Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the issuer was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: [ X ] Yes [ ] No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): [ ] Yes [X] No
State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 29,751,577 common shares as of August 13, 2008.
Our unaudited condensed consolidated financial statements included in this Form 10-QSB are as follows:
CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, 2008
(UNAUDITED)
ASSETS
| Current Assets | | | |
| Cash | | $ | 4,127,852 | |
| Accounts receivable, net | | | 443,407 | |
| Deferred acquisition costs | | | 164,309 | |
| Prepaid expenses and other current assets | | | 350,374 | |
| Deferred financing costs | | | 993,524 | |
| Total Current Assets | | | 6,079,466 | |
| Property and Equipment, net | | | 4,852,123 | |
| Non-Current Assets | | | | |
| Deposits | | | 349,650 | |
| Goodwill | | | 9,846,665 | |
| Intangible assets, net | | | 1,793,884 | |
| Total Non-Current Assets | | | 11,990,199 | |
| Total | | $ | 22,921,788 | |
| | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | |
| | | | | |
| Current Liabilities | | | | |
| Accounts payable | | $ | 2,099,039 | |
| Accrued liabilities | | | 1,225,195 | |
| Capital lease obligations | | | 222,393 | |
| Notes payable | | | 1,320,064 | |
| Convertible notes payable | | | 280,000 | |
| Total Current Liabilities | | | 5,146,691 | |
| Long Term Liabilities | | | | |
| Capital lease obligations, net of current portion | | | 209,736 | |
| Notes payable, net of current portion | | | 1,101,701 | |
| Convertible notes payable, net of current portion | | | 13,719,663 | |
| Total Long Term Liabilities | | | 15,031,100 | |
| Total Liabilities | | | 20,177,791 | |
| | | | | |
| Stockholders' Equity | | | | |
| Convertible preferred stock; par value $0.001 per share; | | | | |
| 20,000,000 authorized shares; | | | | |
| 1,200,000 shares issued and none outstanding; liquidation preference of $2.40 per share | | | - | |
| Common stock; par value $0.001 per share; | | | | |
| 50,000,000 Series B authorized shares; none issued and outstanding | | | - | |
| Common stock; par value $0.001 per share; | | | | |
| 100,000,000 authorized shares; 29,366,577 shares issued and outstanding | | | 29,366 | |
| Additional paid-in capital | | | 29,405,078 | |
| Stockholder receivable | | | (766,280) | |
| Accumulated deficit | | | (25,924,167) | |
| Total Stockholders' Equity | | | 2,753,997 | |
| Total Liabilities and Stockholders' Equity | | $ | 22,921,788 | |
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
| | | THREE MONTHS | | | NINE MONTHS | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Net Sales | | $ | 5,131,563 | | | $ | 2,427,466 | | | $ | 10,377,895 | | | $ | 6,054,794 | |
| | | | | | | | | | | | | | | | | |
| Cost of Sales | | | (1,879,021 | ) | | | (1,252,261 | ) | | | (4,388,731) | | | | (3,114,901 | ) |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Gross Profit | | | 3,252,542 | | | | 1,175,205 | | | | 5,989,164 | | | | 2,939,893 | |
| | | | | | | | | | | | | | | | | |
| Operating Expenses | | | | | | | | | | | | | | | | |
| Delivery expenses | | | 415,066 | | | | 205,744 | | | | 810,526 | | | | 538,089 | |
| Store expenses | | | 1,915,502 | | | | 720,423 | | | | 3,771,810 | | | | 1,623,176 | |
| Selling expenses | | | 238,400 | | | | 153,532 | | | | 588,746 | | | | 464,869 | |
| Administrative expenses | | | 1,412,721 | | | | 1,207,497 | | | | 5,275,878 | | | | 4,130,718 | |
| Depreciation and amortization expenses | | | 241,701 | | | | 96,112 | | | | 449,068 | | | | 245,968 | |
| Other | | | 57,379 | | | | - | | | | 74,412 | | | | - | |
| Total Operating Expenses | | | 4,280,769 | | | | 2,383,308 | | | | 10,970,440 | | | | 7,002,820 | |
| | | | | | | | | | | | | | | | | |
| Operating Loss | | | (1,028,227) | | | | (1,208,103 | ) | | | (4,981,276) | | | | (4,062,927 | ) |
| | | | | | | | | | | | | | | | | |
| Other Income (Expense) | | | | | | | | | | | | | | | | |
| Gain on extinguishment of debt | | | - | | | | - | | | | 423,798 | | | | - | |
Interest expense | | | (896,161) | | | | (744,777) | | | | (1,471,638) | | | | (1,355,920) | |
Other expenses (income) | | | (104,623) | | | | 137,930 | | | | (538,679) | | | | (185,140) | |
Total Other Expenses | | | (1,000,784) | | | | (606,847 | ) | | | (1,586,579) | | | | (1,541,060 | ) |
| | | | | | | | | | | | | | | | | |
| Loss before provisions for income taxes | | | (2,029,011) | | | | (1,814,950 | ) | | | (6,567,795) | | | | (5,603,987 | ) |
| Provision for income taxes | | | - | | | | - | | | | - | | | | - | |
| Net Loss | | $ | (2,029,011) | | | $ | (1,814,950 | ) | | $ | (6,567,795) | | | $ | (5,603,987 | ) |
| | | | | | | | | | | | | | | | | |
| Basic and diluted loss per common share | | $ | (0.11) | | | $ | (0.10 | ) | | $ | (0.33) | | | $ | (0.31 | ) |
| | | | | | | | | | | | | | | | | |
| Basic and diluted weighted average number | | | | | | | | | | | | | | | | |
| of common shares outstanding | | | 18,525,997 | | | | 17,313,060 | | | | 19,999,511 | | | | 17,972,608 | |
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
| | | | | | | |
| | | 2008 | | | | 2007 |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | |
| Net loss | | $ | (6,567,795) | | | $ | (5,603,987 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities: | | | | | | | | |
| Depreciation and amortization | | | 449,068 | | | | 245,968 | |
| Amortization of deferred financing costs and consulting fees | | | 24,375 | | | | 12,187 | |
| Bad debt expense | | | 22,543 | | | | 4,675 | |
| Equity instruments issued for compensation and services | | | 650,508 | | | | 416,070 | |
| Gain on debt extinguishment | | | (423,798) | | | | - | |
| Loss on disposal of assets | | | 4,015 | | | | | |
| Amortization of debt discounts | | | 969,489 | | | | 746,660 | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | 13,846 | | | | 135,309 | |
| Prepaid expenses and other current assets | | | (246,163) | | | | 91,201 | |
| Other assets | | | - | | | | (31,588 | ) |
| Deposits | | | (201,693) | | | | - | |
| Accounts payable and accrued expenses | | | 492,348 | | | | 1,667,863 | |
| Liquidated damages | | | - | | | | (61,125 | ) |
| Net cash used in operating activities | | | (4,813,257) | | | | (2,376,767 | ) |
| | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | |
| Acquisition of property and equipment | | | (2,335,581) | | | | (285,833 | ) |
| Deferred acquisition costs | | | 396,137 | | | | (601,765 | ) |
| Acquired goodwill and intangibles | | | (2,284,360) | | | | - | |
| Acquisition of business | | | - | | | | (98,233 | ) |
| Net cash used in investing activities | | | (4,223,804) | | | | (985,831 | ) |
| | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | |
| Proceeds from issuance of notes payable | | | 937,141 | | | | 475,768 | |
| Proceeds from issuance of convertible notes payable | | | 11,457,600 | | | | 1,800,000 | |
| Proceeds from issuance of related party notes payable | | | - | | | | 200,000 | |
| Repayments on notes payable | | | (201,319) | | | | (244,490 | ) |
| Repayments on related party notes payable | | | (23,019) | | | | (288,890 | ) |
| Repayments on convertible notes payable | | | (295,000) | | | | - | |
| Deferred financing costs | | | (1,577,284) | | | | - | |
| Repayments on capital lease obligation | | | (176,621) | | | | (167,464 | ) |
| Proceeds from issuance of common stock | | | 1,436,051 | | | | 3,617,192 | |
| Proceeds from exercise of warrants | | | 490,000 | | | | - | |
| Repayment on line of credit | | | (500,000) | | | | - | |
| Net cash provided by financing activities | | | 11,547,549 | | | | 5,392,116 | |
| | | | | | | | | |
| Net increase in cash | | | 2,510,488 | | | | 2,029,518 | |
| Cash at beginning of period | | | 1,617,364 | | | | 1,414,456 | |
| Cash at end of period | | $ | 4,127,852 | | | $ | 3,443,974 | |
| | | | | | | | | |
| Cash paid during the period for: | | | | | | | | |
| Interest | | $ | 91,079 | | | $ | 87,337 | |
| | | | | | | | | |
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
| | | | 2008 | | | | 2007 | |
| | | | | | | | |
| Debt discount on convertible notes issued with common stock | | $ | - | | | $ | 1,478,714 | |
| Capital lease additions | | $ | 119,177 | | | $ | 87,036 | |
| Acquisition of businesses with notes payable | | $ | 2,447,000 | | | $ | - | |
| Shares issued in conjunction with business acquisition | | $ | 2,030,374 | | | $ | - | |
| Acquisition of business | | $ | - | | | $ | 2,028,000 | |
| Conversion of note payable to convertible note | | $ | 200,000 | | | $ | 200,000 | |
| Conversion of debt to common stock | | $ | 365,000 | | | $ | 100,000 | |
| Convertible note issued for stockholder receivable | | $ | - | | | $ | 250,000 | |
| Reclassification of accrued expenses to notes payable | | $ | - | | | $ | 125,000 | |
| Debt discount on convertible notes issued with warrants | | $ | 1,334,896 | | | $ | - | |
| Shares issued as collateral in conjunction with debt issuance | | $ | 500 | | | $ | - | |
| Shares issued in conjunction with cashless warrants | | $ | 467 | | | $ | - | |
See accompanying notes to condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
1. ORGANIZATION, NATURE OF OPERATIONS AND BASIS OF PRESENTATION
The Company
US Dry Cleaning Corporation (“USDC”, “we”, or “us”) is a retail service provider of laundry and dry cleaning services consisting of sixty retail locations (“stores”) and three processing plants. The Company’s operations are located in Honolulu, Hawaii, Southern California, Central California, and the mid-east coast.
On June 21, 2008, the Company completed the acquisition of all assets and liabilities of Caesar’s Cleaners, in Honolulu, Hawaii (“Caesar’s”) (see Note 8).
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared by the Company, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to such SEC rules and regulations; nevertheless, the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements and the notes hereto should be read in conjunction with the financial statements, accounting policies and notes thereto included in the Company’s audited consolidated financial statements on Form 10-KSB for the fiscal year ended September 30, 2007 filed with the SEC. In the opinion of management, all adjustments necessary to present fairly, in accordance with GAAP, the Company’s financial position as of June 30, 2008, and the results of operations and cash flows for the interim periods presented have been made. Such adjustments consist only of normal recurring adjustments. The results of operations for the interim periods presented are not necessarily indicative of the results for the full year.
Going Concern
The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. The Company has recurring losses from operations; negative cash flow from operating activities of approximately $4,813,000 for the nine months ended June 30, 2008; working capital of approximately $933,000 and an accumulated deficit of approximately $25,924,000 at June 30, 2008. The Company’s business plan calls for various business acquisitions, which will require substantial additional capital. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The Company intends to fund acquisitions and operations assimilation through debt and equity financing transactions. In connection with such efforts, the Company completed approximately $14,000,000, net of discount and issuance costs, of debt and equity financing during the nine months ended June 30, 2008 (see Notes 3, 4, and 6) and the Company plans to complete similar debt and equity transactions in the future. However, such financing transactions may be insufficient to fund planned acquisitions, capital expenditures, working capital and other cash requirements for the next year. Therefore, the Company will be required to seek additional funds to finance its long-term operations. The successful outcome of future financing activities cannot be determined at this time and there is no assurance that, if achieved, the Company will have sufficient funds to execute its intended growth plans or generate positive operating results.
The accompanying condensed consolidated financial statements do not include any adjustments related to recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of USDC and its wholly-owned subsidiaries, Steam Press Holdings, Inc. (“Steam Press”), Coachella Valley Retail, LLC (“CVR”), Cleaners Club, Inc. (“CCI”), USDC Fresno, Inc., formerly Team Enterprises, Inc., (“Team”), USDC Portsmouth, Inc. (“Zoots”), formerly Zoots Corporation, and Caesar’s. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates made by management include the realization of long-lived assets, the valuation allowance on deferred tax assets, the allowance for doubtful accounts receivable, and the purchase price allocations for business acquisitions. Actual results could differ from those estimates.
Business Segments
The Company currently operates in one segment, that being the consumer dry cleaning (Specialty Consumer Services) business and is geographically concentrated in Hawaii, Virginia, and California.
Risks and Uncertainties
The Company operates in an industry that is subject to intense competition. The Company faces risks and uncertainties relating to its ability to successfully implement its growth strategy. Among other things, these risks include the ability to develop and sustain revenue growth; managing the expansion of its operations; competition; attracting and retaining qualified personnel; maintaining and developing new strategic relationships; and the ability to anticipate and adapt to the changing markets and any changes in government or environmental regulations. Therefore, the Company is subject to the risks of delays and potential business failure.
The dry cleaning industry has been a target for environmental regulation during the past two decades due to the use of certain solvents in the cleaning process. In 2002, air quality officials in Southern California approved a gradual phase out of Perchloroethylene (“Perc”), the most common dry cleaning solvent, by 2020. Under this regulation, which went into effect January 1, 2003, any new dry cleaning business or facility that adds a machine must also add a non-Perc machine. While existing dry cleaners can continue to operate one Perc machine until 2020, by November 2007 all dry cleaners using Perc had to utilize state-of-the-art pollution controls to reduce Perc emissions. The Company believes that it has successfully integrated the new dry cleaning processes.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Risks and Uncertainties (continued)
Management feels that domestic media have generally sensationalized the perceived hazards of Perc to operators, clients and the environment in general. Perc is a volatile, yet non-flammable, substance that requires precautions and proper handling. However, it has proven safe, effective and completely manageable for years and the Company anticipates that its centralized operations and improvements in all facets of the business will further improve the safety for employees, clients and the environment. The Company will continue to utilize Perc where permitted on a limited interim basis to assure an orderly transition. To the extent that additional investment for environmental compliance may be necessary, the Company does not anticipate any significant financial impact to operations. The Company believes that it complies in all material respects with all relevant rules and regulations pertaining to the use of chemical agents. In the opinion of management, the Company complies in all material respects with all known federal, state, and local legislation pertaining to the use of all chemical agents and will endeavor to ensure that the entire organization proactively remains in compliance with all such statutes and regulations in the future.
Other Concentrations
The financial instrument that potentially exposes the Company to a concentration of credit risk principally consists of cash. The Company deposits its cash with high credit financial institutions in the United States of America. At June 30, 2008, the Company’s cash balances were in excess of the Federal Deposit Insurance Corporation limit by approximately $3,751,000.
The Company’s credit risk with respect to the accounts receivable is limited due to the credit worthiness of customers and the fact that most of accounts receivable consists of large commercial customers. The Company also performs periodic reviews of collectability and provides an allowance for doubtful accounts receivable when necessary. Management considers the allowance for doubtful accounts receivable at June 30, 2008 of approximately $23,000 to be adequate.
Cash Restriction
Approximately $3,500,000 of the Company’s cash balance at June 30, 2008 is restricted per the terms of lending agreements for business acquisition use.
Loss per Share
Under Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," basic loss per common share is computed by dividing the loss applicable to common stockholders by the weighted average number of common shares assumed to be outstanding during the period of computation. Diluted loss per common share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of warrants (using the treasury stock method) and the conversion of the convertible preferred stock and convertible debt (using the if-converted method). At June 30, 2008, 17,342,953 convertible securities and 7,023,978 options and warrants to purchase common stock were excluded from the calculation of diluted loss per share because they were anti-dilutive. At June 30, 2007, 2,195,000 convertible securities and 432,432 options and warrants to purchase common stock were excluded from the calculation of diluted loss per share because they were anti-dilutive.
Reclassification
Certain reclassifications have been made to the June 30, 2007 condensed consolidated financial statements to conform to the June 30, 2008 presentations.
Revenue Recognition
The Company recognizes revenue on retail laundry and dry cleaning services when the services have been provided and the earnings process is complete. For “walk-in” retail customers, when an order is complete and ready for customer pick-up, the sale and related account receivable are recorded. For commercial customers, the sale is not recorded until the Company delivers the cleaned garments.
US DRY CLEANING CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
3. CONVERTIBLE NOTES PAYABLE
During fiscal year 2007, the Company accepted subscriptions from accredited investors for $2,250,000 of its Series A Convertible Debentures. The debentures were sold with a built-in thirty percent (30%) rate of return. For each $100,000 paid to the Company, a total of $130,000 is due to the holder. Additionally, upon issuance, the Company issued 16,666 shares of common stock to the note holder for each $100,000 subscription. The debentures mature in one year from the date issued with no interest. The principal amount of the debentures may be converted into common stock of the Company at a fixed conversion rate of $3.00 per share at the holder’s option at any time. The principal amount of the debentures is secured by all of the Company’s assets and those of its operating subsidiaries, including an assignment of its leasehold interests in its retail facilities. Pursuant to a registration rights agreement, the Company is obligated to register or to file a registration statement for all of the common stock that may be issued upon conversion of the debentures, within 270 days from closing on a “best efforts” basis. Broker or underwriting fees or commissions to be paid in connection with the offer and sale was a maximum of 10% of cash received. The Company recorded $1,800,000 in cash proceeds; debt conversion of $200,000 and a stockholder note receivable of $250,000. Accordingly, 374,985 shares of common stock were issued. During the nine months ended June 30, 2008, approximately $50,000 of Series A Convertible Debenture holder converted their debt to common stock and approximately $1,660,000 of Series A Convertible Debenture holders converted their debt to the newly issued below Notes. The debt to debt conversion resulted in debt extinguishment accounting under Accounting Principles Board ("APB") No. 26, “Early Extinguishment of Debt,” and Emerging Issues Task Force ("EITF") Issue No. 96-19, “Debtor’s Accounting for a modification or Exchange of Debt Instruments,” and accordingly, the Company recorded a gain on extinguishment of approximately $424,000 in the accompanying condensed consolidated statement of operations for the nine months ended June 30, 2008. During the three months ended June 30, 2008, a cash payment of $195,000 was made to three investors. At June 30, 2008, balance outstanding on the Series A Convertible Debentures was $280,000. The maturity date of all outstanding notes has been subsequently extended through December 2008. Such amount was included in the convertible notes payable in the accompanying condensed consolidated balance sheet.
During the nine months ended June 30, 2008, the Company completed the closing of a private placement of 10% senior secured convertible notes (the “Notes”) to accredited investors, receiving net cash of approximately $2,740,000. Each Note was issued at a price equal to 90% of its principal amount. The Notes mature two years after the date of their issuance and bear interest at 10% per annum, payable quarterly in arrears in cash. Investors may convert their Notes into shares of the Company’s common stock at any time and from time to time on or before the maturity date, at a conversion price of $2.50 per share, subject to adjustment under customary circumstances. The Notes will automatically convert into shares of the Company’s common stock at the conversion price, if the closing bid price for the common stock has traded at more than $5.00 per share for a period of 20 consecutive trading days, provided that, throughout this period, the common stock has been trading on a national securities exchange or National Association of Securities Dealers Automated Quotation System ("NASDAQ") and such conversion shares have been fully registered for resale and are not subject to any lock-up provisions. At June 30, 2008, the balance outstanding on the notes was $4,450,050, net of discount of $727,259, and was included in convertible notes payable in the accompanying condensed consolidated balance sheet.
US DRY CLEANING CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
3. CONVERTIBLE NOTES PAYABLE (Continued)
On February 12, 2008, the Company issued a conventional convertible debt instrument in connection with the Team acquisition (see Note 8) for $1,728,360 which is secured by certain assets of the company and includes first year interest of $144,000. The debt instrument matures two years after the date of issuance and bears interest at 12% per annum, payable in arrears in cash at maturity date. The holder may convert the debt instrument into shares of the Company’s common stock at any time and from time to time on or before the maturity date, at a conversion price of $0.75 per share, subject to adjustment under customary circumstances. The debt instrument will automatically convert into shares of the Company’s common stock at the conversion price, if the closing bid price for the common stock has traded at more than $5.00 per share for a period of 20 consecutive trading days, provided that, throughout this period, the common stock has been trading on a national securities exchange or NASDAQ and such conversion shares have been fully registered for resale and are not subject to any lock-up provisions. In connection with this agreement, the Company signed a warrant agreement as disclosed in the options and warrants section below. At June 30, 2008, the balance outstanding was $999,691, net of discount of $728,669, and was included in convertible notes payable in the accompanying condensed consolidated balance sheet.
On February 14, 2008, the Company issued a conventional convertible debt instrument in connection with the Team acquisition (see Note 8), for $1,635,540 which is secured by certain assets of the Company. The debt instrument matures two years after the date of issuance and bears interest at 10% per annum, payable in arrears in cash at maturity date. The holder may convert the debt instrument into shares of the Company’s common stock at any time and from time to time on or before the maturity date, at a conversion price of $2.50 per share, subject to adjustment under customary circumstances. The debt instrument will automatically convert into shares of the Company’s common stock at the conversion price, if the closing bid price for the common stock has traded at more than $5.00 per share for a period of 20 consecutive trading days, provided that, throughout this period, the common stock has been trading on a national securities exchange or NASDAQ and such conversion shares have been fully registered for resale and are not subject to any lock-up provisions. At June 30, 2008, the balance outstanding was $1,499,483, net of discounts of $136,057, and was included in convertible notes payable in the accompanying condensed consolidated balance sheet.
On March 12, 2008, the Company issued a conventional convertible debt instrument in connection with the Zoots acquisition (see Note 8), for $1,725,000 which is secured by certain assets of the Company. The debt instrument matures eighteen months after the date of issuance and bears interest at 12% per annum with interest only payments of $17,250. The holder may convert the debt instrument into shares of the Company’s common stock at any time and from time to time on or before the maturity date, at a conversion price of $0.75 per share, subject to adjustment under customary circumstances. The debt instrument will automatically convert into shares of the Company’s common stock at the conversion price, if the closing bid price for the common stock has traded at more than $5.00 per share for a period of 20 consecutive trading days, provided that, throughout this period, the common stock has been trading on a national securities exchange or NASDAQ and such conversion shares have been fully registered for resale and are not subject to any lock-up provisions. In connection with this agreement, the Company signed a warrant agreement as disclosed in the options and warrants section below. At June 30, 2008, the balance outstanding was $1,143,938, net of discount of $581,062, and was included in convertible notes payable in the accompanying condensed consolidated balance sheet.
On May 28, 2008, the Company issued a conventional convertible debt instrument in connection with the Caesar’s acquisition (see Note 8) for $3,175,000 which is secured by certain assets of the Company and includes first year interest of $300,000. The debt instrument matures two years after the date of issuance and bears interest at 12% per annum with interest only payments of $31,750 commencing on June 28, 2009. The holder may convert the debt instrument into shares of the Company’s common stock at any time and from time to time on or before the maturity date, at a fixed conversion price of $0.75 per share, subject to adjustment under customary circumstances. In connection with this agreement, the Company signed a warrant agreement as disclosed in the options and warrants section below. At June 30, 2008, the balance outstanding was $2,544,687, net of discount of $630,313, and was included in convertible notes payable in the accompanying condensed consolidated balance sheet.
On June 26, 2008, the Company issued a conventional convertible debt instrument in connection with a specified future acquisition for $1,725,000 which is secured by certain assets of the Company. The debt instrument matures two years after the date of issuance and bears interest at 12% per annum. First month interest of $19,518 is due August 1, 2008 with interest only payments of $17,250 commencing on September 1, 2008. The holder shall have the right to demand payment of the instrument and accrued interest on December 30, 2009 with a thirty day written notice and the right to demand full payment of the instrument if Robert Y. Lee is no longer serving as Chief Executive Officer and board member. The holder may convert the debt instrument into shares of the Company’s common stock at any time and from time to time on or before the maturity date, at a fixed conversion price of $0.75 per share, subject to adjustment under customary circumstances. In connection with this agreement, the Company signed a warrant agreement as disclosed in the options and warrants section below. At June 30, 2008, the balance outstanding was $1,303,527, net of discount of $421,473, and was included in convertible notes payable in the accompanying condensed consolidated balance sheet.
On June 26, 2008, the Company issued a conventional convertible debt instrument in connection with a specified future acquisition for $2,540,000 which is secured by certain assets of the Company and includes the first year interest of $240,000. The debt instrument matures two years after the date of issuance and bears interest at 12% per annum with interest only payments of $25,400 commencing on July 26, 2009. The holder shall have the right to demand payment of the instrument and accrued interest on December 30, 2009 with a thirty day written notice and the right to demand full payment of the instrument if Robert Y. Lee is no longer serving as Chief Executive Officer and board member. The holder may convert the debt instrument into shares of the Company’s common stock at any time and from time to time on or before the maturity date, at a fixed conversion price of $0.75 per share, subject to adjustment under customary circumstances. In connection with this agreement, the Company signed a warrant agreement as disclosed in the options and warrants section below. At June 30, 2008, the balance outstanding was $1,778,287, net of discount of $761,713, and was included in convertible notes payable in the accompanying condensed consolidated balance sheet.
US DRY CLEANING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
3. CONVERTIBLE NOTES PAYABLE (continued)
During the nine months ended June 30, 2008, the Company recorded approximately $969,000 of debt discount amortization expense related to convertible notes payable and was included in interest expense in the accompanying condensed consolidated statements of operations.
4. NOTES PAYABLE
During February 2008, the Company entered into an eighteen month financing agreement with an unrelated party in the amount of $800,000 that bears interest at 14% per annum. The first monthly payment of approximately $25,000 is due on March 12, 2009 and a final payment of $781,894 is due at the end of the term. The obligation of the Company under this financing agreement is secured by certain equipment of the Company. As of June 30, 2008, no payments have been made. Therefore, the balance outstanding is $800,000.
On March 24, 2008, the Company entered into a debt agreement in connection with the acquisition of Zoots Corporation (see Note 8) for $975,000 at interest rate of 10% per annum, which matures on September 24, 2008 and is secured by certain assets of the Company. Interest payments shall be payable in arrears at the end of each two-month period from the issuance date of the note. As of June 30, 2008, no payments have been made. Therefore, the balance outstanding is $975,000.
The Company has a line of credit with a financial institution in the maximum amount of $1,100,000 and bearing interest at 7.15%. All outstanding borrowings were fully paid off during the quarter ended March 31, 2008.
On June 21, 2008, the Company entered into a secured promissory note in connection with the acquisition of Caesar’s Cleaners (see Note 8) in the amount of $77,142 that bears interest of 15% payable monthly. As of June 30, 2008, no payments have been made. Therefore, the balance outstanding is $77,142.
Various other debt obligation totaling approximately $570,000, which consisted of approximately $190,000 to related parties was outstanding at June 30, 2008 and was included in notes payable in the accompanying condensed consolidated balance sheet.
5. OTHER RELATED PARTY TRANSACTIONS
The Company rents office space located at 125 E. Tahquitz Canyon Way in Palm Springs, California on a month-to-month basis from Transactional Marketing Partners, a company owned by former director Earl Greenburg. The rent is $3,700 per month all inclusive.
US DRY CLEANING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
6. EQUITY TRANSACTIONS
Common Stock
During the three months ended December 31, 2006, the Company issued 125,000 shares of its restricted common stock to the Company’s Chief Financial Officer as a bonus for past services valued at $231,250 based on the estimated fair market value of the Company’s common stock of $1.85 per share. Expenses related to this transaction have been included in administrative expenses in the accompanying condensed consolidated statement of operations.
During the three months ended December 31, 2006, the Company issued 80,000 shares of restricted common stock to directors for past services valued at $148,000 based on the estimated fair market value of the Company’s common stock of $1.85 per share. Expenses related to this transaction have been included in administrative expenses in the accompanying condensed consolidated statement of operations.
During the three months ended December 31, 2006, the Company, pursuant to a consultant agreement, issued 150,000 shares of its restricted common stock in exchange for certain consulting services provided to the Company, which was valued at $37,500 based on the value of the services provided. Expenses related to this transaction have been included in professional fees in the accompanying condensed consolidated statement of operations.
During the three months ended March 31, 2007, the Company issued 780,000 shares of restricted common stock with an estimated fair market value of $1.85 per share pursuant to an agreement of merger in connection with the acquisition of Cleaners Club Inc.
During the nine months ended June 30, 2007, the Company, pursuant to the terms of the Series A Convertible Debentures as disclosed in Note 3 above, issued 374,985 shares of restricted common stock valued at $803,714 using Black-Scholes pricing model.
During the three months ended June 30, 2007, the Company issued 40,000 shares of its restricted common stock for conversion of $100,000 in convertible debentures. The transaction described in this paragraph constituted an exempt offering under section 4(2) of the Securities Act.
During the quarter ended December 31, 2007, the Company issued 242,308 shares of its restricted common stock for conversion of $315,000 in Series A convertible debentures.
During the three months ended March 31, 2008, the Company, pursuant to a warrant agreement, issued 434,210 shares of its restricted common stock upon exercise of cashless warrants.
During the three months ended March 31, 2008, the Company issued 500,000 shares of its restricted common stock and is currently being held in escrow as collateral to a certain note payable (see Note 3).
In connection with the acquisition of Team as discussed in Note 8, the Company issued 2,044,667 shares of its restricted common stock in exchange for certain assets and liabilities of Team valued at $0.86 per share (stock price at closing date) less an 8% marketability discount having total net value of approximately $1,613,000.
During the three months ended March 31, 2008, the Company issued 792,376 shares of its restricted common stock at prices ranging from $0.60 and $0.75 per share to various investors for cash proceeds totaling $570,650.
US DRY CLEANING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
6. EQUITY TRANSACTIONS (continued)
Common Stock (continued)
During the three months ended March 31, 2008, the Company issued 71,429 shares of its restricted common stock as part a $50,000 conversion of the Series A Convertible Note at a modified conversion rate of $0.70 per share. The initial conversion price was $3.00 per share as discussed in Note 3 above. The change in terms was considered to be not significant.
During the three months ended March 31, 2008, the Company issued 24,331 shares of its restricted common stock in exchange for certain professional services provided to the Company which were valued at $19,224 based on the value of the services provided. Expenses related to this transaction have been included in professional services in the accompanying condensed consolidated statements of operations.
During the three months ended June 30, 2008, the Company issued 10,000 shares of its restricted common stock in exchange for certain professional services provided to the Company which were valued at $7,200. Expenses related to this transaction have been included in administrative expenses in the accompanying condensed consolidated statements of operations.
During the three months ended June 30, 2008, the Company issued 500,000 shares of its restricted common stock in exchange for certain professional services provided to the Company which were valued at $330,000 based on the value of the services provided.
In connection with the acquisition of Caesar’s Cleaners as discussed in Note 8, the Company issued 466,667 shares of restricted common stock in exchange for all assets and liabilities of Caesar’s Cleaners valued at $0.80 per share (stock price at closing) having total value of approximately $373,000.
During the three months ended June 30, 2008, the Company received $865,400 in cash from various investors in exchange for 1,236,286 shares of the Company’s common stock and 618,143 warrants with exercise price of $0.70 per share expiring 5 years from issuance.
During the three months ended June 30, 2008, the Company issued 367,605 shares of the Company’s common stock at $0.80 per share in exchange for professional services provided to the Company which were valued at $294,084.
During the three months ended June 30, 2008, five investors exercised their warrants to purchase 140,000 shares of the Company’s common stock at $3.50 per share for total cash proceeds of $490,000. The company issued 810,600 shares of its common stock to these investors as an incentive to exercise early.
The transactions described above constituted an exempt offering under Section 4(2) of the Securities Act.
US DRY CLEANING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
6. EQUITY TRANSACTIONS (Continued)
Options and Warrants
During the quarter ended December 31, 2006, the Company issued 500,000 warrants to an investment banking firm for services directly related to an equity fund raising transaction. Such warrants have an exercise price of $0.25, are exercisable for five (5) years from the effective date, and contain net issuance, anti-dilution provisions for split adjustments and “piggyback” registration rights. The Company did not record any expense related to the fair value of the warrants since the issuance was payment for equity fund raising services.
During the quarter ended March 31, 2007, the Company issued 100,000 warrants to a consultant for professional services at an exercise price of $3.50 per share. The fair value of the transaction using the Black-Scholes pricing model of $65,000 was recorded as deferred consulting fees and presented as an offset to additional paid-in capital. Such amount is being amortized to expense over the two year term of the consulting agreement.
During the quarter ended March 31, 2007, the Company issued 50,000 warrants to a consultant for professional services in conjunction with the recent acquisition at an exercise price of $3.50 per share. The Company included the fair value of the warrants using the Black-Scholes pricing model in the amount of $32,250 as part of the purchase price consideration for Cleaners Club acquisition.
During the quarter ended March 31, 2007, the Company granted 400,000 options (outside of a stock option plan) to the seller of CCI in accordance with the related employment agreement with the Company at exercise prices ranging from $3.50 to $10.00 per share. The Company included the fair value of the options using the Black-Scholes pricing model in the amount of $171,000 as part of the purchase price consideration for Cleaners Club acquisition.
For the transaction noted above where the fair market value of options and warrants was calculated using the Black-Scholes pricing model, the following assumptions were used: risk free interest rate of 4.5%, estimated volatility of 55%, expected life of 5 years, and no expected dividend yield.
During the quarter ended December 31, 2007, there was no significant activity in options and warrants.
During the quarter ended March 31, 2008, the Company issued 1,545,000 warrants to investors of conventional convertible debt instruments as discussed in Note 3 in accordance with warrant agreements at an exercise price of $0.75 per share. The Company included the fair value of the warrants using the Black-Scholes pricing model as part of the debt discount netted against the face value of the debt instrument. The following assumptions were used to calculate the fair value of such warrants: risk free interest rate 1.82%, estimated volatility of 55%, expected life of 5 years, and no expected dividend yield.
During the quarter ended March 31, 2008, there were no options granted.
During the quarter ended June 30, 2008, the Company issued 618,143 warrants to investors in connection with the sale of the Company's common stock as discussed above and in accordance with warrant agreements at an exercise price of $0.70 per share. The following assumptions were used to calculate the fair value of such warrants: risk free interest rate 1.47%, volatility of 337%, expected life of 5 years, and no expected dividend yield.
During the quarter ended June 30, 2008, the Company issued 2,000,000 warrants in connection with the issuance of convertible notes payable as discussed in Note 3 to investors in accordance with warrant agreements at an exercise price of $0.75 per share. The following assumptions were used to calculate the fair value of such warrants: risk free interest rate 2.11%, volatility of 337%, expected life of 5 years, and no expected dividend yield.
During the quarter ended June 30, 2008, there were no options granted.
A summary of option and warrant activities during the nine months ended June 30, 2008 is presented below:
| | | | | | | | | Weighted | |
| | | | | | Weighted | | | Average | |
| | | | | | Average | | | Remaining | |
| | | Number of | | | Exercise | | | Contractual | |
| | | Warrants/Options | | | Price | | | Life in Years | |
| Oustanding, September 30, 2007 | | | 3,500,836 | | | | 3.38 | | | | |
| Granted | | | 4,163,145 | | | | 0.75 | | | | |
| Exercised | | | (640,000 | ) | | | - | | | | |
| Cancelled/Forfeited | | | - | | | | - | | | | |
| | | | | | | | | | | | |
| Oustanding, June 30, 2008 | | | 7,023,981 | | | $ | 2.10 | | | | 4.25 | |
| | | | | | | | | | | | | |
| Option and warrants exercisable, June 30, 2008 | | | 7,023,981 | | | $ | 2.10 | | | | 4.25 | |
US DRY CLEANING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
7. COMMITMENTS AND CONTINGENCIES
Legal Matters
From time to time, the Company may be involved in various claims, lawsuits and disputes with third parties, actions involving allegations of discrimination or breach of contract incidental to the ordinary operations of the business. The Company is not currently involved in any litigation which management believes could have a material adverse effect on the Company's financial position or results of operations.
Subsequent to June 30, 2008, the Company became involved in lawsuits and disputes with two parties, actions involving allegations of breach of contract which are incidental to the ordinary operations of the business. Management believes that the ultimate outcome of these proceedings would not have a material adverse effect on the Company's financial position or results of operations.
Leases
The Company leases corporate office space in Newport Beach, California for approximately $7,400 per month expiring in November 2009. Additionally, the Company assumed various operating leases as a result of the acquisitions of Team, Zoots and Caesar's (see Note 8).
Team Enterprises, Inc. and Affiliates
On February 14, 2008, the Company completed the acquisition of certain assets and liabilities of Team in a purchase business combination by issuing 2,044,667 shares of its restricted common stock, paying cash of $1,572,000, issuing senior debt of $1,472,000, and the assumption of $44,000 in liabilities. Team consisted of four corporations made up of nineteen retail store locations. All such entities were under common control and ownership prior to the purchase. The Company also assumed various operating leases with minimum payments as follows for the fiscal years ending September 30.
| | $ | 129,000 | |
| 2009 | | | 222,500 | |
| 2010 | | | 159,000 | |
| 2011 | | | 102,000 | |
| 2012 | | | 66,500 | |
| Thereafter | | | 41,000 | |
| | | $ | 720,000 | |
In order to measure and allocate the purchase price of the Team business acquisition, the Company engaged a third-party valuation firm to estimate the fair value of the assets acquired and liabilities assumed. The purchase price and purchase price allocation are summarized as follows:
| Cash | | $ | 1,572,000 | |
| Restricted common stock issued ($0.86 per share less 8% marketability discount) | | | 1,613,000 | |
| 10% Senior Convertible Debt | | | 1,472,000 | |
| Acquisition costs incurred by the Company | | | 605,000 | |
| Liabilities assumed by the Company | | | 44,000 | |
| Total purchase consideration | | | 5,306,000 | |
| | | | | |
| Allocated to: | | | | |
| | | | | |
| Property and equipment | | | 700,000 | |
| Prepaid expenses and deposits | | | 101,000 | |
| Noncompete agreement | | | 470,000 | |
| Trademark portfolio | | | 60,000 | |
| Liabilities assumed | | | (44,000 | ) |
| Excess of purchase price over allocation to identifiable assets and liabilities (goodwill) | | $ | 4,019,000 | |
The principal reason that the Company agreed to pay a purchase price for Team in excess of its recorded net assets was to acquire an established revenue stream.
US DRY CLEANING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
8. ACQUISITIONS (continued)
Zoots Corporation
On March 24, 2008, the Company completed the acquisition of certain assets of Zoots Corporation (“Zoots”) in a purchase business combination with the payment of cash of $764,949 and the issuance of a short-term note payable for $975,000. The assets acquired consist of eleven retail store locations and a centralized processing plant. As discussed above in Note 3, in order to finance the acquisition, the Company issued a secured convertible note in the initial principal amount of $1,725,000 to Setal 2, LLC, which is secured by a first priority lien over all of Zoots assets acquired. The Company also assumed various non-cancellable operating leases with minimum payments as follows for the fiscal years ending September 30.
| 2008 (3 months) | | $ | 194,500 | |
| 2009 | | | 389,000 | |
| 2010 | | | 264,000 | |
| 2011 | | | 165,000 | |
| 2012 | | | 97,500 | |
| Thereafter | | | 75,000 | |
| | | $ | 1,185,000 | |
During the three months ended June 30, 2008, the Company completed its purchase price allocation based in part on a third-party valuation analysis performed and re-allocated the Zoots purchase price. The purchase price and purchase price allocation are:
| Cash | | $ | 764,949 | |
| Security deposits and other | | | 187,471 | |
| Acquisition costs incurred by the Company | | | 101,285 | |
| Short-term note payable | | | 975,000 | |
| Liabilities assumed by the Company | | | 145,374 | |
| Total purchase consideration | | | 2,174,079 | |
| | | | | |
| Allocated to: | | | | |
| | | | | |
| Property and equipment | | | 1,684,453 | |
| Intangible assets (principally trade name) | | | 635,000 | |
| Liabilities assumed | | | (145,374 | ) |
| Excess of purchase price over allocation to identifiable assets and liabilities (goodwill) | | $ | - | |
The primary effect of the re-allocation was to increase property and equipment by $498,453 , increase intangible assets by $635,000, and reduce goodwill by $642,000.
US DRY CLEANING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
8. ACQUISITIONS (continued)
Caesar’s Cleaners
On June 21, 2008, the Company completed the acquisition of all assets and liabilities of Caesar’s Cleaners in a purchase business combination by issuing 466,667 shares of its restricted common stock, paying cash of $984,113, and issuing a secured promissory note of $77,142. Caesar’s stores made up of four retail store locations. The Company also assumed various operating leases with minimum payments as follows for the fiscal years ending September 30.
| 2008 (3 months) | | $ | 89,500 | |
| 2009 | | | 182,500 | |
| 2010 | | | 136,000 | |
| 2011 | | | 133,000 | |
| 2012 | | | 114,500 | |
| Thereafter | | | 114,500 | |
| | | $ | 720,000 | |
The purchase price and purchase price allocation are summarized as follows:
| Cash | | $ | 984,113 | |
| Restricted common stock issued at $0.80 per share | | | 373,334 | |
| Acquisition costs incurred by the Company | | | 74,230 | |
| Secured Promissory Note | | | 77,142 | |
| Liabilities assumed by the Company | | | 56,333 | |
| Total purchase consideration | | | 1,565,152 | |
| | | | | |
| Allocated to: | | | | |
| | | | | |
| Property and equipment | | | 956,333 | |
| Intangible assets (primarily licenses and non-compete agreements) | | | 200,000 | |
| Liabilities assumed | | | (56,333 | ) |
| Excess of purchase price over allocation to identifiable assets and liabilities (goodwill) | | $ | 465,152 | |
The principal reason that the Company agreed to pay a purchase price for Caesar’s in excess of its recorded net assets was to acquire an established revenue stream and a larger market share in Hawaii.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2008 AND 2007
(UNAUDITED)
8. ACQUISITIONS (Continued)
Certain pro forma financial information of the Company is presented below, based on the assumption that the three acquisitions above occurred at the beginning of the earliest period presented. | | | Consolidated Pro Forma Financial Information (unaudited) (in thousands) | |
| | | Three Months Ended | | | Nine Months Ended | |
| | | June 30, 2008 | | | June 30, 2007 | | | June 30, 2008 | | | June 30, 2007 | |
| | | | | | | | | | | | | |
| Net Sales | | $ | 7,515 | | | $ | 6,381 | | | $ | 17,619 | | | $ | 17,989 | |
| | | | | | | | | | | | | | | | | |
| Net Loss | | $ | (2,718 | ) | | $ | (2,258 | ) | | $ | (8,444 | ) | | $ | (7,533 | ) |
| | | | | | | | | | | | | | | | | |
| Basic and diluted loss per common share | | $ | (0.13 | ) | | $ | (0.12 | ) | | $ | (0.38 | ) | | $ | (0.37 | ) |
Forward-Looking Statements
Certain statements made herein and in other public filings and releases by the Company contain “forward-looking” information (as defined in the Private Securities Litigation Reform Act of 1995) that involve risk and uncertainty. These forward-looking statements may include, but are not limited to, future capital expenditures, acquisitions (including the amount and nature thereof), future sales, earnings, margins, costs, number and costs of store openings, demand for clothing, market trends in the retail clothing business, inflation and various economic and business trends. Forward-looking statements may be made by management orally or in writing, including, but not limited to, Management's Discussion and Analysis or Plan of Operation section and other sections of our filings with the SEC under the Exchange Act and the Securities Act.
Actual results and trends in the future may differ materially depending on a variety of factors including, but not limited to, domestic economic activity and inflation, our successful execution of internal operating plans and new store and new market expansion plans, performance issues with key suppliers, severe weather, and legal proceedings. Future results will also be dependent upon our ability to continue to identify and complete successful expansions and penetrations into existing and new markets and our ability to integrate such expansions with our existing operations.
Description of Business
The Company
US Dry Cleaning Corporation (“USDC”) was formed in July 2005 and completed a “reverse merger” with a public shell company in December 2005. In August 2005, USDC purchased Steam Press Holdings, Inc. (“Steam Press”), and Coachella Valley Retail, LLC (“CVR”), respectively, in stock-for-stock type transactions. The Company subsequently completed acquisitions of Cleaners Club, Inc. (“CCI”) in February 2007, Team Enterprises, Inc. and Affiliates (“USDC Fresno”) in February 2008, and certain assets of Zoots Corporation (“USDC Portsmouth”) in March 2008. In June 2008, Steam Press expanded its operations by completing the acquisition of all assets and liabilities of Caesar’s Cleaners ("Caesar's"). USDC, Steam Press, CVR, CCI, USDC Fresno, USDC Portsmouth and Caesar's are hereinafter collectively referred to as the “Company.”
Steam Press does business as Young Laundry & Dry Cleaning (“Young”) in Honolulu, Hawaii. Young was founded in 1902 and operates thirteen retail laundry and dry cleaning stores, in addition to providing hotel and other commercial laundry and dry cleaning services. CVR was founded in 2004 and operates two retail laundry and dry cleaning stores under several names in the Palm Springs, California area. CCI owns and operates eleven retail stores and a centralized processing plant in the Riverside, California area. USDC Fresno owns and operates nineteen retail stores in the Fresno, California area and USDC Portsmouth owns and operates eleven retail stores and a centralized processing plant in the Portsmouth, Virginia area, and Caesar's operates four stores in the Honolulu, Hawaii area.
Competition
The Company operates in an industry that is subject to intense competition. A handful of markets are dominated by large, well-capitalized operators who have implemented a model similar to USDC’s vision: serving multiple locations with centralized, large capacity production facilities. Smaller players are finding it more difficult to retain market share due to higher overall operating costs and constraints. The Company believes that its strategy of centralized operations, consolidation, and public corporate structure is unique in the dry cleaning industry. However, there can be no assurance that other enterprises will not seek to acquire a significant number of dry cleaning operations in markets in which the Company currently operates or will prospectively operate.
The Company operates in an industry that is subject to intense competition. The Company faces risks and uncertainties relating to its ability to successfully implement its business strategy. Among other things, these risks include the ability to develop and sustain revenue growth; managing the expansion of its operations; competition; attracting and retaining qualified personnel; maintaining and developing new strategic relationships; and the ability to anticipate and adapt to the changing markets and any changes in government or environmental regulations. Therefore, the Company is subject to the risks of delays and potential business failure.
The dry cleaning industry has been a target for environmental regulation during the past two decades due to the use of certain solvents in the cleaning process. For example, in 2002, air quality officials in Southern California approved a gradual phase out of Perchloroethylene (“Perc”), the most common dry cleaning solvent, by 2020. Under this regulation, which went into effect January 1, 2003, any new dry cleaning business or facility that adds a machine must also add a non-Perc machine. While existing dry cleaners can continue to operate one Perc machine until 2020, by November 2007 all dry cleaners using Perc had to utilize state-of-the-art pollution controls to reduce Perc emissions. The Company believes that it has successfully integrated the new dry cleaning processes.
Management feels that domestic media have generally sensationalized the perceived hazards of Perc to operators, clients and the environment in general. Perc is a volatile, yet non-flammable, substance that requires precautions and proper handling. However, it has proven safe, effective and completely manageable for years and the Company anticipates that its centralized operations and improvements in all facets of the business will further improve the safety for employees, clients and the environment. The Company will continue to utilize Perc where permitted on a limited interim basis to assure an orderly transition. To the extent that additional investment for environmental compliance may be necessary, the Company does not anticipate any significant financial impact. The Company believes that it complies in all material respects with all relevant rules and regulations pertaining to the use of chemical agents. In the opinion of management, the Company complies in all material respects with all known federal, state, and local legislation pertaining to the use of all chemical agents and will endeavor to ensure that the entire organization proactively remains in compliance with all such statutes and regulations in the future.
Major Customers
At June 30, 2008 and 2007, one customer accounted for approximately 14% and 15% of gross accounts receivable, respectively. For the three months ended June 30, 2007, one customer accounted for approximately 15% of net sales. For the three and nine months ended June 30, 2008 no customer accounted for more than 10% of net sales.
Business Acquisitions
On February 15, 2007, 100% of CCI’s authorized; issued and outstanding common stock was acquired in a merger with USDC. The acquired shares were converted into 780,000 shares of $0.001 par value common stock of USDC immediately prior to the merger. The Company’s management has estimated the fair value of the 780,000 common shares given at $1.85 per share (the estimated fair value of the Company’s common stock) for a stock purchase price consideration of $1,443,000. Additionally, the Company issued fully vested stock options valued at approximately $203,000, cash of $100,000 and incurred approximately $282,000 in acquisition related costs for a total purchase price consideration of approximately $2,028,000.
On February 14, 2008, the Company completed the acquisition of certain assets and liabilities of Team in a purchase business combination by issuing 2,044,667 shares of its restricted common stock valued at $1,613,000 ($0.86 per share less 8% marketability discount), paying cash of $1,572,000, issuing senior debt of $1,472,000, and the assumption of $44,000 in liabilities. Team consists of four corporations made up of nineteen retail store locations. All such entities were under common control and ownership prior to the purchase.
On March 24, 2008, the Company completed the acquisition of certain assets of Zoots in a purchase business combination with the payment of cash of $764,949, payment in cash for security deposits of $187,471, the issuance of a short-term note payable for $975,000 and assumption of $145,374 in liabilities. The assets acquired consist of eleven retail store locations and a centralized processing plant. As discussed above in Note 3, in order to finance the acquisition, the Company issued a secured convertible note in the initial principal amount of $1,725,000 to Setal 2, LLC, which is secured by a first priority lien over all of Zoots assets acquired.
On June 21, 2008, the Company completed the acquisition of assets and liabilities of Caesar’s Cleaners in a purchase business combination by issuing 466,667 shares of restricted common stock valued at $373,334, paying cash of $984,113, the issuance of a secured promissory note of $77,142 and assumption of $56,333 in liabilities. The assets acquired consist of four retail store locations.
Results of Operations for the Three Months Ended June 30, 2008 and 2007
Net sales were approximately $5,132,000 for the three months ended June 30, 2008 compared to the three months ended June 30, 2007 of approximately $2,427,000. This reflects an increase of approximately $2,705,000 or 112% increase in revenues. The increase consisted primarily of additional revenues generated from recent acquisitions.
Cost of Sales
Our cost of sales is approximately $1,879,000 for the three months ended June 30, 2008 compared to the three months ended June 30, 2007 of approximately $1,252,000, an increase of approximately $627,000. Cost of sales as a percentage to revenues is 37% and 52% for the three months ended June 30, 2008 and 2007, respectively. Our cost of sales consists of supplies, labor and facilities to process laundry and dry cleaning products. The improvement was due to increased efficiencies at our processing plants, economies of scale due to our recent acquisitions and better bargaining power with our suppliers.
Gross Profit
Gross profit increased approximately $2,078,000 to approximately $3,253,000 for the three months ended June 30, 2008 compared to the three months ended June 30, 2007 of approximately $1,175,000. Gross profit as a percentage of revenue increased by 15% from 48% for the three months ended June 30, 2007 to 63% for the three months ended June 30, 2008. The improvement can be attributed to the preceding paragraph
Operating Expenses
Operating expenses for the three months ended June 30, 2008 are approximately $4,281,000 compared to the three months ended June 30, 2007 of approximately $2,383,000, an increase of approximately $1,898,000.
Our delivery, store and selling expenses for the three months ended June 30, 2008 were approximately $2,569,000 compared to the three months ended June 30, 2007 of approximately $1,080,000. These expenses are primarily related to store rents and delivery costs. The increase of $1,489,000 is primarily attributable to additional stores acquired.
Our administrative expenses for the three months ended June 30, 2008 were approximately $1,413,000 compared to the three months ended June 30, 2007 of approximately $1,207,000, an increase of approximately $206,000. These expenses are primarily related to management, legal and professional fees related to our recent acquisition. Our administrative expenses decreased as a percentage of sales from 50% in 2007 to 28% in 2008
Net Results of Operations
Our operating loss was approximately $1,028,000 for the three months ended June 30, 2008 and approximately $1,208,000 for the three months ended June 30, 2007.
Other Expenses
Interest expense for the three months ended June 30, 2008 was approximately $896,000 compared to approximately $745,000 for the three months ended June 30, 2007, an increase of approximately $151,000. This is related to the amortization of debt discounts against convertible notes payable issued in December 2006 through June 30, 2008.
Net Results
We are reporting a net loss of approximately $2,029,000 or $0.11 per common share for the three months ended June 30, 2008 compared to a net loss of approximately $1,815,000 or $0.10 per common share for the three months ended June 30, 2007. This includes legal, audit, consulting and administrative expenses directly related to the integration of our recent acquisitions.
Results of Operations for the Nine Months Ended June 30, 2008 and 2007
Net sales were approximately $10,378,000 for the nine months ended June 30, 2008 compared to the nine months ended June 30, 2007 of approximately $6,055,000, an increase of approximately $4,323,000. This reflects a 71% increase in revenues. The increase consisted of approximately $693,000 from existing operations and approximately $630,000 from our recent acquisitions.
Cost of Sales
Our cost of sales is approximately $4,389,000 for the nine months ended June 30, 2008 an increase of approximately $1,274,000 compared to the nine months ended June 30, 2007 of approximately $3,115,000. Cost of sales as a percentage to revenues is 42% and 51% for the nine months ended June 30, 2008 and 2007, respectively. Our cost of sales consists of supplies, labor and facilities to process laundry and dry cleaning products. The increase in cost of sales was a result from our recent acquisitions but an overall improvement due to increased efficiencies at our processing plants and economies of scale.
Gross profit increased approximately $3,049,000 to approximately $5,989,000 for the nine months ended June 30, 2008 compared to the nine months ended June 30, 2007 of approximately $2,940,000. Gross profit as a percentage of revenue increased 9% from 49% for the nine months ended June 30, 2007 to 58% for the nine months ended June 30, 2008.
Operating Expenses
Operating expenses for the nine months ended June 30, 2008 are approximately $10,970,000 compared to the nine months ended June 30, 2007 of approximately $7,003,000, an increase of approximately $3,967,000.
Our delivery, store and selling expenses for the nine months ended June 30, 2008 were approximately $5,171,000 compared to the nine months ended June 30, 2007 of approximately $2,626,000. These expenses are primarily related to store rents and delivery costs. The increase of approximately $2,545,000 is primarily attributable to additional stores acquired through our recent acquisitions.
Our administrative expenses for the nine months ended June 30, 2008 were approximately $5,276,000 compared to the nine months ended June 30, 2007 of approximately $4,131,000, an increase of approximately $1,145,000. These expenses are primarily related to management and professional fees. Our management costs are directly related to integrating acquisitions and the cost of being a public company, legal fees related to our recent acquisition and financing fees.
Net Results of Operations
Our operating loss is approximately $4,981,000 for the nine months ended June 30, 2008 and approximately $4,063,000 for the nine months ended June 30, 2007.
Other Expenses
Interest expense for the nine months ended June 30, 2008 was approximately $1,472,000 compared to approximately $1,356,000 for the nine months ended June 30, 2007. This is related to the amortization of debt discounts against convertible notes payable issued in December 2007 through June 30, 2008.
Net Results
We are reporting a net loss of approximately $6,568,000 or ($0.33) per common share for the nine months ended June 30, 2008 compared to a net loss of approximately $5,604,000 or ($0.31) per common share for the nine months ended June 30, 2007. This includes legal, audit, consulting and administrative expenses directly related to our recent acquisitions.
Total assets increased by approximately $12,310,000 from $10,612,000 as of September 30, 2007 to $22,922,000 as of June 30, 2008. The increase is primarily due to an increase in goodwill of approximately $4,484,000; property and equipment of approximately $3,078,000; intangible assets of approximately $1,264,000 and current assets of approximately $3,318,000. These increases primarily relate to our fiscal 2008 acquisitions.
Total liabilities increased by approximately $13,103,000 from approximately $7,075,000 as of September 30, 2007 to approximately $20,178,000 as of June 30, 2008. This is primarily due to an increase in convertible notes payable of approximately $11,680,000; increase in notes payable of approximately $1,488,000.
Our operating activities used approximately $4,813,000 in cash during the nine months ended June 30, 2008. Our net loss of approximately $6,568,000 was the primary component of our negative operating cash flow. This net loss was offset by a number of non-cash items totaling approximately $1,696,000. These include depreciation, amortization, bad debt expense and the issuance of stock for compensation and services and debt discount amortization.
Cash used in investing activities during the nine months ended June 30, 2008 consisted of approximately $4,224,000 used primarily for the recent acquisitions totaling approximately $4,620,000, offset by a decrease in deferred acquisition cost of $396,000 as compared to approximately $1,835,000 for the year ended September 30, 2007 primarily for the deferred acquisition cost for the projects in process.
Cash flows from financing activities were approximately $11,548,000 for the nine months ended June 30, 2008 which primarily consisted of approximately $11,458,000 in net proceeds from the issuance of convertible debentures; $1,926,000 in proceeds from issuance of common stock; and issuance of notes payable of approximately $937,000; offset by repayments on notes payable, capital leases and prepaid financing costs of approximately $2,773,000.
We have a working capital of approximately $993,000 as of June 30, 2008. To meet our current working capital requirements, the Company completed approximately $17,195,000 debt and equity financing during the nine months ended June 30, 2008. However, such financing transactions may be insufficient to fund planned acquisitions, capital expenditures and other cash requirements.
Going Concern Considerations
The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. The Company has recurring losses from operations; negative cash flow from operating activities of approximately $4,813,000 for the nine months ended June 30, 2008; working capital of approximately $993,000 and an accumulated deficit of approximately $25,924,000 at June 30, 2008. The Company’s business plan calls for various business acquisitions, which will require substantial additional capital. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The Company intends to fund acquisitions and operations assimilations through debt and equity financing transactions. In connection with such efforts, the Company completed approximately $14,000,000, net of discounts and issuance cost, of debt and equity financing during the nine months ended June 30, 2008 (see Notes 3, 4 and 6) and the Company plans to complete similar debt and equity transactions in the future. However, such financing transactions may be insufficient to fund planned acquisitions, capital expenditures, working capital and other cash requirements for the next year. Therefore, the Company will be required to seek additional funds to finance its long-term operations. The successful outcome of future financing activities cannot be determined at this time and there is no assurance that, if achieved, the Company will have sufficient funds to execute its intended growth plans or generate positive operating results.
The Company’s capital requirements depend on numerous factors, including the rate of market acceptance of the Company’s services, the Company’s ability to service its customers, the Company’s ability to maintain and expand its customer base, the level of resources required to expand the Company’s marketing and sales organization, and other factors. The Company intends to fund operations through debt and/or equity financing transactions. However, such financing transactions may not be sufficient to fund its planned acquisitions, capital expenditures, working capital, and other cash requirements for the next twelve months.
We are not a party to any off-balance sheet arrangements, do not engage in trading activities involving non-exchange traded contracts, and are not a party to any transaction with persons or entities that derive benefits, except as disclosed herein, from their non-independent relationships with us.
Inflation
We believe that inflation generally causes an increase in sales prices with an offsetting unfavorable effect on the cost of products and services sold and other operating expenses. Accordingly, with the possible exception of the impact on interest rates, we believe that inflation will have no significant effect on our results of operations or financial condition.
Critical Accounting Policies
To prepare the financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make significant 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. In particular, we provide for estimates regarding the collectability of accounts receivable, the recoverability of long-lived assets, as well as our deferred tax asset valuation allowance. On an ongoing basis, we evaluate our estimates based on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Future financial results could differ materially from current financial results.
Long-Lived Assets
We assess the impairment of long-lived assets, including goodwill, annually or whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held for use is based on expectations of future undiscounted cash flows from the related operations, and when circumstances dictate, we adjust the asset to the extent that the carrying value exceeds the estimated fair value of the asset. Our judgments related to the expected useful lives of long-lived assets and our ability to realize undiscounted cash flows in excess of the carrying amounts of such assets are affected by factors such as the ongoing maintenance and improvements of the assets, changes in economic conditions, and changes in operating performance. As we assess the ongoing expected cash flows and carrying amounts of our long-lived assets, these factors could cause us to realize a material impairment charge, which would result in decreased net income (or increased net loss) and reduce the carrying value of these assets.
Goodwill and Intangible Assets
Statement of Financial Accounting standard (“SFAS”) No. 142, "Goodwill and Other Intangible Assets", which is effective for fiscal years beginning after December 15, 2001, addresses how intangible assets that are acquired individually or with a group of other assets should be accounted for upon their acquisition and after they have been initially recognized in the financial statements. SFAS No. 142 requires that goodwill and identifiable intangible assets that have indefinite lives not be amortized but rather be tested at least annually for impairment, and intangible assets that have finite useful lives be amortized over their estimated useful lives.
SFAS No. 142 provides specific guidance for testing goodwill and intangible assets that will not be amortized for impairment. In addition, SFAS No. 142 expands the disclosure requirements about intangible assets in the years subsequent to their acquisition. Impairment losses for goodwill and indefinite-life intangible assets that arise due to the initial application of SFAS No. 142 are to be reported as a change in accounting principle.
We recognize revenue in accordance with SEC Staff Accounting Bulletin No 104, “Revenue Recognition” (“SAB 104”). SAB 104 requires that four basic criteria be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured. The Company recognizes revenue on retail laundry and dry cleaning services when the services are deemed to have been provided. For “walk-in and pickup-and-delivery” type retail customers, the order is deemed to have been completed when the work-order ticket is created and the sale and related account receivable are recorded. For commercial customers, the sale is not recorded until the Company delivers the cleaned garments to the commercial customer. Generally, the Company delivers the cleaned garments to commercial customers the same day they are dropped off (same-day service).
Deferred Tax Assets
Deferred tax assets are recorded net of a valuation allowance. The valuation allowance reduces the carrying amount of deferred tax assets to an amount the Company’s management believes is more likely than not realizable. In making the determination, projections of taxable income (if any), past operating results, and tax planning strategies are considered.
Purchase Price Allocations for Acquisitions
The allocation of the purchase price for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the identifiable tangible and intangible assets acquired and liabilities assumed based upon their respective estimated fair values. We reached our conclusions regarding the estimated fair values assigned to such assets based upon the assistance from third-party valuation firm for significant acquisitions.
We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of June 30, 2008. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2008, our disclosure controls and procedures are not effective.
The ineffective disclosure controls and procedures are a material weakness. The Company intends to address these matters by establishing effective controls over the period-end closing and financial reporting processes. This will require the addition of personnel and the creation of closing protocols for the Company and its subsidiaries as well as the consolidation of all subsidiaries.
As funding becomes available, we plan on remediating the material weaknesses by implementation of new financial reporting systems throughout our operations; adoption of uniform internal controls; and the addition of management personnel to monitor daily organizational activities which will ensure that information is being gathered, reviewed and disclosed at all levels of our company and reported timely in various reports filed or submitted under the Securities Exchange Act.
Limitations on the Effectiveness of Internal Controls
Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the internal control. The design of any system of internal control also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, internal control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.
PART II - OTHER INFORMATION
Item 1: Legal Proceedings
From time to time, the Company may be involved in various claims, lawsuits, or disputes with third-parties incidental to the normal operations of the business. The Company is not currently involved in any such litigation. Furthermore, the Company is not aware of any proceeding that a governmental authority is contemplating.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
In connection with the acquisition of Caesar’s Cleaners as discussed in Note 8, the Company issued 466,667 shares of restricted common stock in exchange for all assets and liabilities of Caesar’s Cleaners valued at $0.80 per share (stock price at closing) having total value of approximately $373,000.
During the three months ended June 30, 2008, the Company received $865,400 in cash from various investors in exchange for 1,236,286 shares of the Company’s common stock and 618,143 warrants with exercise price of $0.70 per share expiring 5 years from issuance.
During the three months ended June 30, 2008, five investors exercised their warrants to purchase 140,000 shares of the Company’s common stock at $3.50 per share for total cash proceeds of $490,000. The company issued 810,600 shares of its common stock to these investors as an incentive to exercise early.
