock based compensation is recorded at fair value. The Company has provided restricted stock grants to employees and consultants as a significant element of their compensation. The Company determines compensation expense as the fair value, at the measurement date, of the service received or the common stock issued, whichever is more reliably determinable. For consulting agreements issued in 2003 and 2004, the fair value was determined using the weighted average value of the proceeds per share received from sales of common stock to unaffiliated purchasers during that year. The Company has also utilized employment and consulting agreements that combine cash and stock elements of compensation, where a fixed dollar value of stock is awarded to settle non-cash compensation. In this case, the fair value of the services is determined based on the number of shares issued valued at the weighted average value of the proceeds per share received from sales of common stock to unaffiliated purchasers during compensation period. In the case of employees, the measurement date is the date of grant. In the case of outside consultants, the measurement date is the date at which their performance is complete. This total cost is first reflected as deferred compensation in stockholders' equity (deficit) and then amortized to compensation expense on a straight-line basis over the period over which the services are performed. When the fair value of the common stock is used and the measurement date is not the date of grant, the total cost is remeasured at the end of each reporting period based on the fair market value on that date, and the amortization is adjusted. 6 The Company awarded some of the common shares in advance of when the service was performed. These amounts are shown as deferred stock compensation in shareholder's deficit in the accompanying balance sheet. The Company has also paid performance bonuses in common stock. During the nine months ended July 31, 2006, the Company granted Class A shares of common stock to employees and consultants at a fair value of approximately $0.85 per share for services rendered in current and prior periods. The fair value per share was determined using the closing price on the OTC Bulletin Board on the grant date. Total compensation expense related to stock awards for employees and consultants was zero and $1,253,926 for the three months ended July 31, 2006 and 2005, respectively, and $286,767 and $2,048,031 for the nine months ended July 31, 2006 and 2005, respectively. 4. Stock Options The Company granted stock options in fiscal year 2005 and the first and second quarters of fiscal year 2006. In the third fiscal quarter of 2006 the company canceled all options by contractual agreement with the option holders. Accordingly there are no options outstanding at July 31, 2006. Stock options were granted with an exercise price equal to the market price of the stock at the date of grant. Substantially all of the options granted were exercisable pursuant to a three-year vesting schedule. The fair value of these options is estimated using the Black-Scholes option pricing model. Expected volatilities of 75% are based on the historical performance of our stock. The expected term of the options of 5 years represents the period of time that options are expected to remain unexercised. The risk-free interest rate of 3.8% to 4.2% for periods within the contractual life of the option is based on the U.S. Treasury bond rate in effect at the time of grant. The following is a summary of all option activity for the nine months ended July 31, 2006: Weighted- Average Number of Exercise Shares Price --------- -------- Outstanding at October 31, 2005 300,000 $ 1.10 --------- -------- Granted 1,590,000 0.95 Exercised - - Canceled 1,890,000 0.97 Expired - - --------- -------- Outstanding at July 31, 2006 - - Exercisable at July 31, 2006 - - The Company follows SFAS No. 123, Accounting for Stock-Based Compensation. In accounting for stock options, as permitted by SFAS No. 123, the Company will account for stock-based compensation to employees in accordance with Accounting Principles Board (APB) Opinion No. 25 Accounting for Stock Issued to Employees, and accordingly recognize compensation expense for fixed stock option grants only when the exercise price is less than the fair value of the shares on the date of the grant. No options were issued or outstanding during the nine month period ended July 31, 2005. 7 The following table illustrates the effect on net loss if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation:
Three Months Ended Nine Months Ended July 31, 2006 July 31, 2006 ------------- ------------- Reported net loss $ (728,485) $(2,381,863) ----------- ----------- Add: pro forma stock option employee compensation income from option cancellation 144,504 6,000 ----------- ----------- Pro forma net loss $ (583,981) $(2,375,863) Earnings per common share: Basic and diluted - as reported $ (0.02) $ (0.07) Basic and diluted - pro forma $ (0.02) $ (0.07)
The Company may elect to issue stock options in the future if additional shares are approved by the stockholders. The timing and extent of any future issuances may result in compensation expense or variable plan accounting for option holders that cancelled their options and received more favorable terms in future grants. 5. Common Stock During the three months ended July 31, 2006, the Class B (special voting rights) common stock was eliminated and all remaining shares were converted to Class A shares on a one-for-one basis. Separately, the Company sold 257,563 shares of common stock for $89,000. 6. Preferred Stock During the three months ended July 31, 2006, the Company sold 6,675 shares of preferred stock at an average price of $20 per share for proceeds of $133,500. The preferred stock is convertible into common stock at the option of the shareholder at a conversion rate of approximately 29.851, or into approximately 199,255 common shares. The conversion rate is the quotient obtained by dividing $20 by $0.67 which is the weighted average fair market price of the common stock during the 20-day trading period prior to the preferred stock purchase closing of the preferred stock lead investor. The preferred stock has the following rights: no dividend requirements, a liquidation preference over all common shares, participating voting rights on an as-converted basis, and 199,255 common shares have been reserved for potential conversion. 7. Note Payable During the three months ended July 31, 2006, the Company received $90,000 in proceeds under a note payable with an existing investor. The $90,000 principal and $10,000 interest is payable three months from receipt of funds, or by October 10, 2006. If payment is not made by October 10, 2006, then an additional $10,000 in interest is payable. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND PLAN OF OPERATION You should read the following discussion in conjunction with our unaudited financial statements and related notes included elsewhere in this document. The following discussion, as well as other discussions in this document, contains forward-looking statements. Please see Forward-Looking Statements for a discussion of uncertainties, risks and assumptions associated with these statements. PLAN OF OPERATION General - ------- CDEX Inc. is a life safety technology development company that currently develops and applies innovative photoelectric technologies to meet the requirements for life safety products in the healthcare, security, and brand protection markets. CDEX is a public company and its common stock is traded on the OTC Bulletin Board (OTCBB) under the symbol "CEXI.OB". CDEX was incorporated in the State of Nevada on July 6, 2001 and maintains its corporate offices in Rockville, Maryland, and its research and development laboratories in Tucson, Arizona. Currently, CDEX is actively marketing in three distinct markets: 1. Healthcare - Validation of substances and quality assurance (e.g., validation of prescription and compounded medications to provide for patient safety, detection of the diversion of narcotics and controlled substances returned from operating room suites to the operating room pharmacy); 2. Security & Public Safety - Identification of substances of concern (e.g., explosives, illegal drugs, chemical/biological weapons, and the detection of counterfeit drugs and medications to assist in the protection of the nation's drug supply); and 3. Brand Protection - Detection of counterfeit or sub-par products for brand protection (i.e., quality assurance inspection of incoming raw materials, outgoing final products, and products in the distribution channel). All current CDEX product development is based on applying the same underlying photoelectric technologies for which the company has five non-provisional and one provisional patent applications pending. CDEX has received notification that three of the applications have allowable subject matter and CDEX expects these three patent applications to issue later in calendar year 2006. CDEX anticipates acquiring other technologies in the future through partnering and investment. However, unless and until such time as we acquire other technology assets, all of the company's revenues will come from its current chemical detection products. ValiMed(TM) Product Line - ------------------------ In April 2006, CDEX management and staff successfully completed the implementation of the initial production plan for ValiMed(TM) and shipped its first ValiMed(TM) production units to Baxa Corporation. In so doing, the company was able to record its highest quarterly revenue and gross profit margin in the history of the company. The ValiMed(TM) units were shipped using Baxa colors and logos, and a ValiMed(TM) logo. ValiMed(TM) represents the first product that has been placed into production in the company's history. CDEX has on-going contracts with Mastek-Innerstep, Inc. and Schnipke Southwest; Tucson, AZ based contract manufacturers, to manufacture the ValiMed(TM) units and the CDEX proprietary cuvettes, respectively. As part of the company's ongoing research and development efforts, CDEX continues to build its medication and drug signature library using the new proprietary cuvettes. To date, a total of fifty-three (53) signatures have been added to the signature library. CDEX has met its contractual obligation to Baxa to ship the ValiMed(TM) units with a minimum of 30 medication/drug signatures. 9 All ValiMed(TM) production units are shipped with the TUV mark indicating that ValiMed(TM) meets the electrical safety, electromagnetic interference (EMI), and electromagnetic compatibility (EMC) test requirements for products sold in the USA, Canada, and the European Union. In addition, ValiMed(TM) has also been tested to the TUV CB Scheme which opens opportunities to market and sell ValiMed(TM) in countries other than the US, Canada, and the European Union. CDEX management expects eventually to transition all of its end-user customers to Baxa in order to provide them with proper on-going field support and customer service. This is required because CDEX does not have the necessary service support infrastructure to provide on-going customer service and support over a large geographical area, such as the USA and Canada. CDEX has entered into discussions with companies outside the USA who have shown an interest in representing CDEX as its ValiMed(TM) distributors in Japan, UK and Ireland, Benelux region, Germany, and the Middle-East. While these companies may represent significant distribution opportunities for ValiMed(TM), CDEX management cannot guarantee that it will be able to close a distribution agreement with any of the companies in these markets. However, it is the intent of CDEX management to begin setting up international distribution for ValiMed(TM) before the end of calendar year 2006. The gross margin from the initial ValiMed(TM) production units was approximately 64% and 53% for the three and nine month periods ended July 31, 2006, respectively. The lower gross margin over the nine month period was due in part to general inefficiencies associated with setting up a contract manufacturer for the first time in the beginning of the fiscal year. Achieving a gross margin in excess of 50% on the initial production runs of the ValiMed(TM) product line is viewed as a significant accomplishment. CDEX management expects the gross margin on the ValiMed(TM) product line to approximate 60%. ValiMed(TM) has transitioned from a beta-test product in to a full-scale production product. Year-on-year revenues are up significantly in 2006, as compared to the three and nine month periods of 2005. Management does not expect the revenues from ValiMed(TM) to grow in a linear or predictable manner due to the fact that ValiMed(TM) is a new product that has just been introduced into the market. It is more likely that revenues will be "lumpy" over the next several quarters; with some quarters up and some down. This will continue into the foreseeable future until we have more fully developed our distribution and sales channels and are better able to predict quarterly sales more precisely. Potential sales for ValiMed(TM) are expected to be in the range of $0.7 to $1.0 million during fiscal year 2006. The downward revision in our sales forecast from the previous quarter is principally due to a lack of funding to be able to execute our sales and marketing plan to develop our international sales channels in a more aggressive and robust manner. Because the company has not had the funds it needs, management has had no choice but to curtail travel in order to reduce expenses and lower our cash burn rate. CDEX believes that ValiMed(TM) could become a significant product portfolio for the company, but management does not guarantee that the sales projections put forth herein will be realized. In order to increase sales, CDEX must receive additional investment funding to implement its business plan, fund its international marketing and sales initiatives, and provide working capital in order to purchase production materials and parts inventories. If the company is unable to obtain the required funding that it needs through debt or equity financing in the near-term, the value potential of the ValiMed(TM) product portfolio over the next eight months cannot be realized. Illicit Drug Detector - --------------------- On August 29, 2006, CDEX entered into a contract with Missouri State Highway Patrol (MSHP) for the Meth Gun Pilot Test Program. CDEX anticipates beginning the Pilot Test Program in September 2006 and completing the test by the end of 2006. CDEX expects to have to refine the design of the Meth Gun based upon inputs from MSHP, and expects the Meth Gun to evolve into an "Illicit Drug Detector" that is capable of detecting more than just methamphetamine. Assuming a successful pilot test program with MSHP, CDEX expects to begin production start-up in early Q1 of 2007 with first production deliveries anticipated in Q2 of 2007. The Meth Gun is transitioning from a marketing demonstrator prototype, to a beta-test product with a bona-fide law enforcement agency in the Missouri State Highway Patrol, acting as a committed beta-test partner for CDEX. CDEX management anticipates that the "Illicit Drug Detector" could become a significant product portfolio for the company over the next five (5) years. In order for the company to take this product through a successful beta-test program, revise its design, start up a production line, and introduce it into the market by Q2 2007, CDEX must receive additional investment funding to implement its business plan, successfully complete the pilot test program with MSHP, establish a national and international reseller and distribution network, and enter into production. This will require investment to fund the production start up, marketing and sales initiatives, and provide working capital in order to purchase production materials and parts inventories. If the company is unable to obtain the required funding that it needs through debt or equity financing, in the near term, the potential of the "Illicit Drug Detector" product portfolio cannot be realized. 10 Explosive Trace and Counterfeit Medication Drug Detectors - --------------------------------------------------------- CDEX management has placed the further development of these two products on hold pending receipt of additional equity or debt financing. CDEX does not have the financial resources, at this time, to engage the additional human resources or incur the additional expenses that would be required to bring these products to market. Intellectual Property - --------------------- CDEX has a portfolio of five non-provisional patent applications and one provisional patent application. We have received notice from the U.S. Patent and Trademark Office (USPTO) that three of the applications contain allowable subject matter and we are awaiting their issuance. The remaining three patent applications are pending. Four of the CDEX patent applications have a corresponding foreign counterpart application. The first application has corresponding patent applications filed in Europe and Hong Kong. The second U.S. application has corresponding applications in Europe and Japan. The third application has corresponding application in Europe, Hong Kong and Canada and the fifth application has a corresponding Patent Cooperation Treaty international application. For a discussion of the status of a certain patent infringement lawsuit filed against CDEX in the District Court of Colorado, see "Legal Proceedings." RESULTS OF OPERATIONS Three Months Ended July 31, 2006 Compared to Three Months Ended July 31, 2005. Revenue: Revenue was $181,316 and $54,489 during the three months ended July 31, 2006 and July 31, 2005, respectively. The increase of $126,827 (or 233%) resulted from the delivery of ValiMed (TM) units to Baxa Corporation in the third fiscal quarter of 2006. All of the revenue in the third fiscal quarters of 2006 and 2005 was from the delivery and support of ValiMed (TM) units. Cost of revenue: Cost of revenue was $65,599 and $15,324 during the three months ended July 31, 2006 and July 31, 2005, respectively. The increase of $50,235 (or 328%) was the result of component and manufacturing costs associated with the ValiMed (TM) units delivered to Baxa Corporation. Research and development costs: Research and development costs were $280,518 during the three months ended July 31, 2006, compared with $986,087 during the three months ended July 31, 2005. The decrease of $705,569 (or 72%) resulted from a decrease primarily in stock compensation and secondarily in payroll expenditures, offset by an increase in expenditures for materials and consultants. Stock compensation decreased because the company is not issuing stock as compensation at the same level in fiscal year 2006 compared to fiscal year 2005. General and administrative expenses: General and administrative expenses were $560,577 during the three months ended July 31, 2006 compared with $860,467 during the three months ended July 31, 2005. This decrease of $299,890 (or 35%) resulted from a decrease in stock compensation, offset by an increase in expenditures primarily in legal fees associated with patent issues and secondarily in payroll. Stock compensation decreased because the company is not issuing stock as compensation at the same level in fiscal year 2006 compared to fiscal year 2005. Other income (expense): Other expense was $3,107 during the three months ended July 31, 2006, compared with other income of $1,981 during the three months ended July 31, 2005. This increase in expense resulted from interest on a note payable and trade account payables. Net loss was $728,485 during the three months ended July 31, 2006, compared with a net loss of $1,805,408 during the three months ended July 31, 2005, due to the foregoing factors. Nine Months Ended July 31, 2006 Compared to Nine Months Ended July 31, 2005. Revenue: Revenue was $622,730 and $162,149 during the nine months ended July 31, 2006 and July 31, 2005, respectively. The increase of $460,581 (or 284%) resulted from the delivery of ValiMed (TM) units to Baxa Corporation in the first three fiscal quarters of 2006. All of the revenue in the first three fiscal quarters of 2006 and 2005 was from the delivery and support of ValiMed (TM) units. 11 Cost of revenue: Cost of revenue was $294,038 and $83,782 during the nine months ended July 31, 2006 and July 31, 2005, respectively. The increase of $210,256 (or 251%) was the result of component and manufacturing costs associated with the ValiMed (TM) units delivered to Baxa Corporation. Research and development costs: Research and development costs were $1,010,789 during the nine months ended July 31, 2006, compared with $1,943,216 during the nine months ended July 31, 2005. The decrease of $932,427 (or 48%) resulted from a decrease primarily in stock compensation and secondarily in payroll expenditures, offset by an increase in expenditures for materials and consultants. Stock compensation decreased because the company is not issuing stock as compensation at the same level in fiscal year 2006 compared to fiscal year 2005. General and administrative expenses: General and administrative expenses were $1,703,860 during the nine months ended July 31, 2006 compared with $1,978,993 during the nine months ended July 31, 2005. This decrease of $275,133 (or 14%) resulted from a decrease in stock compensation, offset by an increase in expenditures primarily in legal fees associated with patent issues and secondarily in payroll. Stock compensation decreased because the company is not issuing stock as compensation at the same level in fiscal year 2006 compared to fiscal year 2005. Legal expenses for fiscal year 2006 to date exceed $500,000 but are expected to decrease in future periods. Legal expenses have been incurred for the defense of the ASD Patent Infringement lawsuit, SEC filings, patent filings, and the filing of corporate governance documents. Please see Legal Proceeding discussion under Part II, Item 1 in this document. Other income (expense): Other income was $4,094 during the nine months ended July 31, 2006, compared with other income of $2,656 during the nine months ended July 31, 2005. This increase in other income resulted primarily from a higher cash balance in an interest earning account in the first three fiscal quarters of 2006 compared with 2005, offset by interest expense in 2006 for a note payable and trade account payables. Net loss was $2,381,863 during the nine months ended July 31, 2006, compared with a net loss of $3,841,186 during the nine months ended July 31, 2005, due to the foregoing factors. LIQUIDITY AND CAPITAL RESOURCES To date, CDEX has incurred substantial losses, and will require financing for working capital to meet its operating objectives. We anticipate that we will require financing on an ongoing basis unless and until we are able to support our operating activities with additional revenues. As of July 31, 2006, we had negative working capital of $602,399, including $10,028 of cash and cash equivalents. We anticipate the need to raise approximately $2,500,000 over the next eighteen months to satisfy our current budgetary projections. Our continued operations, as well as the implementation of our business plan, therefore will depend upon our ability to raise additional funds through bank borrowings, equity or debt financing. If the company is not successful in raising the working capital, it may default in its payments to its creditors and could result in the filing of bankruptcy protection. Currently, the company has sufficient cash to fund operations through the end of September 2006. The company is actively seeking new investments from its current accredited investors as well as new accredited investors. During the nine months ended July 31, 2006, the Company raised $312,500 in funding as follows: - - The Company received $133,500 from the sale of 6,675 shares of preferred stock at an average price of $20 per share. The preferred stock is convertible into common stock at the option of the shareholder at a conversion rate of approximately 29.851, or into approximately 199,255 common shares. The conversion rate is the quotient obtained by dividing $20 by $0.67 which is the weighted average fair market price of the common stock during the 20-day trading period prior to the preferred stock purchase closing of the preferred stock lead investor. - - The Company received $89,000 from the sale of 257,563 shares of common stock at an average price of approximately $0.35 per share. - - The Company received $90,000 in proceeds under a note payable with an existing investor. The $90,000 principal and $10,000 interest is payable three months from receipt of funds, or by October 10, 2006. If payment is not made by October 10, 2006, then an additional $10,000 in interest is payable. 12 We have earned limited revenues from operations to date and are negotiating with potential partners who, in some cases, may either license our technologies for use in products produced by them or, in other cases, may purchase products produced by us. However, we cannot be certain whether or when we will receive such revenues. We earned revenues of $622,730 during the nine months ended July 31, 2006. We had a net decrease in cash and cash equivalents of $1,462,213 during the nine months ended July 31, 2006, compared with a net decrease of $134,622 during the nine months ended July 31, 2005. We used net cash of $1,738,551 and $1,947,764 in operating activities during the nine months ended July 31, 2006 and 2005, respectively, and capitalized $36,162 and $2,108 in property and equipment during the nine months ended July 31, 2006 and 2005, respectively. We received proceeds of $312,500 and 1,815,250 from the sale of shares of common stock, preferred stock and notes payable to accredited investors during the nine months ended July 31, 2006 and 2005, respectively. OFF-BALANCE SHEET ARRANGEMENTS CDEX has not participated in any off balance sheet financing or other arrangements. CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate these estimates, including those related to bad debts, inventory obsolescence, intangible assets, payroll tax obligations, and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of certain assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We have identified below certain accounting policies which we apply in the preparation of our financial statements. We believe that the policies discussed below are those most critical to our business operations. These policies form the basis of our discussion throughout this section and affect our reported and expected financial results. CASH AND CASH EQUIVALENTS: We maintain cash balances that may exceed federally insured limits. We do not believe that this results in any significant credit risk. We consider all highly liquid investments with original maturities of 90 days or less to be cash equivalents. USE OF ACCOUNTING ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect (i) the reported amounts of assets and liabilities, (ii) disclosure of contingent assets and liabilities at the date of the financial statements and (iii) the reported amounts of revenues and expenses during the periods covered by our financial statements. Actual results could differ from those estimates. PROPERTY AND EQUIPMENT: Property and equipment are stated at historical cost and are depreciated using the straight-line method over the estimated useful lives of the related assets, ranging from two to seven years. Depreciation expense was $16,588 and $12,569 during the nine months ended July 31, 2006 and 2005, respectively. INCOME TAXES: We file our income tax returns on the cash basis of accounting, whereby revenue is recognized when received and expenses are deducted when paid. To the extent that items of income or expense are recognized in different periods for income tax and financial reporting purposes, deferred income taxes are provided to give effect to these temporary differences. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured by applying presently enacted statutory tax rates, which are applicable to the future years in which deferred tax assets or liabilities are expected to be settled or realized, to the differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in operations in the period that the tax rate is enacted. 13 As we have never operated at a profit, no tax benefit has been reflected in the statement of operations and a valuation allowance has been established reducing the net carrying value of the deferred tax asset to zero. RISKS, UNCERTAINTIES AND CONCENTRATIONS: Financial instruments that potentially subject CDEX to significant concentration of credit risk consist primarily of cash equivalents and accounts receivable. In addition, at times CDEX's cash balances exceed federally insured amounts. Accounts receivable represents a portion of the revenue outstanding on these contracts. We provide for estimated credit losses at the time of revenue recognition. STOCK-BASED COMPENSATION: We have provided restricted stock grants to employees and consultants as the principal element of their compensation. We determine compensation expense as the fair value, at the measurement date, of the service received or the common stock issued, whichever is more reliably determined. In the case of employees, the measurement date is the date of grant. In the case of outside consultants, the measurement date is the date at which their performance is complete. This total cost is first reflected as deferred compensation in stockholders' equity (deficit) and then amortized to compensation expense on a straight-line basis over the period over which the services are performed. When the fair value of the common stock is used and the measurement date is not the date of grant, the total cost is re-measured at the end of each reporting period based on the fair market value on that date, and the amortization is adjusted. We have also utilized employment and consulting agreements that combine cash and stock elements of compensation, where a fixed dollar value of stock is awarded to settle non-cash compensation. We have awarded some of the common shares in advance of when the service is performed although these shares are subject to forfeiture in the event of non-performance. These amounts are shown as deferred compensation in the accompanying balance sheet. We have also paid performance bonuses in awards of common stock. RISKS RELATED TO OUR BUSINESS A HISTORY OF OPERATING LOSSES AND AN ACCUMULATED DEFICIT MAY AFFECT CDEX'S ABILITY TO SURVIVE. We have a history of operating losses and an accumulated deficit. Since our principal activities to date have been limited to organizational activities, research and development, product development and limited marketing and sales, CDEX has produced only limited revenues. In addition, we have only limited assets. As a result, we cannot be certain that CDEX will continue to generate revenues or become profitable in the future. If we are unable to obtain customers and generate sufficient revenues to operate profitably, our business will not succeed. CDEX HAS RECEIVED A GOING CONCERN OPINION FROM ITS INDEPENDENT AUDITORS THAT EXPRESSES UNCERTAINTY REGARDING ITS ABILITY TO CONTINUE AS A GOING CONCERN. We have received a report from our independent auditors for the fiscal year ended October 31, 2005 containing an explanatory paragraph that expresses uncertainty regarding our ability to continue as a going concern due to historical negative cash flow. We cannot be certain that our business plans will be successful or what actions may become necessary to preserve our business. Any inability to raise capital may require us to reduce operations or could cause our business to fail. Our limited operating history makes our future operating results unpredictable rendering it difficult to assess the health of our business or its likelihood of success. The inability to assess these factors could result in a total loss of an investor's investment in CDEX. In the case of an established company in an ongoing market, investors may look to past performance and financial condition to get an indication of the health of the company or its likelihood of success. Our short operating history and the evolving nature of the explosives detection and chemical identification markets in which we focus make it difficult to forecast our revenues and operating results accurately. We expect this unpredictability to continue into the future due to the following factors: 14 o the timing of sales of our products and services, particularly in light of our minimal sales history; o difficulty in keeping current with changing technologies; o unexpected delays in introducing new products, new product features and services; o increased expenses, whether related to sales and marketing, product development or administration; o deferral of recognition of our revenue in accordance with applicable accounting principles due to the time required to complete projects; o the mix of product license and services revenue; and o costs related to possible acquisitions of technologies or businesses. CDEX could experience operating losses or even a total loss of our business which, as a result of the foregoing factors, would be difficult to anticipate and could thus cause a total loss of capital invested in CDEX. THE ABSENCE OF A PERMANENT FULL-TIME CHIEF FINANCIAL OFFICER LEAVES CDEX WITHOUT THE BENEFIT OF THIS TYPE OF EXPERTISE AND CONSISTENT MONITORING OF CONTROLS AND PROCEDURES WHICH A FULL-TIME CHIEF FINANCIAL OFFICER WOULD AFFORD. In April 2004 we retained a qualified part-time chief financial officer on a consultancy basis. However, we have not retained a permanent, full-time chief financial officer. The responsibilities of the principal accounting and financial officer are currently being handled by our CEO. The Sarbanes-Oxley Act requires public companies to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports filed with the SEC is recorded, processed, summarized and reported within the time required. This includes controls and procedures to ensure that such information is accumulated and communicated to management, including the chief executive and financial officers, so as to allow timely decisions regarding required disclosure of such information. The Sarbanes-Oxley Act also requires documentation of internal control procedures, remediation as needed, and periodic testing of the controls, and these requirements are expected to apply to smaller companies such as CDEX beginning in 2008. A permanent, full-time chief financial officer would coordinate and oversee these procedures and our disclosure, bringing to bear specific financial and accounting expertise. Our CEO currently performs this function with guidance from our part-time chief financial officer and others. LACK OF ADDITIONAL FINANCING COULD PREVENT US FROM OPERATING PROFITABLY WHICH, EVENTUALLY, COULD RESULT IN A TOTAL LOSS OF OUR BUSINESS. Since our inception, we have funded our operations through borrowings and financings. Current funds available to CDEX may not be adequate for us to be competitive in the areas in which we intend to operate, and we have no arrangements or commitments for ongoing funding. If funding is insufficient at any time in the future, we may not be able to grow revenue, take advantage of business opportunities or respond to competitive pressures. The unavailability of funding could prevent us from producing additional revenues or ever becoming profitable. Our continued operations, as well as the successful implementation of our business plan, may therefore depend upon our ability to raise additional funds of approximately $2,500,000 through bank borrowings or equity or debt financing over the next eighteen months. We continue to seek prospective investors who may provide some of this funding. However, such funding may not be available when needed or may not be available on favorable terms. Certain family members of our management team have advanced funds to CDEX on an as-needed basis although there is no definitive or legally binding arrangement to do so. All such advances have been repaid. If we do not produce revenues and become profitable, eventually, we will be unable to sustain our business. CDEX SHAREHOLDERS WILL EXPERIENCE SIGNIFICANT DILUTION IF WE ISSUE ADDITIONAL EQUITY TO FUND OPERATIONS OR ACQUIRE BUSINESSES OR TECHNOLOGIES. If working capital or future acquisitions are financed through the issuance of equity securities, CDEX shareholders will experience significant dilution. In addition, securities issued in connection with future financing activities or potential acquisitions may have rights and preferences senior to the rights and preferences of the currently outstanding CDEX shares of common stock. The conversion of future debt obligations into equity securities could also have a dilutive effect on our shareholders. Regardless of whether our cash assets prove to be inadequate to meet our operational needs, we may elect to compensate providers of services by issuing stock in lieu of cash. 15 OUR POTENTIAL INABILITY TO PROTECT THE PROPRIETARY RIGHTS IN CDEX'S TECHNOLOGIES AND INTELLECTUAL PROPERTY MAY HAMPER OUR ABILITY TO MANUFACTURE PRODUCTS WHICH WOULD PREVENT US FROM EARNING REVENUES OR BECOMING PROFITABLE. Our success and ability to compete will depend in part on the protection of our potential patents and other proprietary information. We currently have six patent applications pending for our chemical detection technologies. We rely on non-disclosure agreements and patent and copyright laws to protect the intellectual property that we have developed and plan to develop. However, such agreements and laws may provide insufficient protection. Moreover, other companies may develop products that are similar or superior to CDEX's or may copy or otherwise obtain and use our proprietary information without authorization. If a third party were to violate one or more of our patents, we may not have the resources to bring suit or otherwise protect the intellectual property underlying the patent. In the event of such a violation or if a third party appropriated any of our unpatented technology, such party may develop and market products which we intend to develop and/or market. We would lose any revenues which we would otherwise have received from the sale or licensing of those products. This could prevent our ever making a profit on any products based upon the misappropriated technology. Policing unauthorized use of CDEX's proprietary and other intellectual property rights could entail significant expense and could be difficult or impossible. In addition, third parties may bring claims of copyright or trademark infringement against CDEX or claim that certain of our processes or features violate a patent, that we have misappropriated their technology or formats or otherwise infringed upon their proprietary rights. Any claims of infringement, with or without merit, could be time consuming to defend, result in costly litigation, divert management attention, and/or require CDEX to enter into costly royalty or licensing arrangements to prevent further infringement, any of which could increase our operating expenses and thus prevent us from becoming profitable. Our competitive position also depends upon unpatented trade secrets. Trade secrets are difficult to protect. Our competitors may independently develop proprietary information and techniques that are substantially equivalent to ours or otherwise gain access to our trade secrets, such as through unauthorized or inadvertent disclosure of our trade secrets. If this occurs, our competitors may use our processes or techniques to develop competing products and bring them to market ahead of us. This could prevent us from becoming profitable. We may rely on certain intellectual property licensed from third parties, and may be required to license additional products or services in the future, in order to move forward with our business plan. These third party licenses may be unavailable on acceptable terms, when needed or at all. An inability to enter into and maintain any of these licenses could prevent us from developing or marketing products based upon the underlying technology and could prevent us from earning revenues on these products or from becoming profitable. For a discussion of the status of a certain patent infringement lawsuit filed against CDEX in the District Court of Colorado, see "Legal Proceedings." NO ASSURANCE OF SUCCESSFUL MANUFACTURING MAY AFFECT OUR ABILITY TO SURVIVE. CDEX itself has no experience in manufacturing commercial quantities of products, and our management has had limited experience in this area. We presently have no plans for developing in-house manufacturing capability beyond aggregating off-the-shelf components for our initial units into a final assembly. Accordingly, we depend upon outside manufacturers to manufacture and assemble our products. In our early stages with each new product, we plan to do the final assembly and testing of the initial units in-house. We cannot be certain that the terms of such arrangement will be favorable enough to permit our products to compete effectively in the marketplace. 16 DEPENDENCE ON OUTSOURCED MANUFACTURING MAY AFFECT OUR ABILITY TO BRING PRODUCTS TO MARKET. At present, we do not plan to manufacture any of our products in-house. We are considering different possibilities for bringing different products to market among them, licensing to third parties or outsourcing manufacturing. The risks of association with outsourced manufacturers are related to their operations, finances and suppliers. CDEX would have little control over an outsourced manufacturer and may suffer losses if any outside manufacturer fails to perform its obligations to manufacture and ship the manufactured product. These manufacturers' financial affairs may also affect our ability to obtain product from them in a timely fashion should they fail to continue to obtain sufficient financing during a period of incremental growth. Problems with outsourced manufacturers could damage our relationships with our clientele and cost us future revenues. If we are unable to contract with adequate manufacturers, and in the absence of licensing or other means, we may be unable to market our products. This would prevent us from earning revenues. LACK OF MARKET ACCEPTANCE MAY LIMIT OUR ABILITY TO SELL PRODUCTS AND GENERATE REVENUES WHICH WOULD PREVENT US FROM EARNING REVENUES OR BECOMING PROFITABLE. We cannot be certain that any products that we successfully develop will ever achieve wide market acceptance. Our products, if successfully developed, may compete with a number of traditional products manufactured and marketed by major technology companies, as well as new products currently under development by such companies and others. In the explosives detection marketplace, for example, many airports and other facilities and agencies have already invested in and implemented systems that are based upon technology that is different from ours. While we believe our technology is superior, we will have to demonstrate its superiority to these potential customers in order to sell our products and generate revenues. We may encounter similar obstacles in other application areas. The degree of market acceptance of our products will depend on a number of factors, including the establishment and demonstration of the efficacy of the product candidates, their potential advantage over alternative methods and reimbursement policies of government and third party payors. We cannot be certain that the marketplace in general will accept and utilize any of our products. If potential customers do not accept and purchase our products, we will be unable to generate revenues and become profitable. WE INTEND TO MARKET OUR PRODUCTS IN INDUSTRIES WHERE TECHNOLOGY CHANGES RAPIDLY, AND WE WILL INCUR COSTS TO KEEP OUR PRODUCTS CURRENT AND INNOVATIVE. OUR FAILURE TO DO SO COULD RENDER OUR PRODUCTS OBSOLETE, MAKING OUR BUSINESS UNPROFITABLE. We hope to market our products in industries characterized by rapid change due to the introduction of new and emerging technologies. Critical issues concerning the governmental or commercial use of chemical detection mechanisms, including security, reliability, accuracy, cost, ease of use, accessibility, or potential tax or other government regulation, may affect the relevance and functionality of our products. Future technology or market changes may cause some of our products to become obsolete more quickly than expected. We will need to make research and development expenditures to create new features for our products to enhance their effectiveness and become and remain competitive. If we are unsuccessful in timely assimilating development changes in the various environments, we may be unable to achieve or maintain profitability. POTENTIAL DEFECTS AND PRODUCT LIABILITY COULD RESULT IN DELAYS IN MARKET ACCEPTANCE, UNEXPECTED LIABILITY AND COSTS AND DIMINISHED OPERATING RESULTS. Technology-based products frequently contain errors or defects, especially when first introduced or when new versions are released. Defects and errors could be found in current versions of our products, future upgrades to current products or newly developed and released products. These defects could result in product liability suits, delays in market acceptance or unexpected redevelopment costs, which could cause any profits we might otherwise have to decline. We anticipate most of our agreements with customers will contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that we will be unable to negotiate such provisions with certain customers or that these provisions, if negotiated, may not be valid as a result of federal, state, local or foreign laws or ordinances or unfavorable judicial decisions. A successful product liability claim could damage our business, operating results and financial condition. Prior to the actual licensing of our technologies for use in distributed products or the entry of our products made by us into the market, we plan to procure product liability insurance. Although we have researched policies for such insurance, we currently have none in place, and we cannot be certain that the amount or extent of coverage will be adequate once we obtain it. 17 OUR POTENTIAL FUTURE BUSINESS AND/OR TECHNOLOGY ACQUISITIONS MAY BE UNPREDICTABLE AND MAY CAUSE OUR BUSINESS TO SUFFER. CDEX intends to expand its operations through the acquisition of additional technologies (either by purchasing other businesses or acquiring their technological assets) which it perceives to be unexploited and develop products based upon these technologies. We have not yet identified these specific technologies, and some of these technologies may be outside our current field of operations. However, we may be unable to identify any such businesses or technologies. Expansion may involve a number of special risks, including possible adverse effects on our operating results or balance sheet (particularly in the event of impairment of acquired intangible assets), diversion of management attention, inability to retain key personnel, risks associated with unanticipated events, any of which could prevent us from becoming profitable. In addition, if competition for acquisition candidates or technologies were to increase, the cost of acquiring businesses or technologies could increase as well. If we are unable to implement and manage our expansion strategy successfully, our business may suffer or fail. SUBSTANTIAL COMPETITION MAY LIMIT OUR ABILITY TO SELL PRODUCTS AND THEREBY OUR CHANCES OF BECOMING PROFITABLE. We may experience substantial competition in our efforts to locate and attract customers for our products. We are aware of two significant competitors in the explosives detection industry which we believe have greater experience, resources and managerial capabilities and may be in a better position than we are to obtain access to and attract customers. A number of larger companies similarly may enter some or all of our target markets and directly compete with us. In the counter-terrorism arena, it is difficult to assess our competition due to the high level of secrecy and lack of available information with respect to defense and homeland security contracts and contractors. We must assume that the demand for the technology in this area has given rise to a corresponding supply of scientists and others who are developing technology similar to, or otherwise competitive with ours. In the area of brand protection, many companies may seek to develop technology in-house to protect their own brands rather than contract with us for our technology. In the areas of medical and pharmaceutical validation and brand protection, various existing technologies compete with ours and already are in use in the marketplace. These include radio frequency identification tags, taggant agents (chemical agents added to the target substance to serve solely as identifying tags) and bar coding. If our competitors are more successful in marketing their products, we may be unable to achieve or maintain profitability. LOSS OF ANY OF OUR CURRENT MANAGEMENT OR INABILITY TO RECRUIT AND RETAIN QUALITY PERSONNEL COULD ADVERSELY IMPACT OUR BUSINESS AND PROSPECTS. OUR DIRECTORS AND OFFICERS EXERT SUBSTANTIAL CONTROL OVER OUR BUSINESS AND OPERATIONS. We are dependent on our officers and other key personnel, i.e., James O. Griffin and Timothy Shriver, respectively, our Chief Executive Officer/President and our Senior Vice President of Manufacturing Operations. The loss of any of our key personnel could materially harm our business because of the cost and time necessary to retain and train a replacement. Such a loss would also divert management attention away from operational issues. This would increase costs and prevent or reduce our profits. To minimize the effects of such loss, we have entered into employment contracts and non-competition agreements with our key officers and employees, including Messrs. Griffin and Shriver. OUR MANAGEMENT LACKS EXPERIENCE IN THIS MARKET. Although widely experienced in other industries, our current senior management team has little experience leading the development, marketing and sales of technology products in the chemical detection and validation marketplace. This lack of experience could lead to inefficiency and slow the process of marketing our products and prevent us from making sales or becoming profitable. ITEM 3. CONTROLS AND PROCEDURES Based upon an evaluation, supervised by James Griffin, our President, Chief Executive Officer and Principal Accounting and Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, Mr. Griffin concluded that our disclosure controls and procedures were effective as of July 31, 2006. In addition, during the three months ended July 31, 2006, there were no significant changes in our internal accounting controls or in other factors that materially affected our internal controls over financial reporting. 18 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On March 13, 2006 Analytical Spectral Device, Inc. ("ASD") served upon CDEX a patent infringement lawsuit in the District Court of Colorado alleging patent infringement by CDEX of U.S. Patent No. 6,771,369 (the "'369 patent"). CDEX filed an Answer with the court on May 1, 2006 denying ASD's claims for patent infringement and setting forth various affirmative defenses and counterclaims, including non-infringement, invalidity, and unenforceability of the `369 patent. A scheduling conference was held on May 23, 2006 in which the Magistrate Judge entered a tentative case schedule. The parties agreed to terms of settlement of the litigation during a settlement conference held by the Magistrate Judge on September 1, 2006. The parties are currently in the process of formalizing the settlement agreement that will form the basis of an Order to Dismiss. The dismissal paper is to be submitted to the Court on or before October 2, 2006. The terms and conditions upon which the settlement agreement is based are to be kept confidential. Trial is currently scheduled for the fall of 2007. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS During the three months ended July 31, 2006, the Company sold 6,675 shares of preferred stock at an average price of $20 per share for proceeds of $133,500, and 257,563 shares of common stock at an average price of $0.35 per share for proceeds of $89,000. The 6,675 shares of preferred stock are convertible into common stock at the option of the shareholder at a conversion rate of approximately 29.851, or into 199,255 common shares. The total proceeds of $222,500 are for working capital and general corporate purposes. All such securities were issued and sold pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D thereunder to accredited investors only and not in connection with any public offering. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 31. Rule 13a-14(a) Certification of James Griffin. 32. Section 1350 Certification of James Griffin. 19 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on September 13, 2006. CDEX INC. By: /s/ James Griffin ------------------ Name: James Griffin Title: President, Chief Executive Officer, and Chief Accounting and Financial Officer 20 EX-31 2 ex31.txt EXHIBIT 31 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF ACCOUNTING AND FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, James Griffin, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of CDEX Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the small business issuer and have: a. designed such disclosure controls and procedures to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this report is being prepared; b. designed such internal control over financial reporting, or caused such internal controls over financial reporting to be designed under my supervision, 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; c. evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this annual report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter that has materially affected, or is reasonably likely to affect, the small business issuer's internal control over financial reporting; 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of small business issuer's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal controls which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. Dated: September 13, 2006 /s/ James Griffin ------------------ James Griffin President, Chief Executive Officer, and Chief Accounting and Financial Officer EX-32 3 ex32.txt EXHIBIT 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of CDEX Inc. (the "Company") on Form 10-QSB for the quarterly period ended July 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, James Griffin, President and Chief Executive Officer (and Chief Accounting and Financial Officer) of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that based on my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: September 13, 2006 /s/ James Griffin ------------------ James Griffin President, Chief Executive Officer, and Chief Accounting and Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----