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 January 31, 2003
[ ] TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ______________ to __________________.
COMMISSION FILE NUMBER: 0-28307
NESCO INDUSTRIES, INC.
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(Exact name of registrant as specified in its charter)
Nevada 13-3709558
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(State of other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
22-09 Queens Plaza North, Long Island City, New York 11101
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(Address of principal executive offices)
718/752-2400
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year
if changed since last report)
APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 13(d) of the Exchange Act after the distribution of
securities under a plan confirmed by the court:
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of outstanding shares of the registrant's Common Stock, par value
$.001, was 6,769,963 as of March 17, 2003.
Traditional Small Business Issuer Disclosure Format (check one):
Yes [ ] No [X]
NESCO INDUSTRIES, INC.
INDEX
PART I: FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets -
January 31, 2003 (unaudited) and April 30, 2002........................................... 1
Consolidated Statements of Operations (unaudited) -
three and nine months ended January 31, 2003 and 2002..................................... 2
Consolidated Statement of Shareholders' Equity (Deficit) (unaudited) -
nine months ended January 31, 2003........................................................ 4
Consolidated Statements of Cash Flows (unaudited) -
nine months ended January 31, 2003 and 2002............................................... 5
Notes to Consolidated Financial Statements (unaudited).................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................................... 15
Item 3. Controls and Procedures................................................................... 27
PART II: OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 28
Item 2. Change in Securities...................................................................... 28
Item 6. Exhibits and Reports on Form 8K........................................................... 29
Signatures .......................................................................................... 30
Certification
Exhibit 99.1
i
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
A S S E T S
January 31 April 30
2003 2002
----------- ---------
(Unaudited)
Current Assets:
Cash and equivalents $ 55,221 $ 111,260
Accounts receivable, net 1,294,296 2,427,457
Unbilled costs and estimated earnings in excess
of billings on uncompleted contracts 101,429 222,700
Inventory 160,464 154,992
Prepaid taxes and expenses 115,450 105,087
----------- -----------
Total current assets 1,726,860 3,021,496
Fixed assets, net 94,477 135,277
Goodwill, net -- 416,954
Other assets 99,049 47,331
----------- -----------
$ 1,920,386 $ 3,621,058
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
January 31 April 30
2003 2002
----------- ---------
(Unaudited)
Current Liabilities:
Accounts payable and accrued expenses $ 1,393,400 $ 1,941,485
Notes payable, convertible note 50,000 --
Notes payable, bridge loan -- 447,274
Loans payable, shareholders, current 448,365 10,263
Billings in excess of costs and estimated
earnings on uncompleted contracts 221,439 397,686
----------- -----------
Total current liabilities 2,113,204 2,796,708
Loans payable, shareholders 584,136 1,022,238
Deferred rental income 222,300 257,400
----------- -----------
Total liabilities 2,919,640 4,076,346
----------- -----------
Stockholders' Equity:
10% convertible preferred stock, $2.00 par value,
1,000,000 shares authorized, 512,500 shares
issued and outstanding 1,087,639 --
Common stock, $0.001 par value, 25,000,000 shares
authorized, 6,769,963 and 6,694,963 shares
issued and outstanding 6,770 6,695
Capital in excess of par value 1,546,740 1,119,105
Accumulated deficit (3,640,403) (1,581,088)
----------- -----------
(999,254) (455,288)
----------- -----------
$ 1,920,386 $ 3,621,058
----------- -----------
See Accompanying Notes
1
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDING JANUARY 31, 2003 AND 2002
January 31
-------------------------
2003 2002
---------- ----------
(Unaudited)
Earned Revenues $1,004,995 $2,640,623
Cost of earned revenues 918,932 2,106,172
---------- ----------
Gross profit 86,063 534,451
General and administrative expenses 349,256 511,551
---------- ----------
Operating income (loss) (263,193) 22,900
---------- ----------
Other Income (Expense):
Sub-lease income 11,700 11,700
Interest expense, net (1,116) (28,709)
Impairment of goodwill (416,954) --
---------- ----------
Income (Loss) before income taxes (669,563) 5,891
Income tax benefit (120,222) (13,410)
---------- ----------
Net Income (Loss) $ (549,341) $ 19,301
---------- ----------
Convertible preferred stock dividends (25,625) --
---------- ----------
Net Income (Loss) available to common shareholders (574,966) 19,301
---------- ----------
Basic and diluted loss per share (0.08) --
---------- ----------
Weighted average common shares outstanding - basic
and diluted 6,769,963 6,694,963
---------- ----------
See Accompanying Notes.
2
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDING JANUARY 31, 2003 AND 2002
January 31
-------------------------
2003 2002
---------- ----------
(Unaudited)
Earned Revenues $ 3,659,990 $6,813,207
Cost of earned revenues 3,263,820 5,631,923
----------- ----------
Gross profit 396,170 1,181,284
General and administrative expenses 1,515,493 1,378,975
----------- ----------
Operating loss (1,119,323) (197,691)
----------- ----------
Other Income (Expense):
Sub-lease income 35,100 35,100
Interest expense, net (102,775) (58,817)
Impairment of goodwill (416,954) --
----------- ----------
Loss before income taxes (1,603,952) (221,408)
Income tax benefit (119,776) (15,156)
----------- ----------
Net Loss $(1,484,176) $ (206,252)
----------- ----------
Convertible preferred stock dividends (62,639) --
Value related to beneficial conversion feature
of convertible preferred stock (512,500) --
----------- ----------
Net Loss available to common shareholders (2,059,315) (206,252)
----------- ----------
Basic and diluted loss per share (0.30) (0.03)
----------- ----------
Weighted average common shares outstanding-basic
and diluted 6,754,474 6,694,963
----------- ----------
See Accompanying Notes.
3
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
NINE MONTHS ENDING JANUARY 31, 2003
Retained
Preferred stock Common stock Capital in earnings/
------------------- ------------------ excess of accumulated
Shares Amount Shares Amount par value deficit Total
------- ---------- --------- ------ ---------- ----------- ----------
Balance at April 30, 2002 -- -- 6,694,963 $6,695 $1,119,105 $(1,581,088) $ (455,288)
Convertible preferred stock issuance 512,500 $1,025,000 (159,041) 865,959
Convertible preferred stock dividends 62,639 (62,639) --
Convertible preferred stock beneficial
conversion feature 512,500 (512,500) --
Common stock issued in connection
with bridge loan financing 75,000 75 74,176 74,251
Net loss for the nine months ended
January 31, 2003 (1,484,176) (1,484,176)
------- ---------- --------- ------ ---------- ----------- -----------
Balance at January 31, 2003 512,500 $1,087,639 6,769,963 $6,770 $1,546,740 $(3,640,403) $ (999,254)
======= ========== ========= ====== ========== =========== ===========
See Accompanying Notes.
4
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDING JANUARY 31, 2003 AND 2002
January 31
------------------------
2003 2002
---- ----
(Unaudited)
Cash Flows from Operating Activities:
Net loss $(1,484,176) $(206,252)
Adjustments to reconcile net loss to
net cash used by operating activities:
Impairment of goodwill 416,954 --
Amortization of discount on bridge loan 52,726 11,000
Amortization of deferred sub-lease income (35,100) (35,100)
Depreciation and amortization 79,172 82,766
Provision for bad debts (23,895) (16,565)
Changes in operating assets and liabilities:
Accounts receivable 1,157,056 4,905
Unbilled costs and estimated earnings in excess
of billings on uncompleted contracts 121,271 (108,629)
Inventory (5,472) (6,300)
Prepaid expenses and taxes (10,363) (142,524)
Other assets (90,090) (35,534)
Accounts payable and accrued expenses (473,834) 253,164
Billings in excess of costs and estimated
earnings on uncompleted contracts (176,247) 71,476
----------- ---------
Net cash provided used in operating activities (471,998) (127,593)
----------- ---------
Cash Flows from Investing Activities:
Purchase of fixed assets (5,549)
----------- ---------
Net cash provided used in investing activities -- (5,549)
----------- ---------
Cash Flows from Financing Activities:
Payment of equipment notes -- (1,577)
Proceeds (repayment) of bridge loan (500,000) 500,000
Net proceeds (repayment) of shareholder loans -- 25,000
Payment of financing costs -- (25,000)
Net proceeds of convertible preferred stock offering 865,959 --
Net proceeds of convertible note 50,000 --
----------- ---------
Net cash provided by financing activities 415,959 498,423
----------- ---------
Net increase (decrease) in cash and equivalents (56,039) 365,281
Cash and equivalents, beginning of year 111,260 68,169
----------- ---------
Cash and equivalents, end of period 55,221 433,450
----------- ---------
Cash Paid for Interest 27,072 --
Taxes Paid 2,459 1,403
----------- ---------
See Accompanying Notes.
5
Notes to Consolidated Financial Statements
- ------------------------------------------
A. Organization, Operations and Significant Accounting Policies
General
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The unaudited consolidated interim financial statements, and accompanying
notes included herein, have been prepared by NESCO Industries, Inc. (the
"Company") pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") and reflect all adjustments which are of a
normal recurring nature and which, in the opinion of management, are
necessary for a fair statement of the results for interim periods. Certain
information and footnote disclosures have been condensed or omitted
pursuant to such rules and regulations. The results of the interim period
are not necessarily indicative of the results for the full year. These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's latest annual report filed with the SEC on Form 10-KSB for the
fiscal year ended April 30, 2002, as amended, and the subsequent quarterly
reports filed with the SEC on Form 10-QSB, as amended.
The Company's fiscal year ends on April 30 and, therefore, references to
fiscal 2002 and fiscal 2003 refer to the fiscal years ending April 30, 2002
and April 30, 2003, respectively. Certain fiscal 2002 amounts have been
reclassified to conform to the fiscal 2003 presentation.
Basis of Presentation and Principles of Consolidation
-----------------------------------------------------
The accompanying financial statements include the accounts of the Company
and its wholly-owned subsidiaries on a consolidated basis. All significant
intercompany accounts and transactions have been eliminated. The
preparation of consolidated financial statements in accordance with
generally accepted accounting principles requires the Company to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingencies as of the date of the
consolidated financial statements and the reported amount of revenues and
expenses during the period. Actual results could differ from those
estimates.
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplate continuation of
the Company as a going concern. Recoverability of a major portion of the
recorded asset amounts shown in the accompanying balance sheet is dependent
on the Company's ability to meet its financing requirements on an as needed
basis and to succeed in its future operations. The financial statements do
not include any adjustments relating to the recoverability and
classification of assets and liabilities that might be necessary should the
Company be unable to continue its existence. See Note B - Liquidity and
Management Discussion and Analysis of Financial Conditions and Results of
Operations for a discussion regarding the Company's change in plan of
operations.
6
Revenue and Cost Recognition
----------------------------
Earned revenues are recorded using the percentage of completion method.
Under this method, earned revenues are determined by reference to the
Company's engineering estimates, contract expenditures incurred, and work
performed. The calculation of earned revenue and the effect on several
asset and liability amounts is based on the common industry standard
revenue determination formula of actual costs-to-date compared to total
estimated job costs. Due to uncertainties inherent in the estimation
process, and uncertainties relating to future performance as the contracts
are completed, it is at least reasonably possible that estimated job costs,
in total or on individual contracts, will be revised. When a significant
loss is anticipated, the entire amount of the estimated loss is provided
for in the period.
The asset, "unbilled costs and estimated earnings in excess of billings on
uncompleted contracts," represents revenues recognized in excess of amounts
billed. The liability, "billings in excess of costs and estimated earnings
on uncompleted contracts," represents billings in excess of revenues
recognized.
B. Liquidity
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America,
which contemplate continuation of the Company as a going concern. As of
January 31, 2003, however, the Company had an accumulated deficit in
stockholders' equity of $3,640,403 and had incurred a net loss available to
common shareholders of $2,059,315 for the nine months ended January 31,
2003.
In the past, the Company relied on shareholders loans for its capital
needs, but believes it can no longer rely on shareholder loans for its
capital needs going forward. In the past, the Company explored debt and
equity markets in order to satisfy its current and future capital
requirements. Although the Company had satisfied in part its capital needs
through debt and equity markets in the past, it was unable to secure
sufficient financing to implement its merger/acquisition growth strategy
for its indoor air quality business in fiscal 2003. The Company will no
longer pursue its merger/acquisition growth strategy for its indoor air
quality business, and is not currently exploring debt and equity markets
for its capital needs.
On April 1, 2002, the Company issued unsecured promissory notes
("Shareholder Loans") totaling $1,032,501, in exchange for and in full
satisfaction of all outstanding balances due on the demand loans,
management fees and consulting fees payable to shareholders and affiliates
of the Company. The Shareholder Loans do not bear interest. Each
Shareholder Loan requires repayment in twenty-one (21) equal monthly
payments. Repayment on a Shareholder Loan in the principal amount of
$10,263 was scheduled to begin in February 2003, however, the lender has
agreed to defer the commencement date indefinitely. The lender could,
however, demand that repayment begin on the $10,263 Shareholder Loan at any
time. Repayment on the remaining Shareholder Loans totaling $1,022,238 is
scheduled to begin in May 2003.
7
On January 10, 2002, the Company secured bridge loan financing in the
aggregate sum of $500,000 from KSH Strategic Investment Fund I, LP and
Cleveland Overseas, Ltd. The Company received net proceeds of $475,000 from
the bridge loan financing. The bridge loan investors were issued secured
promissory notes in the aggregate principal amount of $500,000, which bore
interest at a rate of 10% per annum ("Bridge Notes"). These investors were
also granted warrants to purchase a total of 200,000 shares of common stock
at an exercise price of $.50 per share. KSH Investment Group, Inc., a
registered broker-dealer and an affiliate of KSH Strategic Investment Fund
I, LP, received $25,000 and was issued 75,000 shares of common stock as a
fee for arranging the financing. In June 2002, the Company used a portion
of the proceeds derived from the private placement of 512,500 shares of its
10% Series A Convertible Preferred Stock (as discussed below) to repay the
Bridge Note in the principal amount of $400,000, and all accrued and
payable interest on the Bridge Notes to date. On October 10, 2002, the
Company issued a secured convertible promissory note in the principal
amount of $100,000 ("Convertible Note") in full payment and satisfaction of
the remaining Bridge Note in the principal amount of $100,000. The
Convertible Note was secured by substantially all of the assets of the
Company, bore interest at a rate of 7% per annum and was convertible into
shares of the Company's common stock at a conversion price of $1.00 per
share. The Company repaid the Convertible Note in two installments of
principal in the amount of $50,000, and the accrued interest thereon, in
December 2002 and March 2003.
In June 2002, the Company completed the initial closing of a private
placement of a minimum of 500,000 and a maximum of 1,000,000 shares of its
10% Series A Convertible Preferred Stock ("Preferred Stock") to accredited
investors at $2.00 per share. Five hundred twelve thousand five hundred
shares of Preferred Stock were issued, each of which is convertible into
four shares of common stock at a conversion price of $.50 per share. As of
the closing, it was determined that the holders of the Preferred Stock
received a common stock conversion preference based on the excess of the
common stock's then current market value of $.75 per share over the
Preferred Stock's $.50 per share conversion price. This preference was
assigned a value of $512,500 relative to the 2,050,000 underlying shares of
common stock into which the Preferred Stock may be converted. The Company
received net proceeds of $865,959 from the issuance of the 512,500 shares
of Preferred Stock, a portion of which was used to retire $400,000 in
principal, and all accrued and payable interest to date, on the Bridge
Notes. KSH Investment Group, Inc. served as placement agent and received,
among other things, a cash commission equal to 7.5% of the aggregate
purchase price of the shares sold, a non-accountable expense allowance
equal to 1.5% of the aggregate purchase price of the shares sold, and
warrants to purchase 402,500 shares of common stock at $.65 per share in
connection with the private placement. Warrants for 325,625 shares were
issued in June 2002 and warrants for the remaining 76,875 shares were
issued in September 2002. Dividends on the Preferred Stock at the rate of
$.20 per share per annum are payable in kind, or in shares of the Company's
common stock if a sufficient number of shares of Preferred Stock is not
available. Dividends shall accrue and be payable in May of each year; as of
January 31, 2003, the Company had accrued Preferred Stock dividends of
$62,639. The Preferred Stock is redeemable, at the option of the Company,
after the second anniversary of the closing. Consequently, the Preferred
Stock has been classified as equity.
8
Management believes that the Company has the ability to meet its financing
requirements for the next eight months. However, the Company may require
additional financing during fiscal 2003, without which its ability to
operate could be adversely affected. If the Company requires additional
financing during fiscal 2003 and the markets for debt and equity financing
continue to diminish, the Company's ability to raise additional financing
may be adversely affected. There can be no assurance, however, that
additional financing will be available if and when the Company needs it,
which is dependent, in part, on the Company meeting its operating plan and
collecting its receivables on a timely basis.
The Company's ability to finance its operating cash needs with cash
generated by operations is a function of its return to profitability. The
Company has taken measures to conserve cash by no longer pursuing its
merger/acquisition growth strategy for its indoor air quality business and
cutting back on personnel and related expenses. The Company has also
subleased its New York City office and relocated to less expensive offices.
The Company expects salaries and related expenses to decrease as a result
of the change in management in October 2002 (see Note G below). However, if
the Company's planned cash flow projections for the next eight months are
not met, and the Company begins to seek but cannot obtain the requisite
level of financing, the Company's ability to operate could be adversely
affected.
At January 31, 2003, the Company had an accumulated deficit in
stockholder's equity of $3,640,403 and incurred a net loss available to
common shareholders of $2,059,315 during the nine months then ended. As a
result, the recoverability of a major portion of the recorded asset amounts
shown in the accompanying balance sheet is dependent on the Company's
ability to meet its financing requirements on an as needed basis and to
succeed in its future operations. The financial statements do not include
any adjustments relating to the recoverability and classifications of
assets and liabilities that might be necessary should the Company be unable
to continue in existence.
C. Major Customers
During the nine months ended January 31, 2003, one customer, PPC
Construction LLC, comprised 59% of revenues and three customers comprised
73.5% of revenues, PPC Construction LLC, Structure Tone, Inc. and Boston
Properties, Inc. The Company expects a significant percentage of its
revenues to be provided by a single customer or a few customers for at
least the next twelve months.
D. Loss Per Share Disclosures
Basic loss per share excludes dilution and is calculated by dividing the
loss available to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted loss per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock and
resulted in the issuance of common stock. Because the Company incurred a
net loss available to common shareholders, diluted net loss per share was
the same as basic net loss per share for the nine months ended January 31,
2003 and 2002, since the effect of any potentially dilutive securities
would be antidilutive. Options, warrants and other agreements for the
issuance of common stock which were excluded from the calculation of
diluted loss per share totaled 4,222,500 with an average exercise price of
$.61 as of January 31, 2003, and 645,000 with an average exercise price of
$1.19 as of January 31, 2002.
9
E. New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations." SFAS No. 141 requires the purchase method of accounting for
business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. Adoption of SFAS No. 141 did not have a
material effect on the Company's financial position, results of operations
and cash flows.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which is effective for all fiscal years beginning after December
31, 2001. SFAS No. 142 requires, among other things, the discontinuance of
goodwill amortization. In addition, the standard includes provisions for
the reclassification of certain existing recognized intangibles as
goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously
reported goodwill and the identification of reporting units for purposes of
assessing potential future impairment of goodwill. SFAS No. 142 also
requires the Company to complete a transitional goodwill impairment test
six months from the date of adoption. The transitional goodwill impairment
test was conducted as of the end of the first quarter of fiscal 2003 and
indicated no impairment of goodwill at that time. Ongoing, periodic testing
is required under SFAS No. 142. As a result of this periodic testing,
continuing losses, inability to obtain adequate financing to complete an
indoor air quality merger/acquisition and sell the business (see Note G -
Business Segment Information), the Company recorded an impairment charge of
$416,954 for goodwill in the three months ended January 31, 2003. Goodwill
amortization of $8,526 and $25,578 was expensed during the three and nine
months ended January 31, 2002, respectively. On a pro forma basis, if SFAS
No. 142 had been adopted as of the beginning of fiscal 2002, the net income
for the three and net loss for the nine months ended January 31, 2002 would
have been $27,827 and $180,674, respectively, and the basic and diluted
loss per share for the three and nine month periods would have been $-0-
and $.03, respectively.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement is effective
for fiscal years beginning after December 15, 2001. SFAS No. 144 supercedes
SFAS No. 121 while retaining many of the requirements of SFAS No. 121.
Adoption of SFAS No. 144 did not materially affect the Company's financial
position, results of operations and cash flows.
The FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and
64, Amendment of FASB Statement No. 13, and Technical Corrections," on
April 30, 2002. SFAS No. 145 rescinds Statement No. 4, which required all
gains and losses from extinguishments of debt to be aggregated and, if
material, classified as an extraordinary item, net of related income tax
effect. Upon adoption of SFAS No. 145, companies are required to apply the
criteria in APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions"
in determining the classification of gains and losses resulting from the
extinguishments of debt. SFAS No. 145 is effective for fiscal years
beginning after May 15, 2002. The Company is in the process of evaluating
the impact of adopting this pronouncement on its consolidated financial
statements.
10
On July 30, 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The standard requires
companies to recognize costs associated with exit or disposal activities
when they are incurred rather than at the date of a commitment to an exit
or disposal plan. Examples of costs covered by the standard include lease
termination costs and certain employee severance costs that are associated
with a restructuring, discontinued operation, plant closing, or other exit
or disposal activity. SFAS No. 146 is to be applied prospectively to exit
or disposal activities initiated after December 31, 2002. The Company is in
the process of evaluating the impact of adopting this pronouncement on its
consolidated financial statements.
In November 2002, FASB Interpretation 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45), was issued. FIN 45 requires a guarantor
entity, at the inception of a guarantee covered by the measurement
provisions of the interpretation, to record a liability for the fair value
of the obligation undertaken in issuing the guarantee. The Company
previously did not record a liability when guaranteeing obligations unless
it became probable that the Company would have to perform under the
guarantee. FIN 45 applies prospectively to guarantees the Company issues or
modifies subsequent to December 31, 2002, but has certain disclosure
requirements effective for interim and annual periods ending after December
15, 2002. The Company has historically issued guarantees only on a limited
basis and does not anticipate FIN 45 will have a material effect on its
2003 financial statements.
In December 2002, the FASB issued Statement 148, Accounting for Stock-Based
Compensation -- Transition and Disclosure: an amendment of FASB Statement
123, to provide alternative transition methods for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of
SFAS 123 to require prominent disclosures in annual financial statements
about the method of accounting for stock-based employee compensation and
the pro forma effect on reported results of applying the fair value based
method for entities that use the intrinsic value method of accounting. The
pro forma effect disclosures are also required to be prominently disclosed
in interim period financial statements. This statement is effective for
financial statements for fiscal years ending after December 15, 2002 and is
effective for financial reports containing condensed financial statements
for interim periods beginning after December 15, 2002, with earlier
application permitted. The Company does not plan a change to the fair value
based method of accounting for stock-based employee compensation.
11
F. Contingencies
Litigation
----------
National Abatement Corp. ("NAC") and/or NAC Environmental Services, Inc.
("NACE"), which are wholly-owned subsidiaries of the Company, are
co-defendants in lawsuits involving property damage and/or personal injury
claims arising in the ordinary course of business from job-site accidents.
Plaintiffs' claims in these lawsuits exceed NAC and/or NACE's applicable
insurance coverages. Claims in excess of insurance coverages totaled
approximately $8,750,000 as of January 31, 2003, net of three lawsuits that
settled with limits of insurance coverages. In the third quarter of fiscal
2003, NAC settled two lawsuits and recorded a settlement that occurred in
fiscal 2001. NAC and/or NACE are being represented in these lawsuits by
legal counsel engaged by their insurers and, in most or all cases, have
filed cross-claims and third-party claims against other parties. Any
judgment or settlement in excess of insurance coverages, however, will
require payment by NAC and/or NACE. The Company believes, based on prior
experience, that the amount of ultimate liability of NAC and/or NACE with
respect to these claims will not have a material effect on the Company's
financial position, results of operations and cash flows. There can be no
assurance, however, that any judgment or settlement of these claims will
not exceed NAC's and/or NACE's insurance coverages, which could have a
material effect on the Company's financial position, results of operations
and cash flows.
On January 15, 2003, the U.S. government filed an indictment in the United
States District Court for the Southern District of New York alleging that
NAC and one of its employees violated the Clean Air Act. The indictment,
which relates to work performed in January 1998, alleges that NAC and the
employee caused asbestos material to be stripped from a building without
adequately wetting it, failed to lower the asbestos material to the floor
without dropping or otherwise damaging it, and did not keep asbestos
material that had been removed wet until it was collected and contained. In
January 2003, NAC and the U.S. government entered into an agreement that
tolled the limitations period, to March 21, 2003, for any charges which the
U.S. government could have filed against NAC with respect to the removal
and containment of asbestos to which a grand jury has not returned an
indictment and the statute of limitations has not run as of the date of the
agreement. In March 2003, NAC and the U.S. government entered into another
agreement which tolled the limitations period once again until May 30, 2003
or the date on which a disposition is reached on the Clean Air Act
indictment, whichever occurs first. NAC denies all the charges and is
currently engaged in negotiations to resolve these matters. NAC would be
subject to monetary penalties and other compliance requirements if found
guilty of violating the Clean Air Act.
Except for the claims against NAC and/or NACE set forth above, the Company,
or its subsidiaries, is not involved in any other material legal
proceedings.
Environmental Matters
---------------------
The Company routinely handles waste materials in the ordinary course of
business, some of which may be considered to be hazardous waste. The
Company is subject to numerous local, state and federal laws and
regulations concerning the containment and disposal of asbestos, pursuant
to which it has been required to incur compliance and clean-up costs.
Compliance with environmental laws and regulations due to currently unknown
circumstances or developments could result in substantial costs and could
have a material adverse effect on the Company's financial position, results
of operations and cash flows.
12
G. Business Segment Information
During the first and second quarters of fiscal 2003, the Company began to
implement strategies for achieving its operational goals which included
changes in the way the business is managed and operated. The Company has
consolidated the operations and activities of its various subsidiaries into
a single operating unit to cut costs and improve efficiency. As a result,
the Company believes that it now operates in one business segment.
During first and second quarters of fiscal 2003, the Company focused on
increasing revenues and margins by expanding its indoor air quality
services to businesses and organizations primarily in the tri-state
metropolitan New York City area through strategic mergers, acquisitions or
relationships with leaders in the indoor air quality business. The Company
engaged in confidential negotiations with certain merger or acquisition
targets, but was unable to complete any merger or acquisition due primarily
to a lack of adequate financing. The Company also attempted to expand its
indoor air quality services through promotions and marketing, but achieved
limited success. In October 2002, the Company's chief executive officer and
chief financial officer resigned.
Due primarily to the inability of the Company to implement its growth
strategy for the indoor air quality business, the change in management in
October 2002, and the trend of lower revenues and margins from the
environmental services operating unit, the Company has elected to seek a
new business focus beyond the environmental services industry. In the three
months ended January 31, 2003, the Company began to evaluate alternative
business focuses and engage in negotiations with potential buyers of the
environmental services operating unit (see Note J - Subsequent Events for a
further discussion of the sale of the environmental services unit).
However, there is no assurance that the Company will achieve a change in
its business focus, sell its environmental operating unit or attain its
other operational goals.
H. Executive Compensation
In December 2002, the Company issued to President Michael J. Caputo a
warrant to purchase up to 500,000 shares of the Company's common stock at
an exercise price of $.55 per share for services rendered. The warrant
vested fully upon grant and expires in December 2007. The Company relied
upon Section 4(2) of the Securities Act and Rule 506 of Regulation D
promulgated thereunder in issuing the warrant without registration under
the Act.
I. Income Taxes
Included in the income tax benefit for the three and nine months ended
January 31, 2003 was a refund of approximately $120,000 that relates to a
carryback of net operating losses to prior years due to a change in the tax
law.
13
J. Subsequent Events
In March 2003, the Company and the potential buyers of the environmental
services operating unit terminated negotiations with respect to the
transaction without agreement on definitive purchase documents. If it
cannot identify other potential purchasers for the environmental services
operating unit, the Company may cease operations of the environmental
services operating unit in order to minimize losses and maximize its
chances of transitioning into a new business.
Repayment on a Shareholder Loan in the principal amount of $10,263 was
scheduled to begin in February 2003, however, the lender has agreed to
defer the commencement date indefinitely. The lender could, however, demand
that repayment begin on the $10,263 Shareholder Loan at any time.
In March 2003, the Company repaid in full the outstanding principal and
accrued interest on the Convertible Note.
14
Item 2. Management's Discussion and Analysis of Financial
-------------------------------------------------
Condition and Results of Operations
-----------------------------------
This Quarterly Report on Form 10-QSB of NESCO Industries, Inc. (the "Company")
for the quarter ended January 31, 2003 contains statements that constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements can be identified by
introductory words such as "expects," "plans," "intends," "believes," "will,"
"estimates," "forecasts," "projects" or words of similar meaning, and by the
fact that they do not relate strictly to historical or current facts.
Forward-looking statements frequently convey the Company's current expectations
regarding, among other things,
o success of management;
o transition in business focus;
o achievement of operational goals;
o existing and new product and/or services;
o dependence on a small number of customers;
o ability to secure financing;
o merger and acquisition prospects;
o formation of strategic relationships;
o existing and potential suits, actions and proceedings;
o research and development activities;
o regulatory submissions and approvals;
o financial condition, results of operations and cash flows; and
similar operating matters. Any or all of the Company's forward-looking
statements may turn out to be wrong. Many factors may cause actual results to
differ from forward-looking statements, including inaccurate assumptions and a
broad variety of risks and uncertainties, some of which are known and others of
which are not. Known risks and uncertainties include those identified from time
to time in the Company's reports filed with the Securities and Exchange
Commission, which should be considered together with any forward-looking
statement. No forward-looking statement is a guarantee of future results or
events, and one should avoid placing undue reliance on such statements. The
Company expressly disclaims any obligation or undertaking to update or revise
forward-looking statements made in this report or in its other reports filed
with the Securities and Exchange Commission.
The Company's fiscal year ends on April 30 and, therefore, references to fiscal
2002 and fiscal 2003 refer to the fiscal years ending April 30, 2002 and April
30, 2003, respectively.
Background
- ----------
The Company is engaged in providing asbestos and lead abatement services, indoor
air quality testing, monitoring and remediation, mold remediation, and other
environmental services primarily through its wholly-owned subsidiary National
Abatement Corp. ("NAC"), but also through its wholly-owned subsidiaries
NAC/Indoor Air Professionals, Inc. ("IAP") and NAC Environmental Services, Inc.
("NACE").
15
The Company was incorporated in Nevada in March 1993, and was inactive for a
number of years until it acquired NAC and NACE in March 1998. As a result of
this acquisition, which was the result of arms length negotiations between
previously non-affiliated parties, the former shareholders of NAC and NACE
acquired 5,000,000 shares of the Company's common stock, or 80% of the total
outstanding, immediately following the acquisition. The former shareholders of
NAC were the same as the former shareholders of NACE. For accounting purposes,
NAC was treated as the acquiring corporation. Thus, the historical financial
statements of NAC prior to this acquisition date are deemed to be the historical
financial statements of the Company.
NAC was incorporated in May 1988 to provide asbestos abatement services
primarily in the greater metropolitan New York City area, and today is a full
service asbestos and lead abatement contractor and indoor air quality services
provider.
NACE was incorporated in May 1993 and, in the past, provided environmental
services such as subsurface soils/groundwater remediation, Phase I and Phase II
environmental site assessments and underground storage tank management and
remediation. The Company has phased out the business conducted by NACE in order
to focus on indoor air quality services.
In June 1999, the Company incorporated IAP to provide indoor air quality
testing, monitoring and remediation services, primarily in New York, New Jersey
and Connecticut. Prior to the organization of IAP, the Company provided limited
indoor air quality services through NACE.
During the first and second quarters of fiscal 2003, the Company began to
implement strategies for achieving its operational goals which included changes
in the way the business is managed and operated. The Company has consolidated
the operations and activities of its various subsidiaries into a single
operating unit to cut costs and improve efficiency. As a result, the Company
believes that it now operates in one business segment.
Change in Plan of Operations
- ----------------------------
During first and second quarters of fiscal 2003, the Company focused on
increasing revenues and margins by expanding its indoor air quality services to
businesses and organizations primarily in the tri-state metropolitan New York
City area through strategic mergers, acquisitions or relationships with leaders
in the indoor air quality business. The Company engaged in confidential
negotiations with certain merger or acquisition targets, but was unable to
complete any merger or acquisition due primarily to a lack of adequate
financing. The Company also attempted to expand its indoor air quality services
through promotions and marketing, but achieved limited success. In October 2002,
the Company's the chief executive officer and chief financial officer resigned.
Due primarily to the inability of the Company to implement its growth strategy
for the indoor air quality business, the change in management in October 2002,
and the trend of lower revenues and margins from the environmental services
operating unit, the Company has elected to seek a new business focus beyond the
environmental services industry. In the three months ended January 31, 2003, the
Company began to evaluate alternative business focuses and engage in
negotiations with potential buyers of the environmental services operating unit.
To date, the Company has not determined the direction of its new business focus.
In addition, the Company and the potential buyers of the environmental services
operating unit terminated negotiations with respect to the transaction without
agreement on definitive purchase documents.
16
If it cannot identify other potential purchasers for the environmental services
operating unit, the Company may cease operations of the environmental services
operating unit in order to minimize losses and maximize its chances of
transitioning into a new business. However, there is no assurance that the
Company will be able to sell its environmental services operating unit, achieve
a change in business focus or attain its other operational goals.
Critical Accounting Policies and Estimates
- ------------------------------------------
The Company considers certain accounting policies related to revenue
recognition, impairment of long-lived assets, allowance for doubtful accounts
and valuation of deferred tax assets, to be critical policies due to the
estimation processes involved in each.
Revenue Recognition
-------------------
The Company derives a significant portion of its revenue from fixed
price contracts, which require continuing estimations of costs to
complete each job. From time to time due to job conditions, job
scheduling and productivity, the cost to complete estimates are revised
upward or downward which correspondingly increases or decreases both
estimated revenues and estimated gross profits, and earned revenues and
earned gross profits. The Company uses the percentage of completion
method to recognize revenue for each project. When an estimate
indicates a significant loss (i.e., estimated costs exceed estimated
revenues), the entire estimated loss is recognized in the Company's
results of operations. Any changes in estimated amounts, including
contract losses, could be material to the Company's results of
operation in both current and future periods, as jobs progress to
completion.
Allowance for Doubtful Accounts
-------------------------------
The Company records an allowance for uncollectible amounts based on a
review of the collectibility of its accounts receivable. Management
determines the adequacy of this allowance by analyzing historical bad
debts, continually evaluating individual customer receivables and
considering the customer's financial condition and current economic
conditions. If the financial condition of the Company's customers were
to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances could be required. The Company's
accounts receivable balance as of January 31, 2003 was $1,294,296, net
of an allowance for doubtful accounts of $315,128.
Impairment of Long Lived Assets
-------------------------------
The Company's long-lived assets included goodwill with a carrying value
of $416,954 as of January 31, 2003. In assessing the recoverability of
the Company's goodwill, the Company made assumptions regarding
estimated future operating results, cash flows and other factors to
determine the fair value of this asset. As a result of this evaluation,
the Company recorded an impairment of $416,954 for goodwill in the
three months ended January 31, 2003.
17
Valuation of Deferred Tax Assets
--------------------------------
The Company records the tax benefit of unused income tax losses and
credits as recoverable assets and evaluates the realizability of
recorded deferred tax assets by considering future cash flows and the
applicability of tax laws, tax jurisdictions and certain other
assumptions. The Company has determined that a one hundred percent
(100.0%) valuation allowance is appropriate at the present time,
therefore, the carrying value of the Company's deferred tax asset is
zero in amount, and is evaluated on a quarterly basis.
Results of Operations
- ---------------------
The following table presents selected consolidated financial data for the
periods indicated expressed as a percentage of net sales:
=================================================================================================
Three Months Ended Nine Months Ended
January 31, January 31,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------
Earned revenues 100.0% 100.0% 100.0% 100.0%
Cost of earned revenues 91.4 79.8 89.2 82.7
- -------------------------------------------------------------------------------------------------
Gross profit 8.6 20.2 10.8 17.3
General and administrative expense
(excluding depreciation) 33.4 18.1 40.3 19.0
Depreciation 1.4 1.2 1.1 1.3
- -------------------------------------------------------------------------------------------------
Operating loss (26.2) 0.9 (30.6) (3.0)
Other income 1.2 0.4 1.0 0.5
Other expense -.- -.- -.-
Interest expense (-.2) (1.1) (2.9) (0.7)
Impairment of goodwill (41.5) -.- (11.4) -.-
Income tax benefit 12.0 0.5 3.3 0.2
Convertible preferred stock
dividends (2.5) -.- (1.7) -.-
Convertible preferred stock
beneficial conversion feature -.- -.- (14.0) -.-
- -------------------------------------------------------------------------------------------------
Net Income (Loss) available to
common shareholders (57.2)% 0.7% (56.3)% (3.0)%
=================================================================================================
Three months ended January 31, 2003 and 2002:
- ---------------------------------------------
The Company's revenues during the three months ended January 31, 2003 declined
by $1,635,628 to $1,004,995, or 61.9% compared with revenues of $2,640,623 in
the comparable period in the prior fiscal year. The decline was primarily due to
the completion of certain long-term projects and a decrease in demand for the
Company's environmental services. The decline in demand for the Company's
asbestos abatement services, however, was significantly less than the decline in
demand for its other services. As a result, revenues from asbestos abatement
comprised substantially all of the revenues generated by the Company in the
three months ended January 31, 2003.
18
The Company's gross margin was 8.6% of revenues during the three months ended
January 31, 2003, compared with 20.2% in the comparable period in the prior
fiscal year. The significant decline in the gross margin in the third quarter of
fiscal 2003 is primarily due to the absence of revenues from indoor air quality
services, which comprised a substantial percentage of revenues in the comparable
period in the prior fiscal year. Historically, indoor air quality services have
yielded higher gross margins that asbestos abatement services, primarily due to
the fact that the asbestos abatement market is finite and lacks a recurring
services component. The decline in gross margin in the third quarter of fiscal
2003 is also attributable in part to a historically low gross margin from
asbestos abatement services. The gross margin for asbestos abatement in the
third quarter of fiscal 2003 was lower than the historical average gross margin
for asbestos abatement because certain indirect expenses did not decrease in
proportion with the decrease in total revenues from asbestos abatement in this
quarter. The Company did not experience any significant losses on jobs in the
third quarter of fiscal 2003.
The Company's general and administrative expenses decreased to $349,256 during
the three months ended January 31, 2003, from $511,551 in the comparable period
in the prior fiscal year. The decrease was primarily due to lower salaries,
consulting fees and related employee expenses as a result of the change in
management in October 2002 and the consolidation of the Company's various
operating subsidiaries into a single operating unit, which in turn employs fewer
personnel.
Interest expense decreased to $1,116 in the three months ended January 31, 2003,
compared with $28,709 in the comparable period in the prior fiscal year. The
decrease was primarily due to repayment of interest-bearing debt. In fiscal
2003, the Company repaid the January 2002 bridge loan in the principal amount of
$500,000. A bridge loan in the principal amount of $400,000 was repaid with a
portion of the proceeds from the June 2002 private placement and a bridge loan
in the principal amount of $100,000 was repaid by the issuance of a secured
convertible note in the aggregate amount of $100,000 ("Convertible Note"). The
Convertible Note was repaid in two equal installments of principal, and accrued
interest thereon, in December 2002 and March 2003.
An income tax benefit of $120,222 was recorded in the three months ended January
31, 2003, compared with $13,410 during the comparable period in the prior fiscal
year. The benefit in the third quarter of fiscal 2003 was primarily due to a
refund received by applying new five year carry back procedures for use of net
operating losses.
The Company recorded accrued dividends of $25,625 in the three months ended
January 31, 2003, payable to holders of the Preferred Stock. The Preferred
Stock, which was issued in June 2002, pays dividends of 10% per annum in the
form of additional shares of Preferred Stock or in shares of the Company's
common stock if a sufficient number of shares of Preferred Stock is not
available.
As a result of the foregoing, the Company incurred a net loss available to
common shareholders of $574,966 for the three months ended January 31, 2003.
19
Nine months ended January 31, 2003 and 2002:
- --------------------------------------------
The Company's revenues during the nine months ended January 31, 2003 declined by
$3,153,217 to $3,659,990, or 46%, compared with revenues of $6,813,207 in the
comparable period in the prior fiscal year. The significant decline was
primarily due to the overall slowdown in the economy and the restructuring of
the Company's sales force, which has resulted in lower overall revenues. The
restructured sales force has not achieved the level of sales anticipated by the
Company. The decline in sales and revenues from asbestos abatement services,
however, was significantly less than the decline in sales and revenues from our
other services, notably, indoor air quality services. There can be no assurance
that the restructured sales force will ever be successful at increasing sales,
or that the Company will take the necessary actions to increase revenues.
The Company's gross margin was 10.8% of revenues during the nine months ended
January 31, 2003, compared with 17.3% in the comparable period in the prior
fiscal year. The decline in gross margin in this period was primarily
attributable to the fact that revenues from asbestos abatement services
comprised a significantly greater portion of total revenues as compared to the
comparable period in the prior fiscal year. Asbestos abatement has historically
had lower gross margins than indoor air quality services, primarily due to the
fact that the asbestos abatement market is finite and lacks a recurring services
component. The gross margin from asbestos abatement in the nine months ended
January 31, 2003 was historically lower than the historical average gross margin
for asbestos abatement primarily because certain indirect expenses did not
decrease in proportion with the decrease in total revenues in this period. The
decline in gross margin is also attributable in part to the lower gross margin
from indoor air quality services in the nine months ended January 31, 2003, as
compared to the comparable period in the prior fiscal year. The indoor gross
margin for indoor air quality services was significantly lower in this period
primarily because the Company expensed certain unrecoverable direct costs for
jobs that did not take place. The Company did not experience any significant
losses on jobs in this period.
The Company's general and administrative expenses increased to $1,515,493 during
the nine months ended January 31, 2003, from $1,378,975 in the comparable period
in the prior fiscal year. The increase was primarily due to costs incurred to
reposition the Company in the first and second quarters of fiscal 2003. These
costs included the addition of new management and consultants, exploration of
strategic mergers/acquisitions and financing alternatives, and the evaluation
and development of a new corporate strategy. However, due to the inability of
the Company to implement its merger/acquisition growth strategy for the indoor
air quality business and the change in management in October 2002, the Company
has taken efforts to eliminate many of these costs. There can be no assurances,
however, that the Company's efforts will result in lower general and
administrative expenses.
Interest expense increased to $102,775 in the nine months ended January 31,
2003, compared with $58,817 in the comparable period in the prior fiscal year.
The increase was primarily due to the amount of deferred costs of the June 2002
private placement and the amount of the debt discount related to the January
2002 bridge loan in the principal amount of $500,000. In June 2002, the Company
used a portion of the proceeds derived from the June 2002 private placement to
repay $400,000 in principal, and all accrued and payable interest to date, on
the bridge loan. In October 2002, the Company issued the Convertible Note in
full payment and satisfaction of the remaining $100,000 obligation due on the
bridge loan. The Convertible Note was repaid in two equal installments of
principal, and accrued interest thereon, in December 2002 and March 2003.
20
An income tax benefit of $119,776 was recorded in the nine months ended January
31, 2003, as compared with an income tax benefit of $15,156 during the
comparable period in the prior fiscal year. The expense recorded during this
period is primarily due to refund received by applying new five year carry-back
procedures for use of net operating losses.
The Company recorded accrued dividends of $62,639 in the nine months ended
January 31, 2003, payable to holders of the Preferred Stock. The Preferred
Stock, which was issued in June 2002, pays dividends of 10% per annum in the
form of additional shares of Preferred Stock or in shares of the Company's
common stock if a sufficient number of shares of Preferred Stock is not
available.
Issuance of the Preferred Stock resulted in a preferential conversion feature
that was valued at $512,500 during the nine months ended January 31, 2003. The
preference's value was determined based on: (a) the number of underlying common
shares into which the Preferred Stock may be converted, and (b) the difference
between the Preferred Stock conversion price per share of common stock and the
prevailing market value of a share of common stock on the date the Preferred
Stock was issued.
As a result of the foregoing, the Company incurred a net loss available to
common shareholders of $2,059,315 for the nine months ended January 31, 2003.
Liquidity and Capital Resources:
- --------------------------------
Net cash used in operating activities was $471,998 for the nine months ended
January 31, 2003, compared with $127,593 in the comparable period in the prior
fiscal year. The net cash used during this period was primarily due to the net
loss for the period, and the costs incurred to reposition the Company, which
included the addition of new management and consultants, exploration of
strategic mergers/acquisitions and financing alternatives, and the evaluation
and development of a new corporate strategy. No cash was used in or provided by
investing activities during the nine months ended January 31, 2003, compared
with $5,549 used in investing activities in the comparable period in the prior
fiscal year. Net cash provided by financing activities was $415,959 for the nine
months ended January 31, 2003, compared with $498,423 in the comparable period
in the prior fiscal year. The net cash provided during this period was primarily
derived from the June 2002 initial closing of a private placement of a minimum
of 500,000 and a maximum of 1,000,000 shares of the Company's Preferred Stock to
accredited investors at $2.00 per share and the Convertible Note in the
principal amount of $100,000.
Five hundred twelve thousand five hundred shares of Preferred Stock were issued
in the June 2002 private placement, each share of which is convertible into four
shares of common stock at a conversion price of $.50 per share. As of the
closing, it was determined that the holders of the Preferred Stock received a
common stock conversion preference based on the excess of the common stock's
then current market value of $.75 per share over the Preferred Stock's $.50 per
share conversion price. This preference was assigned a value of $512,500
relative to the 2,050,000 underlying shares of common stock into which the
Preferred Stock may be converted. The Company received net proceeds of $865,959
from the issuance of the 512,500 shares of Preferred Stock, a portion of which
was used to retire $400,000 in principal and all accrued and payable interest to
21
date on the January 2002 bridge loan. KSH Investment Group, Inc. served as
placement agent and received, among other things, a cash commission equal to
7.5% of the aggregate purchase price of the shares sold, a non-accountable
expense allowance equal to 1.5% of the aggregate purchase price of the shares
sold, and warrants to purchase 402,500 shares of common stock at $.65 per share
in connection with the private placement. Warrants for 325,625 shares were
issued in June 2002 and warrants for the remaining 76,875 shares were issued in
September 2002. Dividends on the Preferred Stock at the rate of $.20 per share
per annum are payable in kind, or in shares of the Company's common stock if a
sufficient number of shares of Preferred Stock is not available. Dividends shall
accrue and be payable in May of each year; as of January 31, 2003, the Company
had accrued Preferred Stock dividends of $62,639. The Preferred Stock is
redeemable, at the option of the Company, after the second anniversary of the
closing. Consequently, the Preferred Stock has been classified as equity.
Although the Company has successfully completed the initial closing of the
Preferred Stock offering, the Company does not believe it will complete the
second half of the offering as the market for equity financing continues to
diminish.
At January 31, 2003, the Company had an accumulated deficit in stockholder's
equity of $3,640,403 and incurred a net loss available to common shareholders of
$2,059,315 for the nine months then ended. As a result, the recoverability of a
major portion of the recorded asset amounts shown in the accompanying balance
sheet is dependent on the Company's ability to meet its financing requirements
on an as needed basis and to succeed in its future operations. The financial
statements do not include any adjustments relating to the recoverability and
classifications of assets and liabilities that might be necessary should the
Company be unable to continue in existence.
In the past, the Company relied on shareholders loans for its capital needs, but
believes it can no longer rely on shareholder loans for its capital needs going
forward. In the past, the Company explored debt and equity markets in order to
satisfy its current and future capital requirements. Although the Company had
satisfied in part its capital needs through debt and equity markets in the past,
it was unable to secure sufficient financing to implement its merger/acquisition
growth strategy for its indoor air quality business in fiscal 2003. The Company
will no longer pursue its merger/acquisition growth strategy for its indoor air
quality business, and is not currently exploring debt and equity markets for its
capital needs.
Management believes that the Company has the ability to meet its financing
requirements for the next eight months. However, the Company may require
additional financing during fiscal 2003, without which its ability to operate
could be adversely affected. If the Company requires additional financing during
fiscal 2003 and the markets for debt and equity financing continue to diminish,
the Company's ability to raise additional financing may be adversely affected.
There can be no assurance, however, that additional financing will be available
if and when the Company needs it, which is dependent, in part, on the Company
meeting its operating plan and collecting its receivables on a timely basis.
22
The Company's ability to finance its operating cash needs with cash generated by
operations is a function of its return to profitability. The Company has taken
measures to conserve cash by no longer pursing its merger/acquisition growth
strategy for its indoor air quality business and cutting back on personnel and
related expenses. The Company has also subleased its New York City office and
relocated to less expensive offices. Salaries and related expenses have
decreased as a result of the change in management in October 2002. However, if
the Company's planned cash flow projections for the next eight months are not
met, and the requisite level of financing is unattainable, the Company's ability
to operate could be adversely affected.
National Abatement Corp. ("NAC") and/or NAC Environmental Services, Inc.
("NACE"), which are wholly-owned subsidiaries of the Company, are co-defendants
in lawsuits involving property damage and/or personal injury claims arising in
the ordinary course of business from job-site accidents. Plaintiffs' claims in
these lawsuits exceed NAC and/or NACE's applicable insurance coverages. Claims
in excess of insurance coverages totaled approximately $8,750,000 as of January
31, 2003, net of three lawsuits that settled with limits of insurance coverages.
In the third quarter of fiscal 2003, NAC settled two lawsuits and recorded a
settlement that occurred in fiscal 2001. NAC and/or NACE are being represented
in these lawsuits by legal counsel engaged by their insurers and, in most or all
cases, have filed cross-claims and third-party claims against other parties. Any
judgment or settlement in excess of insurance coverages, however, will require
payment by NAC and/or NACE. The Company believes, based on prior experience,
that the amount of ultimate liability of NAC and/or NACE with respect to these
claims will not have a material effect on the Company's financial position,
results of operations and cash flows. There can be no assurance, however, that
any judgment or settlement of these claims will not exceed NAC's and/or NACE's
insurance coverages, which could have a material effect on the Company's
financial position, results of operations and cash flows.
On January 15, 2003, the U.S. government filed an indictment in the United
States District Court for the Southern District of New York alleging that NAC
and one of its employees violated the Clean Air Act. The indictment, which
relates to work performed in January 1998, alleges that NAC and the employee
caused asbestos material to be stripped from a building without adequately
wetting it, failed to lower the asbestos material to the floor without dropping
or otherwise damaging it, and did not keep asbestos material that had been
removed wet until it was collected and contained. In January 2003, NAC and the
U.S. government entered into an agreement that tolled the limitations period, to
March 21, 2003, for any charges which the U.S. government could have filed
against NAC with respect to the removal and containment of asbestos to which a
grand jury has not returned an indictment and the statute of limitations has not
run as of the date of the agreement. In March 2003, NAC and the U.S. government
entered into another agreement which tolled the limitations period once again
until May 30, 2003 or the date on which a disposition is reached on the Clean
Air Act indictment, whichever occurs first. NAC denies all the charges and is
currently engaged in negotiations to resolve these matters. NAC would be subject
to monetary penalties and other compliance requirements if found guilty of
violating the Clean Air Act.
Except for the claims against NAC and/or NACE set forth above, the Company, or
its subsidiaries, is not involved in any other material legal proceedings.
23
The following table provides a summary of our contractual obligations at January
31, 2003:
Less than 1-3 3 or More
Total 1 Year Years Years
----------- ----------- ---------- ---------
Notes payable, convertible note (a) $ 50,000 $ 50,000 $ -- $ --
Loans payable, shareholders (b) 1,032,501 448,365 584,136 --
Operating leases (c) 1,085,341 195,686 413,095 476,560
----------- ----------- ---------- ---------
Total contractual obligations $ 2,167,842 $ 694,051 $ 997,231 $ 476,560
=========== =========== ========== =========
(a) Notes payable, convertible note
-------------------------------
On January 10, 2002, the Company secured bridge loan financing
in the aggregate amount of $500,000 from KSH Strategic
Investment Fund I, LP and Cleveland Overseas, Ltd. The bridge
loan investors were issued secured promissory notes in the
aggregate principal amount of $500,000 ("Bridge Notes"), which
bore interest at a rate of 10% per annum. In June 2002, the
Company repaid in full the Bridge Note in the principal amount
of $400,000, and all accrued and payable interest on the
Bridge Notes to date. On October 10, 2002, the Company issued
a secured convertible promissory note in the principal amount
of $100,000 ("Convertible Note") in full payment and
satisfaction of the remaining Bridge Note in the principal
amount of $100,000. The Convertible Note, which was secured by
substantially all of the assets of the Company, bore interest
at a rate of 7% per annum and was convertible into shares of
the Company's common stock at a conversion price of $1.00 per
share, was repaid in two equal installments of principal, and
accrued interest thereon, in December 2002 and March 2003.
(b) Loans payable, shareholders
---------------------------
On April 1, 2002, the Company issued unsecured promissory
notes ("Shareholder Loans") totaling $1,032,501, in exchange
for and in full satisfaction of all outstanding balances due
on the demand loans, management fees and consulting fees
payable to shareholders and affiliates of the Company. The
Shareholder Loans do not bear interest. Each Shareholder Loan
requires repayment in twenty-one (21) equal monthly payments.
Repayment on a Shareholder Loan in the principal amount of
$10,263 was scheduled to begin in February 2003, however, the
lender has agreed to defer the commencement date indefinitely.
The lender could, however, demand that repayment begin on the
$10,263 Shareholder Loan at any time. Repayment on the
remaining Shareholder Loans totaling $1,022,238 is scheduled
to begin in May 2003.
(c) Operating leases
----------------
In the past, the Company has entered into operating leases for
office and warehouse facilities which expire through September
30, 2008. During the nine months ended January 31, 2003, the
Company signed a lease for approximately 8,500 square feet of
warehouse space located in Rahway, New Jersey. The lease,
which runs for a three-year term ending July 31, 2005,
required two security deposits totaling $49,350. Rents due
under the lease total $3,116.66 per month.
24
At January 31, 2003 and 2002, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. In addition, the Company does
not engage in trading activities involving non-exchange traded contracts. As
such, the Company is not exposed to any financing, liquidity, market, or credit
risk that could arise if the Company had engaged in such activities.
New Accounting Pronouncements:
- ------------------------------
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations."
SFAS No. 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. Adoption of SFAS No. 141 did not have a material
effect on the Company's financial position, results of operations and cash
flows.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which is effective for all fiscal years beginning after December 31,
2001. SFAS No. 142 requires, among other things, the discontinuance of goodwill
amortization. In addition, the standard includes provisions for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the identification of reporting units for purposes of assessing potential future
impairment of goodwill. SFAS No. 142 also requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption. The
transitional goodwill impairment test was conducted as of the end of the first
quarter of fiscal 2003 and indicated no impairment of goodwill at that time.
Ongoing, periodic testing is required under SFAS No. 142. As a result of this
periodic testing, continuing losses, inability to obtain adequate financing to
complete an indoor air quality merger/acquisition and sell the business (see
Change in Plan of Operations on page 16), the Company recorded an impairment
charge of $416,954 for goodwill in the three months ended January 31, 2003.
Goodwill amortization of $8,526 and $25,578 was expensed during the three and
nine months ended January 31, 2002, respectively. On a pro forma basis, if SFAS
No. 142 had been adopted as of the beginning of fiscal 2002, the net income for
the three and net loss for the nine months ended January 31, 2002 would have
been $27,827 and $180,674, respectively, and the basic and diluted loss per
share for the three and nine month periods would have been $-0- and $.03,
respectively.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement is effective for fiscal years
beginning after December 15, 2001. SFAS No. 144 supercedes SFAS No. 121 while
retaining many of the requirements of SFAS No. 121. Adoption of SFAS No. 144 did
not materially affect the Company's financial position, results of operations
and cash flows.
25
The FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," on April 30,
2002. SFAS No. 145 rescinds Statement No. 4, which required all gains and losses
from extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. Upon adoption of SFAS No.
145, companies are required to apply the criteria in APB Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" in determining the classification of gains and losses
resulting from the extinguishments of debt. SFAS No. 145 is effective for fiscal
years beginning after May 15, 2002. The Company is in the process of evaluating
the impact of adopting this pronouncement on its consolidated financial
statements.
On July 30, 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to
be applied prospectively to exit or disposal activities initiated after December
31, 2002. The Company is in the process of evaluating the impact of adopting
this pronouncement on its consolidated financial statements.
In November 2002, FASB Interpretation 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45), was issued. FIN 45 requires a guarantor entity, at the
inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company previously did not record a
liability when guaranteeing obligations unless it became probable that the
Company would have to perform under the guarantee. FIN 45 applies prospectively
to guarantees the Company issues or modifies subsequent to December 31, 2002,
but has certain disclosure requirements effective for interim and annual periods
ending after December 15, 2002. The Company has historically issued guarantees
only on a limited basis and does not anticipate FIN 45 will have a material
effect on its 2003 financial statements.
In December 2002, the FASB issued Statement 148, Accounting for Stock-Based
Compensation -- Transition and Disclosure: an amendment of FASB Statement 123,
to provide alternative transition methods for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosures in annual financial statements about the method of
accounting for stock-based employee compensation and the pro forma effect on
reported results of applying the fair value based method for entities that use
the intrinsic value method of accounting. The pro forma effect disclosures are
also required to be prominently disclosed in interim period financial
statements. This statement is effective for financial statements for fiscal
years ending after December 15, 2002 and is effective for financial reports
containing condensed financial statements for interim periods beginning after
December 15, 2002, with earlier application permitted. The Company does not plan
a change to the fair value based method of accounting for stock-based employee
compensation.
26
Item 3. Controls and Procedures
-----------------------
Evaluation of Disclosure Controls and Procedures
- ------------------------------------------------
The principal executive officer and principal financial officer of the Company,
who are the same person (the "Certifying Officer"), maintains a system of
disclosure controls and procedures that is designed to provide reasonable
assurance that information, which is required to be disclosed, is accumulated
and communicated to management timely. The Certifying Officer, with the
assistance of advisors, evaluated the effectiveness of the design and operation
of the Company's disclosure controls and procedures (as defined in Rule
[13a-14(c)/15d-14(c)] under the Exchange Act) within 90 days prior to the filing
date of this report. Based upon that evaluation, the Certifying Officer
concluded that the Company's disclosure controls and procedures are effective in
timely alerting management to material information relative to the Company which
is required to be disclosed in its periodic filings with the SEC.
Changes in Internal Controls
- ----------------------------
The Certifying Officer has indicated that there were no significant changes in
the Company's internal controls or other factors that could significantly affect
such controls subsequent to the date of its evaluation, and there were no such
control actions with regard to significant deficiencies and material weaknesses.
27
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In the three months ended January 31, 2003, NAC settled claims against it within
limits of its insurance coverages in two lawsuit filed by plaintiff Josef Petru
in the Supreme Court of New York, County of Kings, and plaintiffs Boston
Properties Inc. and Boston Properties Limited Partnership filed in the Supreme
Court of New York, County of New York. In the three months ended January 31,
2003, NAC recorded the fiscal 2001 settlement of claims against it within limits
of its insurance coverage in a lawsuit originally filed by plaintiffs Gerald and
Becky Gliber in the Supreme Court of New York, County of New York. The three
lawsuits related to property damage and/or personal injury claims arising in the
ordinary course of business from job-site accidents.
On January 15, 2003, the U.S. government filed an indictment in the United
States District Court for the Southern District of New York alleging that NAC
and one of its employees violated the Clean Air Act. The indictment, which
relates to work performed in January 1998, alleges that NAC and the employee
caused asbestos material to be stripped from a building without adequately
wetting it, failed to lower the asbestos material to the floor without dropping
or otherwise damaging it, and did not keep asbestos material that had been
removed wet until it was collected and contained. In January 2003, NAC and the
U.S. government entered into an agreement that tolled the limitations period, to
March 21, 2003, for any charges which the U.S. government could have filed
against NAC with respect to the removal and containment of asbestos to which a
grand jury has not returned an indictment and the statute of limitations has not
run as of the date of the agreement. In March 2003, NAC and the U.S. government
entered into another agreement which tolled the limitations period once again
until May 30, 2003 or the date on which a disposition is reached on the Clean
Air Act indictment, whichever occurs first. NAC denies all the charges and is
currently engaged in negotiations to resolve these matters. NAC would be subject
to monetary penalties and other compliance requirements if found guilty of
violating the Clean Air Act.
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------
In December 2002, the Company issued to President Michael J. Caputo a warrant to
purchase up to 500,000 shares of the Company's common stock at an exercise price
of $.55 per share for services rendered. The warrant vested fully upon grant and
expires in December 2007. The Company relied upon Section 4(2) of the Securities
Act and Rule 506 of Regulation D promulgated thereunder in issuing the warrant
without registration under the Act.
28
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
Exhibits
- --------
o Exhibit 99.1: Certification of Principal Executive and Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (18 U.S.C.ss.1350)
Reports on Form 8-K
- -------------------
Current Reports on Form 8-K filed during the three months ended January 31,
2003, and the subsequent interim period ended March 17, 2003, are as follows:
o Report on Form 8-K, filed with the Commission on November 6, 2002,
announcing the appointment of Michael J. Caputo as acting President,
principal executive officer and principal financial officer and the
resignations of Jeffrey L. Powell, Paul Bailey and Joel Schoenfeld
under Item 5 - Other.
o Report on Form 8-K, filed with the Commission on January 21, 2003,
regarding the indictment of the Company's subsidiary under the Clean
Air Act under Item 5 - Other.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned.
NESCO INDUSTRIES, INC.
Dated: March 24, 2003 By: /s/ Michael J. Caputo
-------------------------------------------
Michael J. Caputo,
President
(Principal Executive and Financial Officer)
30
CERTIFICATION
I, Michael J. Caputo, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of NESCO
Industries, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Dated: March 24, 2003 By: /s/ Michael J. Caputo
-------------------------------------------
Michael J. Caputo,
President
(Principal Executive and Financial Officer)