UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-19049
FORTUNE DIVERSIFIED INDUSTRIES, INC.
(Exact name of Registrant as specified in its charter)
INDIANA 20-2803889
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
6402 CORPORATE DRIVE 46278
INDIANAPOLIS, IN (Zip Code)
(Address of principal executive offices)
(317) 532-1374
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of January 13, 2006, 10,559,843 shares of the Company's $0.10 per share par
value common stock were outstanding.
FORTUNE DIVERSIFIED INDUSTRIES, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2005
INDEX
Page
----
PART I. Financial Information
ITEM 1. Financial Statements
Consolidated Statements of Operations for the three month periods
ended November 30, 2005 and 2004 (unaudited) 3
Consolidated Balance Sheets as of November 30, 2005 (unaudited) and
August 31, 2005 4
Consolidated Statement of Changes in Stockholders' Equity for the
three month period ended November 30, 2005 (unaudited) 6
Consolidated Statements of Cash Flows for the three month periods
ended November 30, 2005 and 2004 (unaudited) 7
Notes to the Consolidated Financial Statements 9
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 27
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 35
ITEM 4. Controls and Procedures 35
PART II. Other Information
ITEM 1. Legal Proceedings 36
ITEM 1A. Risk Factors 36
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 36
ITEM 3. Defaults Upon Senior Securities 36
ITEM 4. Submission of Matters to a Vote of Security Holders 36
ITEM 5. Other Information 36
ITEM 6. Exhibits 36
Signatures 37
2
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
FORTUNE DIVERSIFIED INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
---------------------------
NOVEMBER 30, NOVEMBER 30,
2005 2004
------------ ------------
NET REVENUES
Net revenues wireless infrastructure services $ 4,293 $ 2,702
Net revenues wireless infrastructure products 16,777 11,998
Net revenues manufacturing and distribution 5,635 5,684
Net revenues business solutions (gross billings of $70,450 and
$34,588 less worksite employee payroll cost of $60,712 and $29,924 for the three
months ended November 30, 2005 and 2004, respectively) 9,738 4,664
----------- -----------
TOTAL NET REVENUES 36,443 25,048
COST OF REVENUES
Cost of revenues wireless infrastructure services 3,015 1,800
Cost of revenues wireless infrastructure products 14,981 10,604
Cost of revenues manufacturing and distribution 3,978 4,094
Cost of revenues business solutions 7,231 3,660
----------- -----------
TOTAL COST OF REVENUES 29,205 20,158
----------- -----------
GROSS PROFIT 7,238 4,890
OPERATING EXPENSES
Selling, general and administrative expenses 5,457 3,553
Depreciation and amortization 481 377
----------- -----------
Total Operating Expenses 5,938 3,930
----------- -----------
OPERATING INCOME 1,300 960
OTHER INCOME (EXPENSE)
Interest income 56 --
Interest expense (544) (266)
Loss on investments in marketable securities, net -- (29)
Exchange rate gain (loss) (5) 43
Other income 61 59
----------- -----------
Total Other Expense (432) (193)
NET INCOME BEFORE PROVISION FOR INCOME TAXES 868 767
----------- -----------
PROVISION FOR INCOME TAXES 21 64
----------- -----------
NET INCOME $ 847 $ 703
=========== ===========
BASIC INCOME PER COMMON SHARE $ 0.08 $ 0.07
=========== ===========
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 10,559,843 10,264,344
=========== ===========
DILUTED INCOME PER COMMON SHARE $ 0.08 $ 0.07
=========== ===========
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 10,726,256 10,304,344
=========== ===========
See Accompanying Notes to Unaudited Interim Consolidated Financial Statements
3
FORTUNE DIVERSIFIED INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOVEMBER 30, AUGUST 31,
2005 2005
(UNAUDITED) (AUDITED)
------------ ----------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 4,771 $ 3,787
Restricted savings account 1,489 1,484
Available for sale investments 1,305 2,199
Accounts receivable, net 23,115 21,358
Costs and estimated earnings in excess of billings on uncompleted contracts 3,843 2,681
Inventory, net 7,631 8,315
Deferred tax asset 1,014 1,014
Prepaid expenses and other current assets 1,037 1,790
------- -------
Total Current Assets 44,205 42,628
OTHER ASSETS
Property, plant & equipment, net 5,348 5,064
Goodwill 11,926 11,680
Other intangible assets, net 4,550 4,705
Accounts receivable - long term 600 600
Other long term assets 1,513 409
------- -------
Total Other Assets 23,937 22,458
------- -------
TOTAL ASSETS $68,142 $65,086
======= =======
See Accompanying Notes to Unaudited Interim Consolidated Financial Statements
4
FORTUNE DIVERSIFIED INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOVEMBER 30, AUGUST 31,
2005 2005
(UNAUDITED) (AUDITED)
------------ ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 7,490 $ 7,095
Lines of credit 15,045 18,998
Current maturities of long-term debt 2,663 2,675
Health and workers' compensation reserves 3,938 4,000
Accrued expenses 4,516 6,288
Billings in excess of costs and estimated earnings on uncompleted contracts 2,340 2,101
Other current liabilities 713 271
------- -------
Total Current Liabilities 36,705 41,428
LONG-TERM LIABILITIES
Long-term debt, less current maturities 4,147 4,898
Convertible term note 7,500 --
Line of credit - related party -- 6,618
Other long-term liabilities 335 69
------- -------
Total Long-term Liabilities 11,982 11,585
------- -------
Total Liabilities 48,687 53,013
STOCKHOLDERS' EQUITY
Common stock, $0.10 par value; 150,000,000 authorized; 10,559,843 issued and
outstanding at November 30, 2005 and August 31, 2005 1,046 1,046
Preferred stock, $0.10 par value; 1,000,000 authorized; 66,180 and 0 issued and
outstanding at November 30, 2005 and August 31, 2005, respectively 6,618 --
Additional paid-in capital and warrants outstanding 17,440 17,340
Accumulated deficit (5,559) (6,406)
Accumulated other comprehensive income (loss) (90) 93
------- -------
Total Stockholders' Equity 19,455 12,073
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $68,142 $65,086
======= =======
See Accompanying Notes to Unaudited Interim Consolidated Financial Statements
5
FORTUNE DIVERSIFIED INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
(UNAUDITED)
ADDITIONAL
PAID-IN ACCUMULATED
CAPITAL AND ACCUMULATED OTHER TOTAL
COMMON PREFERRED WARRANTS EARNINGS COMPREHENSIVE STOCKHOLDERS COMPREHENSIVE
STOCK STOCK OUTSTANDING (DEFICIT) INCOME EQUITY INCOME
------ --------- ----------- ----------- ------------- ------------ -------------
BALANCE AT AUGUST 31, 2005 $1,046 $ -- $17,340 $(6,406) $ 93 $12,073
====== ====== ======= ======= ===== =======
Issuance of 66,180
shares of preferred
stock -- 6,618 -- -- -- 6,618 $ --
Purchase accounting
adjustment -- -- 100 -- -- 100 --
Net income -- -- -- 847 -- 847 847
Translation adjustments,
net of tax -- -- -- -- (41) (41) (41)
Unrealized investments
gains (losses), net of
tax -- -- -- -- (142) (142) (142)
------ ------ ------- ------- ----- ------- -----
Total comprehensive income -- -- -- -- -- -- $ 664
------ ------ ------- ------- ----- ------- =====
BALANCE AT NOVEMBER 30,
2005 $1,046 $6,618 $17,440 $(5,559) $ (90) $19,455
====== ====== ======= ======= ===== =======
See Accompanying Notes to Unaudited Interim Consolidated Financial Statements
6
FORTUNE DIVERSIFIED INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
---------------------------
NOVEMBER 30, NOVEMBER 30,
2005 2004
------------ ------------
OPERATING ACTIVITIES
Net Income $ 847 $ 703
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 481 377
Loss on sale of investments -- 29
(Increase) decrease in certain operating assets:
Restricted cash (5) --
Accounts receivable (1,757) (1,357)
Costs and estimated earnings in excess of billings on uncompleted contracts (1,162) (110)
Inventory 697 828
Other current assets 753 160
Other long term assets (146) 2
Increase (decrease) in certain operating liabilities:
Accounts payable 395 278
Health and workers' compensation reserves (62) 6
Billings in excess of costs and estimated earnings on uncompleted contracts 239 (247)
Accrued expenses and other current liabilities (1,230) (37)
Due to related party -- 55
------- -------
Net Cash Provided by (Used in) Operating Activities (950) 687
INVESTING ACTIVITIES
Capital expenditures (644) (183)
Purchases of available for sale securities (11) (39)
Acquisition of productive assets and businesses, net of cash received (262) (465)
------- -------
Net Cash Used in Investing Activities (917) (687)
FINANCING ACTIVITIES
Proceeds from convertible debentures 6,808 --
Borrowings on available for sale investment account 800 --
Net borrowings (payments) under line of credit (3,953) 1,544
Payments on long-term debt (763) (653)
------- -------
Net Cash Provided by Financing Activities 2,892 891
Effect of exchange rate changes on cash (41) 65
------- -------
NET INCREASE IN CASH AND EQUIVALENTS 984 956
CASH AND EQUIVALENTS
Beginning of Period 3,787 3,527
------- -------
End of Period $ 4,771 $ 4,483
======= =======
See Accompanying Notes to Unaudited Interim Consolidated Financial Statements.
7
FORTUNE DIVERSIFIED INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
---------------------------
NOVEMBER 30, NOVEMBER 30,
2005 2004
------------ ------------
SUPPLEMENTAL DISCLOSURES
Interest paid $ 798 $205
====== ====
Taxes paid $ 21 $ 64
====== ====
Non-cash investing and financing activities
Issuance of preferred stock for debt extinguishment $6,618 $ --
Issuance of warrants in connection with loan refinancing 266 --
------ ----
$6,884 $ --
====== ====
Acquisition of Audio Video Revolution, Inc.
Fair value of assets acquired $ 262
Cash paid 262
------
Liabilities recorded $ --
======
See Accompanying Notes to Unaudited Interim Consolidated Financial Statements.
8
FORTUNE DIVERSIFIED INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED,
EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The financial data presented herein is unaudited and
should be read in conjunction with the consolidated financial statements and
accompanying notes included in the 2005 Annual Report on Form 10-KSB filed by
Fortune Diversified Industries, Inc. (together with its subsidiaries, the
"Company"). The accompanying unaudited consolidated financial statements have
been prepared by the Company without audit. These unaudited financial statements
contain, in the opinion of management, all adjustments (consisting of normal
accruals and other recurring adjustments) necessary for a fair presentation of
the consolidated financial position, results of operations, and cash flows for
the periods presented in conformity with accounting principles generally
accepted in the United States. The operating results for the three-month period
ended November 30, 2005 are not necessarily indicative of the operating results
to be expected for the full fiscal year.
Nature of Business: Fortune Diversified Industries, Inc. is a holding company
headquartered in Indianapolis, Indiana. The term "Company" as used herein refers
to Fortune Diversified Industries, Inc. and its subsidiaries unless the context
otherwise requires. The Company conducts its business directly and through its
wholly-owned subsidiaries.
The Company's current operating focus is achieved through its following thirteen
subsidiaries (grouped by segment):
- Wireless Infrastructure
James H. Drew Corp. (JH Drew); PDH, Inc. (PDH); Magtech Services, Inc.
(Magtech); Cornerstone Wireless Construction Services, Inc.
(Cornerstone Construction); Innovative Telecommunications Consultants,
Inc. (ITC); Telecom Technology Corp. (TTC); StarQuest Wireless
Services, Inc. (StarQuest); and Fortune Wireless, Inc ("Fortune
Wireless")
- Manufacturing and Distribution
Nor-Cote International, Inc. (Nor-Cote); Kingston Sales Corporation
(Kingston); and Commercial Solutions, Inc. (Commercial Solutions)
- Business Solutions
Professional Staff Management, Inc., Professional Staff Management,
Inc. II and Pro Staff, Inc. (collectively "PSM"); and CSM, Inc. (CSM)
The Wireless Infrastructure segment is composed of businesses that provide
wireless services and products. PDH, Magtech, ITC, and StarQuest generate
revenues from providing wireless services while JH Drew and Cornerstone
Construction generate revenue from providing wireless products. TTC generates
revenues from providing both wireless services and products. Additionally,
Fortune Wireless, Inc. is a direct subsidiary of the holding company and the
owner of the stock of certain entities comprising the Wireless Infrastructure
segment.
Effective September 1, 2005, the Company is no longer eligible as a small
business reporter on Form 10-QSB under Regulation S-B but is subject to the
reporting requirements on Form 10-Q under Regulation S-K.
Principles of Consolidation: The accompanying consolidated financial statements
include the accounts of Fortune Diversified Industries, Inc. and its
wholly-owned subsidiaries. Nor-Cote contains foreign subsidiaries from the
United Kingdom and Singapore, which have been eliminated in consolidation at the
Nor-Cote subsidiary level. All significant inter-company accounts and
transactions of the Company have been eliminated.
9
Foreign Currency Translation: Assets and liabilities of the foreign subsidiaries
of the Company's wholly owned Nor-Cote subsidiary are translated into U.S.
dollars at the exchange rate in effect at the end of the period. Revenue and
expense accounts are translated at a weighted-average of exchange rates in
effect during the year. Translation adjustments that arise from translating the
subsidiaries financial statements from local currency to U.S. dollars are
accumulated and presented, net of tax, as a separate component of stockholders'
equity.
Comprehensive Income (Loss): Comprehensive income (loss) refers to the change in
an entity's equity during a period resulting from all transactions and events
other than capital contributed by and distributions to the entity's owners. For
the Company, comprehensive income (loss) is equal to net income plus the change
in unrealized gains or losses on investments and the change in foreign currency
translation adjustments. The Company has elected to report comprehensive income
(loss) in the consolidated statements of stockholders' equity.
Estimates: Management uses estimates and assumptions in preparing consolidated
financial statements in accordance with accounting principles generally accepted
in the United States. Those estimates and assumptions affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities and the reported revenues and expenses. Actual results could vary
from the estimates that were used.
Significant estimates used in preparing these consolidated financial statements
include those assumed in computing profit percentages under the
percentage-of-completion revenue recognition method. It is reasonably possible
that the significant estimates used will change within the next year.
Revenue and Cost Recognition: In the Wireless Infrastructure segment, PDH, ITC,
and Magtech enter into contracts principally on the basis of competitive bids,
the final terms and prices of which are frequently negotiated with the customer.
Although the terms of its contracts vary considerably, most are made on a unit
price basis in which the Company agrees to do the work for units of work
performed. The Company also performs services on a cost-plus or time and
materials basis. The Company completes most projects within six months. The
Company generally recognizes revenue utilizing output measures, such as when
services are performed, units are delivered or when contract milestones are
reached. Additionally, in the Wireless Infrastructure segment, Cornerstone
Construction and JH Drew recognize revenue using the percentage of completion
method on contracts in process. Under this method, the portion of the contract
price recognized as revenue is based on the ratio of costs incurred to the total
estimated cost of the contract. The estimated total cost of a contract is based
upon management's best estimate of the remaining costs that will be required to
complete a project. The actual costs required to complete a project and,
therefore, the profit eventually realized, could differ materially in the near
term. Costs and estimated earnings in excess of billings on uncompleted
contracts are shown as a current asset. Billings in excess of costs and
estimated earnings on uncompleted contracts are shown as a current liability.
Anticipated losses on contracts, if any, are recognized when they become
evident. TTC and StarQuest recognize revenue when product is shipped and
installation is complete.
In the Manufacturing and Distribution segment, revenue from the sale of products
at Nor-Cote, Kingston, and Commercial Solutions is recognized according to the
terms of the sales arrangement, which is generally upon shipment. Revenues are
recognized, net of estimated costs of returns, allowances and sales incentives,
title and principal ownership transfers to the customer, which is generally when
products are shipped to customers. Products are generally sold on open account
under credit terms customary to the geographic region of distribution. Ongoing
credit evaluations are performed on customers and the Company does not generally
require collateral to secure accounts receivable.
In the Business Solutions segment, PSM and CSM, licensed Professional Employer
Organizations (PEO's), bill clients under their Professional Services Agreement,
which includes each worksite employee's gross wages, plus additional charges for
employment related taxes, benefits, workers' compensation insurance,
administrative and record keeping, as well as safety, human resources, and
regulatory compliance consultation. All wages, taxes and insurance coverage are
provided under PSM's and CSM's federal, state, and local or vendor
identification numbers. No identification or recognition is given to the client
when these monies are remitted or calculations are reported. All calculations or
amounts PSM and CSM owe the government and its employment insurance vendors are
based on the experience levels and activity of PSM and CSM with no consideration
to client detail. There is no direct relationship between what PSM and CSM pay
versus what is billed to a client. PSM and CSM bill the client their worksite
employees' gross wages plus an overall service fee that includes all components
of employment related taxes, employment benefits insurance, and administration
of those items. This service fee is intended to cover PSM's and CSM's cost of
those items and yield a profit to PSM and CSM. What is paid to the government
and vendors is different than what is charged to the client due to the different
methods of calculation as to what PSM and CSM owe those entities versus what the
client is charged. The component of the service fee related to administration
varies, in
10
part, according to the size of the client, the amount and frequency of payroll
payments and the method of delivery of such payments. The component of the
service fee related to workers' compensation and unemployment insurance is
based, in part, on the client's historical claims experience. All charges by PSM
and CSM are invoiced along with each periodic payroll delivered to the client.
PSM and CSM report revenues in accordance with Emerging Issues Task Force
("EITF") No. 99-19, Reporting Revenue Gross as a Principal versus Net as an
Agent. PSM and CSM report revenues on a gross basis, the total amount billed to
clients for service fees which includes health and welfare benefit plan fees,
workers' compensation insurance, unemployment insurance fees, and
employment-related taxes. PSM and CSM report revenues on a gross basis for such
fees because PSM and CSM are the primary obligor and deemed to be the principal
in these transactions under EITF No. 99-19. However, PSM and CSM report revenues
on a net basis for the amount billed to clients for worksite employee salaries
and wages. This accounting policy of reporting revenue net as an agent versus
gross as a principal has no effect on gross profit, operating income, or net
income.
PSM and CSM account for their revenues using the accrual method of accounting.
Under the accrual method of accounting, revenues are recognized in the period in
which the worksite employee performs work. PSM and CSM accrue revenues for
service fees, health and welfare benefit plan fees, workers' compensation and
unemployment insurance fees relating to work performed by worksite employees but
unpaid at the end of each period. PSM and CSM accrue unbilled receivables for
payroll taxes, service fees, health and welfare benefits plan fees, workers'
compensation and unemployment insurance fees relating to work performed by
worksite employees but unpaid at the end of each period. In addition, the
related costs of services are accrued as a liability for the same period.
Subsequent to the end of each period, such costs are paid and the related
service fees are billed.
Consistent with its revenue recognition policy, PSM and CSM's direct costs do
not include the payroll cost of its worksite employees. The Company's direct
costs associated with its revenue generating activities are comprised of all
other costs related to its worksite employees, such as the employer portion of
payroll-related taxes, employee benefit plan premiums and workers' compensation
insurance costs.
Revenue is reduced by appropriate allowances, estimated returns, price
concessions, and similar adjustments, as applicable.
Cash and Equivalents: Cash and equivalents may include money market fund shares,
bank time deposits, certificates of deposits, and other instruments with
original maturities of three months or less.
Marketable Securities: Marketable securities include common stocks classified as
"available for sale" in accordance with the provisions of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The securities are carried at fair value based on current
market quotations. Unrealized holding gains and losses, net of tax, are not
included in "net income," but are accounted for as "other comprehensive income"
and reflected as a separate component of the change in stockholders' equity. The
cost of securities used to compute realized gains and losses is based on
specifically identified securities. The fair value of investment securities is
determined by currently available market prices. Dividends on marketable equity
securities are recognized in income when declared.
Accounts Receivable: Accounts receivable is stated at the amount billable to
customers. The Company provides allowances for doubtful accounts and for returns
and sales allowances, which are based upon a review of outstanding receivables,
historical information and existing economic conditions. Accounts receivable are
ordinarily due 30-60 days after the issuance of the invoice. Delinquent
receivables are written off based on individual credit evaluation and specific
circumstances of the customer. The Company's policy is not to accrue interest on
past due trade receivables.
Inventories: Inventories of raw materials are recorded at the lower of cost
(primarily first-in, first-out) or market value. Inventories of work-in-process
and finished goods include estimated direct labor, indirect labor, and other
manufacturing expenses applied as a function of material costs. The Company
records finished goods inventory on an average cost basis.
Shipping and Handling: Costs incurred for shipping and handling are included in
the Company's consolidated financial statements as a component of costs of
revenue.
11
Property, Equipment, and Depreciation: Property and equipment are carried at
cost and includes expenditures for new additions and those which substantially
increase the useful lives of existing assets. Depreciation is computed at
various rates by use of the straight-line method and certain accelerated
methods, depending on the entity. Depreciable lives generally range from 3 to 30
years.
Expenditures for normal repairs and maintenance are charged to operations as
incurred. The cost of property or equipment retired or otherwise disposed of and
the related accumulated depreciation are removed from the accounts in the year
of disposal with the resulting gain or loss reflected in earnings or in the cost
of the replacement asset.
Goodwill and Other Indefinite-Lived Intangible Assets: The Company accounts for
goodwill and other indefinite-lived intangible assets under Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, goodwill and other intangible assets with
indeterminate lives are assessed for impairment at least as often as annually
and as triggering events occur. In making this assessment, management relies on
a number of factors including operating results, business plans, economic
projections, anticipated future cash flows, and transactions and market place
data. There are inherent uncertainties related to these factors and management's
judgment in applying them to the analysis of both goodwill and other intangible
assets impairment. Since management's judgment is involved in performing
goodwill and other intangible assets valuation analyses, there is risk that the
carrying value of the goodwill and other intangible assets may be overstated or
understated.
The Company has elected to perform the annual impairment test of recorded
goodwill and other indefinite-lived intangible assets as required by SFAS 142 as
of the end of fiscal fourth quarter. The results of this annual impairment test
indicated that the fair value of each of the reporting units as of August 31,
2005, exceeded the carrying, or book value, including goodwill, and therefore
recorded goodwill and other intangible assets were not subject to impairment.
The required annual impairment test may result in future periodic write-downs.
Long-lived Assets: The Company evaluates the carrying value of long-lived
assets, primarily property, plant and equipment and other intangible assets,
whenever significant events or changes in circumstances indicate the carrying
value of these assets may be impaired. If such indicators of impairment are
present, the Company determines whether the sum of the estimated undiscounted
cash flows attributable to the assets in question is less than their carrying
value. If less, the Company recognizes an impairment loss based on the excess of
the carrying amount of the assets over their respective fair values. The fair
value of the asset then becomes the asset's new carrying value, which the
Company depreciates over the remaining estimated useful life of the asset. Fair
value is determined by discounted future cash flows, appraisals or other
methods.
Fair Value of Financial Instruments: The fair value of financial instruments is
estimated using relevant market information and other assumptions. Fair value
estimates involve uncertainties and matters of significant judgment regarding
interest rates, prepayments, and other factors. Changes in assumptions or market
conditions could significantly affect these estimates. The amounts reported in
the consolidated balance sheets for cash and equivalents, marketable securities,
receivables, and payables approximate fair value.
Stock-based Compensation: As allowed by SFAS Statement No. 148, "Accounting for
Stock Based Compensation - Transition and Disclosure" (FAS 148), which amends
SFAS Statement No. 123, "Accounting for Stock Based Compensation", the Company
has elected to follow Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25), and to adopt the disclosure-only
provisions as required under Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (FAS 123), and Statement of
Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation
- - Transition and Disclosure (SFAS No. 148). The Company accounts for stock
awards to non-employees in accordance with the provisions of FAS 123 and FAS
148, and Emerging Issues Task Force Consensus No. 96-18 "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services" (EITF 96-18). Under FAS 123, FAS
148, and EITF 96-18, stock awards issued to non-employees are accounted for at
their deemed fair value based on independent valuations or by using an
option-pricing model, as appropriate.
In December 2004, the FASB issued Statement No. 123R (FAS 123R), "Share-Based
Payment," a revision of FAS 123. FAS 123R requires the measurement of all
stock-based payments to employees, including grants of employee stock options
and stock purchase rights granted pursuant to certain employee stock purchase
plans, using a fair-value based method and the recording of such expense in our
Consolidated Statements of Operations. The accounting provisions of FAS 123R for
the Company are effective, and will be adopted, beginning September 1, 2006, the
beginning of the next fiscal year. The pro forma disclosures previously
permitted under FAS 123 will no longer be an alternative to financial statement
recognition. FAS 123R provides two alternatives for adoption: (1) a "modified
12
prospective" method in which compensation cost is recognized for all awards
granted subsequent to the effective date of this statement as well as for the
unvested portion of awards outstanding as of the effective date; or (2) a
"modified retrospective" method which follows the approach in the "modified
prospective" method, but also permits entities to restate prior periods to
record compensation cost calculated under FAS 123 for the pro forma disclosure.
The Company has not yet determined which method of adoption it will apply.
The adoption of FAS 123R is expected to have an impact on the Company's results
of operations, although it will have no impact on the Company's overall
financial position. The impact of adopting FAS 123R cannot be accurately
estimated at this time, as it will depend on the market value and the amount of
share-based awards granted in future periods. However, had the Company adopted
FAS 123R in a prior period, the impact would approximate the impact of FAS 123,
using the Black-Scholes model. FAS 123R also requires tax deductions in excess
of recognized compensation cost to be reported as a financing cash flow, rather
than as an operating cash flow, in the Consolidated Statements of Cash Flows.
Excess tax deductions for future periods cannot be accurately estimated at this
time, as they depend on the timing of stock option exercises and the Company's
share price on the exercise date.
Income per Common Share: Income per common share has been computed in accordance
with SFAS No. 128, "Earnings per Share." Under SFAS No. 128, basic income per
common share is computed based on net income applicable to common stock divided
by the weighted average number of common shares outstanding for the period.
Diluted income per common share is computed based on net income applicable to
common stock divided by the weighted average number of shares of common stock
outstanding during the period after giving effect to securities considered to be
dilutive common stock equivalents.
All references in the form 10-Q consolidated financial statements and notes to
the consolidated financial statements related to share amounts, per share
amounts and average shares outstanding have been adjusted retroactively to
reflect the 1-for-10 stock split of the Company's common stock effective June 2,
2005.
Income Taxes: The Company accounts for income taxes under the provisions of SFAS
No. 109, "Accounting for Income Taxes." Accordingly, deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax basis of assets and liabilities and are measured using the enacted tax
rates. Changes in deferred income tax assets and liabilities that are associated
with components of other comprehensive income, primarily unrealized investment
gains, are charged or credited directly to other comprehensive income.
Otherwise, changes in deferred income tax assets and liabilities are included as
a component of income tax expense. The Company files separate United States,
United Kingdom, Singapore, and Malaysia income tax returns.
Research and Development Costs: Research and development costs are expensed as
incurred and totaled $115 and $120 for the three month periods ended November
30, 2005 and 2004, respectively. Research and development expense is recorded in
the Company's Nor-Cote subsidiary.
Warrants Issued With Convertible Debt: The Company has issued and anticipates
issuing warrants along with debt and equity instruments to third parties. These
issuances are recorded based on the fair value of these instruments. Warrants
and equity instruments require valuation using the Black Scholes model and other
techniques, as applicable, and consideration of various assumptions including
but not limited to the volatility of the Company's stock, risk free rates and
the expected lives of these equity instruments.
Debt and equity issuances may have features which allow the holder to convert at
beneficial conversion terms, which are then measured using similar valuation
techniques and amortized to interest expense in the case of debt or recorded as
dividends in the case of preferred stock instruments. No issuances have
beneficial conversion terms as of November 30, 2005.
Self Insurance: The Company's Nor-Cote subsidiary has elected to act as a
self-insurer for certain costs related to employee health and accident benefit
programs. Costs resulting from non-insured losses are estimated and charged to
income when incurred. The Company has purchased insurance which limits its
annual exposure for individual claims to $40 and which limits its aggregate
annual exposure to approximately $460.
The Company's PSM subsidiary has elected to enter into a partially self-funded
arrangement related to worksite employees' health and accident benefit programs.
Under the insurance policy, PSM's self-funded liability is limited to $180 per
employee, with an aggregate liability limit of approximately $11,110. The
liability limits are adjusted monthly, based on the number of participants.
13
The Company's PSM and CSM subsidiaries have elected to enter into a
loss-sensitive workers' compensation insurance program. Under the insurance
policy, PSM and CSM's self funded liability is limited to $200 per employee,
with an aggregate liability limit of approximately $1,100.
NOTE 2 - ACQUISITIONS AND PRO FORMA INFORMATION
During the quarter ended November 30, 2005, the Company had the following
acquisition:
AUDIO VIDEO REVOLUTION, INC.
The Company's TTC subsidiary acquired certain assets and assumed certain
liabilities of Audio Video Revolution, Inc. ("Audio Video") through an asset
purchase agreement entered into as of November 14, 2005 by and among Audio
Video, an Indiana corporation, George Summers, Gilbert Pritt, and TTC. Purchased
assets in the agreement include, at a minimum, goodwill, proprietary property
and products, furniture, equipment, machinery and other intellectual property.
TTC's acquisition of Audio Video enabled TTC to offer a wider range of design,
engineering and installation of structured cabling systems for the residential
and commercial marketplace.
The following is a condensed balance sheet disclosing the amount assigned to
each major asset and liability caption of Audio Video at the acquisition date:
Inventory, net $ 13
Property, Plant and equipment, net 59
Goodwill 190
----
$262
====
Cash consideration $262
----
$262
====
PRO FORMA RESULTS
The following unaudited pro forma data summarize the results of operations for
the periods indicated as if the Audio Video, Ink Source, Magtech, EI Solution,
and CSM acquisitions had been completed as of the beginning of the periods
presented. The pro forma data give effect to actual operating results prior to
the acquisitions and adjustments to interest expense and income taxes. No effect
has been given to cost reductions or operating synergies in this presentation.
These pro forma amounts do not purport to be indicative of the results that
would have actually been achieved if the acquisition had occurred as of the
beginning of the periods presented or that may be achieved in the future.
Three Months Ended
---------------------------
November 30, November 30,
2005 2004
------------ ------------
Net revenue $ 36,443 $ 29,122
Cost of revenues 29,205 23,719
----------- -----------
Gross profit 7,238 5,403
Operating expenses 5,938 4,628
----------- -----------
Operating income 1,301 775
Other income (expense) (432) (242)
----------- -----------
Net income before provision for income taxes 868 533
Provision for income taxes 21 64
----------- -----------
Net income $ 847 $ 469
=========== ===========
Basic income per common share $ 0.08 $ 0.04
=========== ===========
14
Diluted income per common share $ 0.08 $ 0.04
=========== ===========
Basic weighted average number of common shares outstanding 10,559,843 10,559,843
=========== ===========
Diluted weighted average number of common shares outstanding 10,726,256 10,726,256
=========== ===========
NOTE 3 - ACCOUNTS RECEIVABLE AND CONTRACTS RECEIVABLE
Accounts receivable and contracts receivable include the following:
November 30, August 31,
2005 2005
(Unaudited) (Audited)
------------ ----------
Amounts currently due $17,290 $16,178
Contracts in process
Progress billing 5,591 5,075
Retainages 1,855 1,752
------- -------
24,736 23,005
Less allowance for doubtful accounts (1,486) (1,512)
Less allowance for sales returns (135) (135)
------- -------
$23,115 $21,358
======= =======
Accounts receivable - long-term $ 600 $ 600
======= =======
NOTE 4 - INVENTORIES
Inventories reflected on the accompanying consolidated balance sheets are
summarized as follows:
November 30, August 31,
2005 2005
(Unaudited) (Audited)
------------ ----------
Raw materials $ 736 $ 757
Work-in-process 23 39
Finished goods 7,249 7,896
Less inventory reserve (377) (377)
------ ------
$7,631 $8,315
====== ======
NOTE 5 - COSTS AND BILLINGS ON UNCOMPLETED CONTRACTS
Information related to contracts in progress is as follows:
15
November 30, August 31,
2005 2005
(Unaudited) (Audited)
------------ ----------
Costs incurred on uncompleted contracts $ 28,075 $ 25,744
Estimated earnings recognized to date on uncompleted contracts 6,886 5,412
-------- --------
34,961 31,156
Less billings on uncompleted contracts (33,458) (30,576)
-------- --------
$ 1,503 $ 580
======== ========
The net amount is included in the accompanying consolidated balance sheets under
the following captions:
November 30, August 31,
2005 2005
(Unaudited) (Audited)
------------ ----------
Costs and estimated earnings in excess of billings on uncompleted contracts $3,843 $2,681
Billings in excess of costs and estimated earnings on uncompleted contracts 2,340 2,101
------ ------
$1,503 $ 580
====== ======
NOTE 6 - INVESTMENTS IN MARKETABLE EQUITY SECURITIES
The amortized cost and approximate fair values of available-for-sale securities
held are as follows:
November 30, August 31,
2005 2005
(Unaudited) (Audited)
------------ ----------
Amortized cost $2,247 $2,221
Borrowings on investments (800) --
Net unrealized loss (142) (22)
------ ------
Estimated fair value $1,305 $2,199
====== ======
At November 30, 2005, the Company borrowed $800 under terms of the investment
account. The net tax effect of the unrealized gain (loss) after consideration of
the valuation allowance is insignificant and is not included in deferred tax
asset or accumulated other comprehensive income. There were no realized gains or
losses from the sale of available-for-sale securities for the three months ended
November 30, 2005. There was ($29) of realized losses for the three months ended
November 30, 2004.
NOTE 7 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including capital leases, are comprised of the
following:
16
November 30, August 31,
2005 2005
(Unaudited) (Audited)
------------ ----------
Land and building $ 1,951 $ 1,951
Machinery and equipment 5,872 5,615
Research equipment 385 420
Office equipment 4,426 4,131
Vehicles 2,992 3,067
Leasehold improvements 290 145
-------- --------
15,916 15,329
Less accumulated depreciation (10,568) (10,265)
-------- --------
$ 5,348 $ 5,064
======== ========
The provision for depreciation amounted to $326 and $281 for the three month
periods ended November 30, 2005 and 2004, respectively.
NOTE 8 - GOODWILL AND OTHER INTANGIBLE ASSETS
The changes in the carrying amount of goodwill, as recorded under SFAS 142, are
as follows:
BUSINESS MANUFACTURING AND WIRELESS HOLDING SEGMENT
SOLUTIONS DISTRIBUTION INFRASTRUCTURE COMPANY TOTALS
--------- ----------------- -------------- ------- -------
Goodwill at August 31, 2005 $4,287 $5,970 $1,423 $-- $11,680
Goodwill Acquired -- -- 190 -- 190
Goodwill Adjustment 56 -- -- -- 56
Impairment losses -- -- -- -- --
------ ------ ------ --- -------
Goodwill at November 30, 2005 $4,343 $5,970 $1,613 $-- $11,926
====== ====== ====== === =======
The total amount of goodwill that is deductible for tax purposes is $2,029 and
$1,839 at November 30, 2005 and August 31, 2005, respectively.
The following table sets forth the gross carrying amount and accumulated
amortization of the Company's intangible assets:
17
AT NOVEMBER 30, 2005 AT AUGUST 31, 2005
---------------------------------- ----------------------------------
WEIGHTED WEIGHTED
GROSS AVERAGE GROSS AVERAGE
CARRYING ACCUMULATED AMORT CARRYING ACCUMULATED AMORT
AMOUNT AMORTIZATION PERIOD AMOUNT AMORTIZATION PERIOD
-------- ------------ -------- -------- ------------ --------
Customer relationships $3,222 $431 10 YRS $3,222 $352 10 YRS
Non-compete 1,229 284 5 YRS 1,229 222 5 YRS
Non-compete 100 53 3 YRS 100 44 3 YRS
Non-compete 200 23 10 YRS 200 18 10 YRS
------ ---- ------ ------ ---- ------
Intangible assets subject to
amortization 4,751 791 8 YRS 4,751 636 8 YRS
Tradename 590 -- -- 590 -- --
------ ---- ------ ------ ---- ------
Intangible assets not subject to
amortization 590 -- -- 590 -- --
Total $5,341 $791 8 YRS $5,341 $636 8 YRS
====== ==== ====== ====== ==== ======
Intangible asset amortization expense is $155 and $96 for the three month
periods ended November 30, 2005 and 2004, respectively, which includes $4 and $5
of amortization related to loan origination fees, respectively.
Amortization expense on intangible assets currently owned by the Company at
November 30, 2005 for each of the next five fiscal years is as follows:
2006 $ 621
2007 602
2008 575
2009 508
2010 398
2011 and thereafter 1,256
------
Total $3,960
======
NOTE 9 - LINES OF CREDIT AND DEBT ARRANGEMENTS
LINES OF CREDIT
The Company has a $20,000 line of credit facility available through February 28,
2006. Interest on the line is charged at 0.5% less than the credit facility's
Prime Rate as defined therein. Outstanding borrowings amounted to $15,045 and
$18,998 at November 30, 2005 and August 31, 2005, respectively.
Covenants under the line of credit require the Company to maintain a specified
tangible net worth position and certain other financial ratios. The line of
credit is secured by substantially all assets of the Company and personal
guarantees of the Company's majority stockholder and the Company's Chief
Executive Officer. As of November 30, 2005, the Company was not in compliance
with certain covenants; however, the bank has granted a waiver of default
remedies with respect to noncompliance as a result of guarantees executed by
certain stockholders of the Company.
Total unused lines of credit amounted to $4,955 at November 30, 2005 and $384 at
August 31, 2005.
LONG-TERM DEBT ARRANGEMENTS
Long-term debt consisted of the following:
18
Unaudited Audited
November 30, August 31,
Description of Debt Outstanding: 2005 2005
- -------------------------------- ------------ ----------
Notes payable to financial institutions:
Due in monthly installment of $40 plus interest at .5% less than the credit
facility's Prime Rate through maturity date, July 15, 2009. The loan is secured by
the business assets of the Company, with a second lien on assets pledged by a
stockholder. $ 1,800 $ 1,920
Due in monthly installment of $33 plus interest at .5% less than the credit
facility's Prime Rate through maturity date, July 15, 2009. The loan is secured by
the business assets of the Company, with a second lien on assets pledged by a
stockholder. 1,467 1,567
Due in monthly installment of $33 plus interest at .5% less than the credit
facility's Prime Rate through maturity date, April 30, 2009. The loan is secured by
the business assets of the Company, with a second lien on assets pledged by a
stockholder. 1,336 1,466
Due in monthly installment of $55 plus interest at .5% less than the credit
facility's Prime Rate through maturity date, April 30, 2007. The loan is secured by
the business assets of the Company, with a second lien on assets pledged by a
stockholder. 990 1,210
Due in monthly installment of $50 plus interest at .5% less than the credit
facility's Prime Rate through maturity date, April 30, 2007. The loan is secured by
the business assets of the Company, with a second lien on assets pledged by a
stockholder. 800 950
Due in monthly installments of $6, including interest at ranges from 4.9% to 9.03%
through April 2010. The loan is secured by vehicles and equipment. 212 233
Convertible Term Note:
Due in monthly installment of $227 plus interest at the Prime Rate plus 3.0%
(subject to adjustments as described below) through maturity date, November 21,
2008. The loan is guaranteed by two stockholders. 7,500 --
Debt with stockholder:
Due in monthly installments of $3 including interest at 4.00% through September
2008. The loan is secured by vehicles and equipment. 85 94
Capital Leases:
Due in monthly installments of $4 including interest at ranges from 2.3% to 11.6%
through June 2010. The loan is secured by computers and equipment. 120 133
------- -------
Total Debt 14,310 7,573
Less current maturities (2,663) (2,675)
------- -------
Long-term portion of outstanding debt $11,647 $(4,898)
======= =======
19
Principal payments due on long-term debt outstanding (including convertible term
note) at November 30, 2005 are approximately as follows:
2006 $ 2,663
2007 3,281
2008 4,082
2009 4,253
2010 31
-------
$14,310
=======
Cancellation of Line of Credit
As described in Note 10, on November 30, 2005, the Company issued 66,180 shares
of $0.10 par value preferred stock to the majority stockholder of the Company as
consideration for cancellation of certain debt obligations owed by the Company
under a Line of Credit Promissory Note dated May 25, 2005. A total of $6,618 of
debt was retired under the Agreement.
Convertible Term Note
On November 21, 2005 the Company issued a convertible term note (the "Note")
payable to an unrelated party, Laurus Master Fund, Ltd. ("Laurus"), in the
principal amount of $7,500. The Note has a term of three years and is
convertible into the Company's common stock at an exercise price of $5.50 per
share subject to certain adjustments contained in the Note. Principal payments
are payable monthly at $227 beginning March 1, 2006. Interest is payable monthly
in arrears beginning January 1, 2006 at prime plus 3.0% subject to a floor of
9.5%. This interest rate is subject to adjustments as later described and as
fully set forth in the Note. Additionally, the Company issued a warrant to
Laurus (the "Warrant") to purchase up to an aggregate of 272,727 shares of the
Company's common stock and the Company also anticipates issuing a warrant
exercisable for shares of the Company's common stock to CB Capital Partners,
Inc. ("CB Capital"), a financial advisor, the terms of which have yet to be
finalized. The Warrant has a term of five years and an exercise price of $6.60
per share. The Company intends to use the proceeds from the offering of the Note
and the Warrant for general working capital purposes. The Note is guaranteed by
two of the Company's majority stockholders.
Subject to the terms of the Note, the monthly principal and interest payments
are payable in shares of the Company's common stock if certain criteria are met,
as follows:
- - the average closing price of the Company's common stock as reported by
Bloomberg, L.P. for the five trading days immediately preceding the
repayment date is greater than or equal to 109% of the conversion price of
the Note, set in the Note at $5.50 per share (based upon the conversion
price of $5.50, the average closing price required would be $6.00);
- - the total value of the shares converted cannot exceed 25% of the aggregate
dollar trading volume of the Company's common stock for the previous twenty
two trading days;
- - there must be an effective registration statement covering the shares of
the Company's common stock into which the principal and interest under the
Note are convertible or an exemption from registration for resale must be
available pursuant to Rule 144 of the Securities Act; and
- - there must be no event of default existing under the Note that has not been
cured or is otherwise waived in writing by Laurus at Laurus' option.
If the above criteria are not met with respect to a portion or all of the
Company's monthly repayment obligations, then the Company must pay that portion
or all of the monthly principal payment in cash at a rate of 102% of the
respective monthly amortization amounts. The Company shall have the option to
postpone payment of any 12 principal payments due. These deferred principal
amounts shall be due and payable, at the Company's option, on any subsequent
payment date or on the maturity date of the Note.
The Company may prepay the Note at any time by paying 130% of the principal
amount then outstanding, together with accrued but unpaid interest thereon. Upon
an event of default under the Note, Laurus may demand repayment in full at a
rate of 105% of the outstanding principal and interest amount of the Note. If
the Note remains outstanding after an event of default that is not cured, the
interest rate increases an additional 1.0% per month. Events of default include:
20
- a failure to make payments under the Note when due;
- a material breach of the transaction documents by the Company;
- bankruptcy related events;
- a change of control transaction without prior approval; and
- events of default under certain other agreements to which the Company
is a party.
On a month-by-month basis, if the Company registers the shares of common stock
issuable upon conversion of the Note and upon exercise of the Warrant on a
registration statement declared effective by the SEC, the interest rate on the
Note is subject to reduction by 2% for every 25% increase in the market price of
the Company's common stock above the fixed conversion price of the Note, but in
no event shall the interest rate be less than 0%.
Laurus also has the option to convert all or a portion of the Note into shares
of the Company's common stock at any time, at an initial fixed conversion price
of $5.50 per share, subject to limitations and adjustment as described below.
The Note is currently convertible into 1,363,636 shares of the Company's common
stock, excluding the conversion of any accrued interest. The conversion price is
adjustable on a weighted average basis upon certain future issuances of
securities by the Company at a price less than the conversion price then in
effect. There are a number of limitations on Laurus' ability to convert the Note
and exercise the Warrant. These limitations include:
- - Laurus may not convert the Note or exercise the Warrant for a number of
shares that would cause all shares then held by Laurus to exceed 4.99% of
the Company's outstanding shares of common stock unless there has been an
event of default or Laurus provides us with seventy-five days prior notice,
or if the Company receives a Notice of Redemption from Laurus triggered by
the Company's attempt to pre-pay the Note, in which case the number of
shares of common stock beneficially owned by Laurus shall at no time exceed
19.99% of the outstanding shares of common stock.
- - Laurus agreed that it would not acquire in aggregate more than 2,108,764
shares of common stock at a weighted average conversion or exercise price
below $4.95 per share through the conversion of the Note or the Warrant or
through any agreement related thereto unless the Company's stockholders
approved such issuance.
Subject to prior satisfaction of the conversion of amounts due and subject to
certain other restrictions set fourth in the Note, if (i) the average closing
price of common stock as reported by Bloomberg, L.P. for five consecutive
trading days in any calendar month shall be greater than or equal to 200% of the
conversion price, then Laurus shall convert on each such occurrence (limited to
once per calendar month), such principal amount of the Note as does not exceed
25% of the aggregate dollar trading volume of the common stock for the period of
twenty-two trading days immediately preceding such date less any amounts
previously converted.
The Warrant has been recorded at fair value and classified as a liability. Any
discount accretion is considered immaterial based on the Black-Scholes model.
The Company recorded $778 for debt issue costs, including $293 paid to
affiliates of Laurus, $475 to CB Capital, and $10 for legal and professional
fees. The debt issue costs are included in other assets in the accompanying
consolidated balance sheet as of November 30, 2005.
The Company is obligated to file a registration statement registering the resale
of shares of the Company's common stock issuable upon conversion of the Note and
exercise of the Warrant no later than thirty days after the effective date of
the Note and to have such registration statement declared effective by the SEC
no later than one hundred twenty days after the effective date. As of the date
of this filing, the shares underlying the Note and Warrant are expected to be
registered within the agreement's terms as such filing and effective dates have
been mutually extended by the parties. If the registration statement is
suspended other than as permitted in the Registration Rights Agreement, or if
the Company's common stock is not listed for five consecutive trading days
subject to an applicable cure provision, the Company is obligated to pay Laurus
an additional 2% of 1/30th of the outstanding principal balance for each day the
Company is not in compliance with the terms.
NOTE 10 - STOCKHOLDERS' EQUITY
Common Stock
21
During the fiscal year ended August 31, 2005, the Company declared a 1-for-10
stock split to stockholders of record, effective June 2, 2005. The following are
the details of the Company's common stock as of November 30, 2005 and August 31,
2005:
Number of Shares
-----------------------------------------------
Authorized Issued Outstanding Amount
----------- ---------- ----------- ------
November 30, 2005 (Unaudited)
Common stock, $0.10 par value 150,000,000 10,559,843 10,559,843 $1,046
======
August 31, 2005 (Audited)
Common stock, $0.10 par value 150,000,000 10,559,843 10,559,843 $1,046
======
As discussed in Note 9 above, a warrant was issued on November 21, 2005
entitling the holder thereof to purchase, at any time through November 20, 2010,
272,727 shares of the Company's common stock at a price of $6.60 per share. As
of November 30, 2005, this warrant has not been exercised.
Preferred Stock
The following are the details of the Company's non-voting preferred stock as of
November 30, 2005 and August 31, 2005:
Number of Shares
------------------------------------------
Authorized Issued Outstanding Amount
---------- ------ ----------- ------
November 30, 2005 (Unaudited)
Preferred stock, $0.10 par value 1,000,000 66,180 66,180 $6,618
======
August 31, 2005 (Audited)
Preferred stock, $0.10 par value 1,000,000 -- -- $ --
======
On November 30, 2005, the Company issued 66,180 shares of $0.10 par value
non-voting preferred stock to a majority stockholder of the Company as
consideration for cancellation of certain debt obligations owed by the Company
under a Line of Credit Promissory Note dated May 25, 2005. The shares are
subject to restrictions set forth in the "Debt Retirement Agreement." The shares
issued are single class and shall pay an annual cash dividend of $7.50 per
share, paid monthly beginning on January 1, 2006. The shares are not convertible
to common stock.
NOTE 11 - INCOME TAXES
The reconciliation for 2006 and 2005 of income tax expense (benefit) computed at
the U.S. Federal statutory tax rate to the Company's effective income rate is as
follows:
Unaudited Audited
November 30, August 31,
2005 2005
------------ ----------
Tax at U.S. Federal statutory rate 34.0% 34.0%
State and local taxes, net of federal benefit 5.6 5.6
Other -- --
Change in valuation allowance (39.6) (39.6)
----- -----
0.0% --
===== =====
Significant components of the provision for income tax expense (benefit) from
continuing operations are as follows:
22
Unaudited Audited
November 30, August 31,
2005 2005
------------ ----------
Current:
Federal $ 404 $ (41)
State 88 72
----- -----
492 31
----- -----
Deferred:
Federal 11 (567)
State 2 (318)
----- -----
13 (854)
Change in valuation allowance (484) 936
----- -----
Net income tax (benefit) $ 21 $ 82
===== =====
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial statement
purposes and the amounts used for income tax purposes. The significant
components of the Company's deferred tax asset are as follows:
Unaudited Audited
November 30, August 31,
2005 2005
------------ ----------
Deferred Tax Assets:
Current:
Allowances for doubtful accounts and inventory $ 827 $ 850
Accrued liabilities and other 537 524
Noncurrent:
Amortization of covenants 294 304
Depreciation (84) (91)
Net operating losses and other carryforwards 1,987 2,458
------- -------
Valuation allowance 3,561 4,045
(2,547) (3,031)
------- -------
$ 1,014 $ 1,014
======= =======
SFAS 109 requires a valuation allowance to reduce the deferred tax assets
reported if, at November 30, 2005, the Company had federal tax operating loss
based on the weight of the evidence, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. After
consideration of all the evidence, both positive and negative, management has
determined that a $2,547 valuation allowance at November 30, 2005 is necessary
to reduce the deferred tax assets to the amount that will more likely than not
be realized. The change in the valuation allowance for the current period is
$484. At November 30, 2005 the Company has federal net operating loss
carryforwards of $3,358 which expire between 2020 and 2023. The state tax
operating loss carryforwards were $5,917. The difference between federal and
state net operating loss carryforwards represents a change in business venue in
a prior period. The Company's capital loss carryforward is $933, which expires
in the fiscal year ending August 31, 2007. The Company also incurred net
operating losses related to European operations that can be carried forward
indefinitely.
NOTE 12 - PER SHARE DATA
The following presents the computation of basic income per common share and
diluted income per common share:
23
THREE MONTHS ENDED
---------------------------
NOVEMBER 30, NOVEMBER 30,
2005 2004
(UNAUDITED) (UNAUDITED)
------------ ------------
Net Income $ 847 $ 703
=========== ===========
Basic Income Per Common Share $ 0.08 $ 0.07
=========== ===========
Diluted Income Per Common Share: $ 0.08 $ 0.07
=========== ===========
Basic weighted average number of common shares outstanding 10,559,843 10,264,344
=========== ===========
Diluted weighted average number of common shares outstanding 10,726,256 10,304,344
=========== ===========
At November 30, 2005, diluted shares represent 5,000 shares of warrants to a
former employee, 1,363,636 shares of the Laurus convertible term note, and
272,727 shares of the Laurus warrant. At November 30, 2004, diluted shares
represent 50,000 shares of warrants to a former employee.
NOTE 13 - RELATED PARTY TRANSACTIONS
The Company leases a building in Indianapolis, Indiana with a related party. All
of the Company's subsidiaries, excluding JH Drew, Nor-Cote, PSM and CSM are
located in this facility. The lease agreement includes a five-year term through
March 2009 with one option to extend the lease term for a one-year period and
provides for a base rent of $42 per month, which is adjusted annually to fair
market value. In addition, the Company pays certain expenses including taxes,
assessments, maintenance and repairs. The Company recognized rental expense of
$152 and $96 for the three months ended November 30, 2005 and 2004, respectively
for this facility.
The Company's JH Drew subsidiary leases three buildings in Indiana, Tennessee
and Missouri with the same related party. The lease agreement includes a
five-year term through April 2009 with one option to extend the lease term for a
one-year period and provides for base rent of $15 per month, which is adjusted
annually to fair market value. In addition the Company pays certain expenses
including taxes, assessments, maintenance and repairs. The Company recognized
rental expense of $47 and $45 for the three months ended November 30, 2005 and
2004, respectively for these facilities.
The Company's Nor-Cote subsidiary leases a building in Crawfordsville, Indiana
with the same related party. The lease expires in August 2009 with one option to
extend the lease term for a one-year period and provides for base rent of $7 per
month, which is adjusted annually to fair market value. The Company recognized
rental expense of $20 for the three months ended November 30, 2005. As the lease
agreement was not entered into until August 2005, no related party rental
expense was recognized in the three months ended November 30, 2004.
The Company's PSM subsidiary leases an office building in Richmond, Indiana from
a related party. The lease is for a period of five years and expires in May 2008
and provides for base rent of $2 per month with nominal annual increases. The
Company recognized rental expense of $9 and $6 for the three months ended
November 30, 2005 and 2004, respectively for this facility.
The Company makes principal and interest payments to a stockholder for the
purchase of vehicles and equipment. The loans are secured by the assets. The
Company recognized interest expense of $1 and $1 for the three months ended
November 30, 2005 and 2004, respectively for these assets.
Following is a summary of all related party liabilities included in the
consolidated balance sheets at November 30, 2005 and August 31, 2005:
24
November 30, August 31,
2005 2005
(Unaudited) (Audited)
------------ ----------
Long-term line of credit $ -- $(6,618)
Installment notes payable (85) (94)
---- -------
Net liabilities $(85) $(6,712)
==== =======
NOTE 14 - SEGMENT INFORMATION
The operations of the Company are organized into the following segments;
Wireless Infrastructure, Manufacturing and Distribution, Business Solutions, and
holding company. These business segments are consistent with the Company's
management of these businesses and its financial reporting structure.
WIRELESS MANUFACTURING AND BUSINESS HOLDING SEGMENT
INFRASTRUCTURE DISTRIBUTION SOLUTIONS COMPANY TOTALS
-------------- ----------------- --------- ------- -------
THREE MONTHS ENDED NOVEMBER 30, 2005
Net revenues $21,070 $5,635 $9,738 $ -- $36,443
Cost of revenues 17,996 3,978 7,231 -- 29,205
------- ------ ------ ----- -------
Gross profit 3,074 1,657 2,507 -- 7,238
Operating expenses
Selling, general and administrative 1,981 1,401 1,381 694 $ 5,457
Depreciation and amortization 188 107 153 33 481
------- ------ ------ ----- -------
Total operating expense 2,169 1,508 1,534 727 5,938
------- ------ ------ ----- -------
Segment operating income (loss) $ 905 $ 149 $ 973 $(727) $ 1,300
======= ====== ====== ===== =======
WIRELESS MANUFACTURING AND BUSINESS HOLDING SEGMENT
INFRASTRUCTURE DISTRIBUTION SOLUTIONS COMPANY TOTALS
-------------- ----------------- --------- ------- -------
THREE MONTHS ENDED NOVEMBER 30, 2004
Net revenues $14,700 $5,684 $4,664 $ -- $25,048
Cost of revenues 12,404 4,094 3,660 -- 20,158
------- ------ ------ ----- -------
Gross profit 2,296 1,590 1,004 -- 4,890
Operating expenses
Selling, general and administrative 939 1,654 621 339 $ 3,553
Depreciation and amortization 182 137 40 18 377
------- ------ ------ ----- -------
Total operating expense 1,121 1,791 661 357 3,930
------- ------ ------ ----- -------
Segment operating income (loss) $ 1,175 $ (201) $ 343 $(357) $ 960
======= ====== ====== ===== =======
25
WIRELESS MANUFACTURING AND BUSINESS HOLDING SEGMENT
INFRASTRUCTURE DISTRIBUTION SOLUTIONS COMPANY TOTALS
-------------- ----------------- --------- ------- -------
AS OF NOVEMBER 30, 2005
Cash and equivalents $ (550) $ 381 $ 5,060 $ (120) $ 4,771
Restricted savings account -- -- 1,489 -- 1,489
Available for sale investments -- -- 1,305 -- 1,305
Accounts receivable, net 18,917 3,133 1,065 -- 23,115
Costs and estimated earnings in excess
of billing on uncompleted contracts 3,843 -- -- -- 3,843
Inventory, net 3,490 4,130 11 -- 7,631
Deferred tax asset 281 -- 733 -- 1,014
Prepaid expenses and other current asset 557 167 205 108 1,037
Property and equipment, net 2,272 2,258 328 490 5,348
Goodwill 1,612 5,971 4,343 -- 11,926
Other intangible assets, net 180 718 3,652 -- 4,550
Accounts receivable - long term 600 -- -- -- 600
Other long term assets -- 49 27 1,437 1,513
------- ------- ------- ------ -------
Total Segment Assets $31,202 $16,807 $18,218 $1,915 $68,142
======= ======= ======= ====== =======
WIRELESS MANUFACTURING AND BUSINESS HOLDING SEGMENT
INFRASTRUCTURE DISTRIBUTION SOLUTIONS COMPANY TOTALS
-------------- ----------------- --------- ------- -------
AS OF AUGUST 31, 2005
Cash and equivalents $ 414 $ 399 $ 3,103 $(129) $ 3,787
Restricted savings account -- -- 1,484 -- 1,484
Available for sale investments -- -- 2,199 -- 2,199
Accounts receivable, net 16,736 3,315 1,304 3 21,358
Costs and estimated earnings in excess
of billing on uncompleted contracts 2,681 -- -- -- 2,681
Inventory, net 4,180 4,120 15 -- 8,315
Deferred tax asset 451 -- 563 -- 1,014
Prepaid expenses and other current asset 940 198 421 231 1,790
Property and equipment, net 2,077 2,212 306 469 5,064
Goodwill 1,423 5,970 4,287 -- 11,680
Other intangible assets, net 192 740 3,773 -- 4,705
Accounts receivable - long term 600 -- -- -- 600
Other long term assets -- 55 18 336 409
------- ------- ------- ----- -------
Total Segment Assets $29,694 $17,009 $17,473 $ 910 $65,086
======= ======= ======= ===== =======
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS.
This report contains statements that constitute "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended. The words
"expect," "estimate," "anticipate," "predict," "believe" and similar expressions
and variations thereof are intended to identify forward-looking statements.
These statements appear in a number of places in this report and include
statements regarding the intent, belief or current expectations of the Company,
its directors or its officers with respect to, among other things, trends
affecting the Company's financial condition or results of operations. The
readers of this report are cautioned that any such forward-looking statements
are not guarantees of future performance and involve risks and uncertainties
that could cause actual results to differ materially. Factors that might cause
or contribute to such differences, include, but are not limited to, the risks
and uncertainties that are discussed under the heading "Management's Discussion
and Analysis or Plan of Operations." The Company does not ordinarily make
projections of its future operating results and undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise. Readers should carefully review the
risk factors disclosed within Form 10-KSB for the year ended August 31, 2005 and
the other documents filed by the Company with the Securities and Exchange
Commission.
OVERVIEW
Fortune Diversified Industries, Inc. is a holding company headquartered in
Indianapolis, Indiana. The term "Company" as used herein refers to Fortune
Diversified Industries, Inc. and its subsidiaries unless the context otherwise
requires. The Company conducts its business directly and through its
wholly-owned subsidiaries.
The Company's current operating focus is achieved through its following thirteen
subsidiaries (grouped by segment):
- Wireless Infrastructure
James H. Drew Corp. (JH Drew); PDH, Inc. (PDH); Magtech Services, Inc.
(Magtech); Cornerstone Wireless Construction Services, Inc.
(Cornerstone Construction); Innovative Telecommunications Consultants,
Inc. (ITC); Telecom Technology Corp. (TTC); StarQuest Wireless
Services, Inc. (StarQuest); and Fortune Wireless, Inc ("Fortune
Wireless")
- Manufacturing and Distribution
Nor-Cote International, Inc. (Nor-Cote); Kingston Sales Corporation
(Kingston); and Commercial Solutions, Inc. (Commercial Solutions)
- Business Solutions
Professional Staff Management, Inc., Professional Staff Management,
Inc. II and Pro Staff, Inc. (collectively "PSM"); and CSM, Inc. (CSM)
The Wireless Infrastructure segment is composed of businesses that provide
wireless services and products. PDH, Magtech, ITC, and StarQuest generate
revenues from providing wireless services while JH Drew and Cornerstone
Construction generate revenue from providing wireless products. TTC generates
revenues from providing both wireless services and products. Additionally,
Fortune Wireless, Inc. is a direct subsidiary of the holding company and the
owner of the stock of certain entities comprising the Wireless Infrastructure
segment.
Effective September 1, 2005, the Company is no longer eligible as a small
business reporter on Form 10-QSB under Regulation S-B but is subject to the
reporting requirements on Form 10-Q under Regulation S-K.
WIRELESS INFRASTRUCTURE
The Wireless Infrastructure segment is conducted through the Company's JH Drew,
PDH, Magtech, Cornerstone Construction, ITC, TTC, and StarQuest subsidiaries. JH
Drew is a specialty contractor in the field of infrastructure, including fiber
optics, smart highway systems, traffic signals, street signs, high mast and
ornamental lighting, guardrail, wireless communications, and fabrications of
structural steel. JH Drew has been operating over fifty years serving
contractors
27
and state departments of transportation throughout the Midwestern United States.
PDH offers a full range of network infrastructure and real estate development
services to the telecommunications industry and other types of real estate
network critical industries. PDH's full service list of network real estate
development services includes program management, site acquisition, land use
planning, architectural & engineering design, construction management,
co-location facilitation, environmental services, lease capitalization, lease
renegotiation, site marketing and asset management.
Magtech specializes in providing engineering and architectural services for the
telecommunications and the traditional real estate development industries. The
telecommunications industry includes cellular, personal communication services
(PCS), specialized mobile radio (SMR), enhanced specialized mobile radio (ESMR),
microwave systems, fixed wireless, broadband and fiber optics technologies for
carriers, tower consolidators and utilities.
Cornerstone Construction offers construction services to the telecommunications
industry, primarily developing wireless networks for wireless carriers. Services
include program and construction management, electrical, foundation and tower
installations, and antennae and line installations.
ITC provides technical services for wireless equipment manufacturers and
wireless service providers including switch and radio base station engineering
as well as providing the site, survey, delivery, installation and integration
process for the implementation of end user equipment offered by a wide range of
wireless equipment manufacturers.
TTC specializes in the design, engineering and installation of structured
cabling systems for the commercial marketplace and sells telephone and voice
mail systems. TTC provides the data cabinets, racks, cable trays, HUBS, patch
panels, computer furniture, cable management and any peripheral equipment
necessary for a complete voice and data-cabling infrastructure.
StarQuest is a provider of premium communication/ information services,
including digital satellite television and high speed (broadband) Internet, both
wired and wireless. These services are provided exclusively to the United States
multi-dwelling unit (MDU) marketplace.
Fortune Wireless, Inc. is a direct subsidiary of the holding company and the
owner of the stock of certain entities comprising the Wireless Infrastructure
segment.
MANUFACTURING AND DISTRIBUTION
The Manufacturing and Distribution segment is conducted through the Company's
Nor-Cote, Kingston, and Commercial Solutions subsidiaries. Nor-Cote is a
manufacturer of UV curable screen printing inks. Nor-Cote inks are printed on
many types of plastic, metals and other substrates that are compatible with the
UV curing process. Typical applications are plastic sheets, point-of-purchase
(POP) signage, banners, decals, cell phones, bottles and containers, CD and DVD
disks, rotary-screen printed labels, and membrane switch overlays for which
Nor-Cote provides conductive ink. Nor-Cote has operating facilities in the
United States, United Kingdom, and Singapore, with worldwide distributors
located in South Africa, Australia, Canada, China, Colombia, Hong Kong, India,
Indonesia, Italy, Japan, Korea, New Zealand, Poland, Spain, Taiwan, Thailand,
Latin America and the United States.
Kingston and Commercial Solutions are distributors for prominent national
companies in the electronic, sound, security, and video markets. Kingston and
Commercial Solutions offer the latest technology in televisions, sound systems,
electronic locking devices, wire, cable and fiber optics, and intercom systems,
selling to customers in lodging, healthcare, education, transportation and
retail industries.
BUSINESS SOLUTIONS
The Business Solutions segment is conducted through the Company's PSM and CSM
subsidiaries. PSM and CSM, Professional Employer Organizations (PEO's), provide
cost-effective employee administrative solutions to companies in 37 states
nationwide. The PEO's provide services typically managed by internal human
resources and accounting departments - including payroll and tax processing and
management, worker's compensation and risk management, benefits administration,
unemployment administration, human resource compliance services, 401k and
retirement plan administration and employee assessments.
28
HOLDING COMPANY
The Company's revenues vary throughout the year. As is typical with construction
companies, revenues and operating income are usually lowest in the Company's
second fiscal quarter. In general, across the Company's diversified businesses
the negative business risks the Company faces are not unusual or specific to the
Company. Like other companies and industries, the Company faces rising oil and
health care costs. The Company also faces the potential adverse effects of
natural disasters, terrorist attacks, unexpected negative downturns in the
economy and new competition. These factors can have an adverse impact on
revenues and costs throughout all of the Company's business segments. Management
is aware of these risks and works to manage the Company around and through these
risks as a part of its planning and operational execution within the family of
companies.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies, which are in compliance with accounting
principles generally accepted in the United States, require application of
methodologies, estimates and judgments that have a significant impact on the
results reported in the Company's financial statements. Those policies that, in
the belief of management, are critical and require the use of complex judgment
in their application, are disclosed on Form 10-KSB for the year ended August 31,
2005. Since August 31, 2005, there have been no material changes to the
Company's critical accounting policies.
RESULTS OF OPERATIONS: COMPARISON OF THE THREE MONTH PERIODS ENDED NOVEMBER 30,
2005 AND NOVEMBER 30, 2004
EXECUTIVE OVERVIEW OF FINANCIAL RESULTS
Net income was $847, or $.08 per share on revenues of $36,443 for the three
months ended November 30, 2005 compared with net income of $703, or $.07 per
share on revenues of $25,048 for the three months ended November 30, 2004. This
represents a 45% increase in revenues and a 20% percent increase in net income.
Revenue growth was due primarily to the acquisition of CSM on April 5, 2005 and
increased demand in the marketplace for expansion and upgrades of wireless
carrier networks, along with effective marketing of turnkey solutions to these
carriers and subcontractors in the Company's real estate, engineering and
construction companies, resulting in record revenues in the Wireless
Infrastructure segment. The increase in net income was primarily the result of
the acquisition of CSM on April 5, 2005, a decrease in the Company's health
insurance reserves based upon a decrease in claims paid in its Business
Solutions segment, and reductions in selling, general and administrative
expenses in the Company's Manufacturing and Distribution segment. These
increases were partially offset by an increase in costs of goods sold and
administrative expenses increasing at a rate greater than revenues in the
Company's Wireless Infrastructure segment due to increased costs related to
market expansion and training and to unfavorable job closings due to increased
costs in one division. Additionally, interest expense for the quarter increased
105% due primarily to partial bank financing of the CSM acquisition and
additional borrowings on the Company's line of credit with the bank for working
capital needs.
WIRELESS INFRASTRUCTURE
Wireless Infrastructure segment operating results for the three months ended
November 30, 2005 and 2004 are as follows:
29
THREE MONTHS ENDED
---------------------------
NOVEMBER 30, NOVEMBER 30,
2005 2004 $ CHANGE % CHANGE
------------ ------------ -------- --------
THREE MONTHS ENDED NOVEMBER 30, 2005
Net revenues $21,070 $14,700 $6,370 43%
Cost of revenues 17,996 12,404 5,592 45%
------- ------- ------
Gross profit 3,074 2,296 778 34%
Gross profit as % of revenue 15% 16%
Operating expenses
Selling, general and administrative 1,981 939 1,042 111%
Depreciation and amortization 188 182 6 3%
------- ------- ------
Total operating expense 2,169 1,121 1,048 93%
------- ------- ------
Segment operating income $ 905 $ 1,175 $ (270) -23%
======= ======= ======
Revenues
Revenues for the quarter ended November 30, 2005 were $21,070 compared to
$14,700 for the quarter ended November 30, 2004, an increase of $6,370 or 43%.
Results are described by subsidiary as follows. Revenues at JH Drew increased
$2,147 or 18% due primarily to a change in job mix where JH Drew acted as
general contractor, thereby having control over timing of completion and
scheduling of their construction crews. The remaining increase in revenues was
due primarily to increased demand by customers for wireless network expansion
and upgrade services. Our companies which provide this service include PDH,
Cornerstone Construction, ITC and Magtech (which was acquired on November 1,
2004). The companies experienced revenue increases ranging from 125% to 350% as
a result of additional work procured from existing customers and new customer
contracts. Additionally, we believe the revenue increase is due to our ability
to offer turnkey services to wireless carriers therefore creating an advantage
over our competitors.
Gross Profit
Gross profit for the quarter ended November 30, 2005 was $3,074, representing
15% of sales, compared to $2,296 representing 16% of sales for the quarter ended
November 30, 2004, an increase of $778, or 34%. Results are described by
subsidiary as follows. Gross profit dollars at JH Drew remained flat and
decreased as a percentage of revenues due to unfavorable job closings due to
increased costs in one operating division. This resulted in an estimated 3%
decrease in JH Drew's gross profit margins. JH Drew generates lower profit
margins than other subsidiaries within the Wireless Infrastructure segment due
to the nature of its business in the highway construction industry as compared
to certain other subsidiaries in the segment which operate in the service
industry. The increase in gross profit dollars was due primarily to the increase
in revenues in PDH, Cornerstone Construction, ITC and Magtech. Generally, gross
profit margins decreased as a percentage of revenues due primarily to increased
costs associated with hiring of new personnel and employee training.
Additionally, work outsourced to subcontractors increased as a percentage of
revenues due to internal staffing limitations..
Operating Income
Operating income for the quarter ended November 30, 2005 was $905, compared to
$1,175 for the quarter ended November 30, 2004, a decrease of $270, or 23%.
Results are described by subsidiary as follows. Operating income at JH Drew
decreased as a direct result of unfavorable job closings due to increased costs
in one operating division. Generally, operating income decreased in Cornerstone
Construction, ITC and Magtech due to increased selling, general and
administrative expenses as the subsidiaries have increased their expansion
efforts at a rate greater than current quarter revenues. Operating income
increased in PDH as revenue increases for the quarter outpaced their increase in
expenses related to expansion.
MANUFACTURING AND DISTRIBUTION
Manufacturing and Distribution segment operating results for the three months
ended November 30, 2005 and 2004 are as follows:
30
THREE MONTHS ENDED
---------------------------
NOVEMBER 30, NOVEMBER 30,
2005 2004 $ CHANGE % CHANGE
------------ ------------ -------- --------
THREE MONTHS ENDED NOVEMBER 30, 2005
Net revenues $5,635 $5,684 $ (49) -1%
Cost of revenues 3,978 4,094 (116) -3%
------ ------ -----
Gross profit 1,657 1,590 67 4%
Gross profit as % of revenue 29% 28%
Operating expenses
Selling, general and administrative 1,401 1,654 (253) -15%
Depreciation and amortization 107 137 (30) -22%
------ ------ -----
Total operating expense 1,508 1,791 (283) -16%
------ ------ -----
Segment operating income (loss) $ 149 $ (201) $ 350 174%
====== ====== =====
Revenues
Revenues for the quarter ended November 30, 2005 were $5,635 compared to $5,684
for the quarter ended November 30, 2004, a decrease of $49 or 1%. Results are
described by subsidiary as follows. Revenues at Commercial Solutions and
Kingston decreased approximately 6% due primarily to loss of a master
distributor agreement with a manufacturer of commercial television products in
April 2005 which was offset somewhat by increased offerings of various
manufacturers' products. Revenue at Nor-Cote increased 4% due to additional
product offerings with the Ink Source acquisition in September 2004 with POP/
decal inks and as a result of rate increases across various products. The
increase in revenues at Nor-Cote was offset somewhat by lower Nor-Cote U.S.
sales to the loose leaf, tag and label and compact disk markets due to
competition.
Gross Profit
Gross profit for the quarter ended November 30, 2005 was $1,657 representing 29%
of sales, compared to $1,590 representing 28% of sales for the quarter ended
November 30, 2004, an increase of $67, or 4%. Results are described by
subsidiary as follows. Gross profit dollars at Commercial Solutions and Kingston
decreased slightly despite the 6% decrease in revenues due primarily to
management's change in selling standards. Gross profit at Nor-Cote increased
slightly due to increases in selling prices that were offset somewhat by
increases in raw material prices. Gross margins at Commercial Solutions and
Kingston are lower than Nor-Cote due to the nature of the distribution business.
Operating Income
Operating income for the quarter ended November 30, 2005 was $149, compared to
an operating loss of ($201) for the quarter ended November 30, 2004, an increase
of $350, or 174%. Results are described by subsidiary as follows. Operating
income at Commercial Solutions and Kingston increased due to a reduction in
selling, general, and administrative expenses primarily related to reduction in
administrative and sales personnel. Operating income at Nor-Cote increased due
to a reduction in selling, general, and administrative expenses.
BUSINESS SOLUTIONS
Business Solutions segment operating results for the three months ended November
30, 2005 and 2004 are as follows:
31
THREE MONTHS ENDED
---------------------------
NOVEMBER 30, NOVEMBER 30,
2005 2004 $ CHANGE % CHANGE
------------ ------------ -------- --------
THREE MONTHS ENDED NOVEMBER 30, 2005
Net revenues $9,738 $4,664 $5,074 109%
Cost of revenues 7,231 3,660 3,571 98%
------ ------ ------
Gross profit 2,507 1,004 1,503 150%
Gross profit as % of revenue 26% 22%
Operating expenses
Selling, general and administrative 1,381 621 760 122%
Depreciation and amortization 153 40 113 283%
------ ------ ------
Total operating expense 1,534 661 873 132%
------ ------ ------
Segment operating income $ 973 $ 343 $ 630 184%
====== ====== ======
Revenues
Revenues for the quarter ended November 30, 2005 were $9,738, compared to $4,664
for the quarter ended November 30, 2004, an increase of $5,074, or 109%. The
increase in revenues was primarily due to the acquisition of CSM on April 5,
2005, which had revenues of $3,876 for the quarter ended November 30, 2005.
Additionally, revenues at PSM increased 26% due to an increase in customer base.
On a pro-forma basis, revenue increased $1,000 primarily due to an increase in
the customer base of PSM. Though PSM and CSM's primary focus involves fee
revenue associated with the administration of payroll and employee benefits, the
companies continue to expand other services including human resource
outsourcing, employment training and testing. The business variables that PSM
and CSM work to overcome include the volatile insurance industry, government
regulations on employment, and the risk of partially self funded insurance
reserves.
Gross Profit
Gross profit for the quarter ended November 30, 2005 was $2,507, representing
26% of sales, compared to $1,004, representing 22% of sales for the quarter
ended November 30, 2004, an increase of $1,503, or 150%. The increase in gross
profit was due primarily to the acquisition of CSM, which had reported gross
profits of $980 or 25% of revenues for the quarter ended November 30, 2005. The
remaining increase in gross profit at PSM was due to lower claims expense with
its health insurance and workers compensation programs offset somewhat by a
decrease in gross margin as a percentage of revenue due to an increase in SUTA
rates and due to the addition of significantly larger employee groups, which
account for smaller administrative fees per employee. On a pro-forma basis,
gross profit increased $990 primarily due to PSM results described above.
Operating Income
Operating income for the quarter ended November 30, 2005 was $973, compared to
$343 for the quarter ended November 30, 2004, an increase of $630, or 184%. The
increase in operating income was due primarily to the acquisition of CSM, which
had reported operating income of $267. The remaining increase in operating
income was due to the financial performance of PSM described above. On a
pro-forma basis, operating income increased $1,109 primarily due to operating
losses at CSM in the prior year.
HOLDING COMPANY
Operating Expense
The Holding Company does not have any income producing operating assets. As
such, the operating loss was equal to operating expenses. Operating expenses
consist primarily of employee compensation and benefits, legal, accounting and
consulting fees. Operating expenses for the quarter ended November 30, 2005 were
$727, compared to $357 for the quarter ended November 30, 2004, an increase of
$370, or 104%. The increase was due to the Company's hiring of additional
personnel in accounting and information technology departments and as a result
of increased accounting and legal expenses primarily as a result of corporate
growth.
32
Interest Expense
Interest expense was $544 for the quarter ended November 30, 2005, compared to
$266 for the quarter ended November 30, 2004, an increase of $278, or 105%. The
increase was primarily due to partial bank financing of the CSM acquisition in
April 2005 and to additional borrowings under the line of credit for working
capital needs.
As of November 30, 2005, the Company was not in compliance with certain
covenants; however, the bank has granted a waiver of default remedies with
respect to noncompliance as a result of guarantees pledged by certain
stockholders of the Company. Future non-issuance of the waiver could negatively
affect our future performance; however, the Company believes there is no reason
a waiver would not be granted.
Income Taxes
Income taxes for the quarter ended November 30, 2005, resulted in a state income
tax expense of $21. Federal income tax expense was offset through the release of
the Company's valuation allowance to the extent of current period earnings. As
of November 30, 2005, the Company reported no additional release of the
valuation allowance for future periods. Management deems the likelihood of
incurring taxable income for fiscal year ending August 31, 2006, in excess of
the deferred tax benefit of $1,014, to be more likely than not.
Management believes the majority of the Company's remaining net operating loss
carryforwards may be absorbed in fiscal year 2006. As a result of the release of
the valuation allowance to offset 100% of current federal taxes and recognition
of the deferred tax benefit, the Company's effective tax rate is substantially
lower than statutory rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of approximately $7,500 at November 30, 2005
compared with $1,200 at August 31, 2005. The increase in working capital was
primarily due to the elimination of a related party line of credit of $6,618
which was converted to 66,180 shares of preferred stock. Current assets are
composed primarily of cash and equivalents, net accounts receivable, available
for sale investments, inventories, and costs & estimated earnings in excess of
billings on uncompleted contracts.
Operating Activities
Net cash flow provided by (used in) operating activities was ($950) for the
three months ended November 30, 2005 compared to $687 for the three months ended
November 30, 2004. The decrease of 1,637 was primarily due to an increase in
accounts receivable. The Company believes future cash flows provided by
operations will be positive as a result of projected earnings and collections on
receivables. Cash flows provided by operating activities are historically the
highest in our third and fourth quarters due to the seasonality of our
construction business within the wireless infrastructure segment.
The Company's principal sources of liquidity included cash and equivalents and
available for sale investments of $6,076 and $5,986 at November 30, 2005 and
August 31, 2005, respectively. Additional sources of liquidity are cash raised
from the private sale of a convertible term note, issuance of preferred stock,
and other long-term debt financing. At November 30, 2005 the Company had $4,955
available on its line of credit with the bank. Subsequent to November 30, 2005,
the availability under the line of credit was reduced to $17,000.
The various debt agreements contain restrictive covenants which limit, among
other things, certain mergers and acquisitions, redemptions of common stock, and
payment of dividends. In addition, the Company must meet certain financial
ratios (as defined) and is subject to annual capital expenditure limitations.
Investing Activities
Net cash flow used in investing activities was ($917) for the three months ended
November 30, 2005 compared to ($687) for the three months ended November 30,
2004. The increase of $230 was due primarily to an increase in additional
capital expenditures.
Capital expenditures primarily relate to leasehold improvements to various
office facilities, wireless communications purchases, and computer equipment.
The Company expects future requirements for capital expenditures will include
33
expenditures in the ordinary course of business and infrastructure expansion
within the wireless communications division. We expect to fund such capital
expenditures with cash generated from operating activities and borrowings under
our existing line of credit or a new line of credit.
Financing Activities
Net cash flow provided by financing activities was $2,892 for the three months
ended November 30, 2005 compared to $891 for the three months ended November 30,
2004. The increase of $2,001 was the result of borrowings of a convertible term
note to finance in part operating uses of cash, capital expenditures and
acquired businesses.
On November 21, 2005, we issued a convertible term note, ("the Note"), in the
principal amount of $7,500 to Laurus. The Note is convertible into shares of the
Company's common stock at an initial fixed conversion price of $5.50 per share.
The Company also issued to Laurus a warrant, to purchase up to 272,727 shares of
the Company's common stock at an exercise price of $6.50 per share with a term
of five years. If the Note and Warrant were fully converted as of November 30,
2005, earnings per share would have decreased $0.01 per share from $0.08
currently diluted under the weighted average method to $0.07 per share.
The Note has a term of three years and accrues interest at the prime rate plus
3% per year. Interest on the principal amount is payable monthly, in arrears, on
the first business day of each consecutive calendar month thereafter until the
maturity date. Under the terms of the Note, the monthly principal payment is
payable either in cash at 102% of the respective monthly amortization amounts
or, if certain criteria are met, in shares of our common stock. See Note 9 to
the consolidated financial statements for additional discussion of the terms of
the financing with Laurus.
The Company reviews, as opportunities arise, the potential acquisition and/or
operation of other businesses. Any such action will be based upon the Company's
analysis of the specific business and the respective industry, as well as the
Company's ability to utilize a capital structure that is beneficial to the
Company's stockholders.
The Company's short and long term capital requirements will depend upon many
factors, including whether it acquires and/or operates other businesses and the
operating success of its current operating segments. Many of these and other
factors are beyond the Company's control.
Management anticipates continued growth in the Company's Wireless Infrastructure
segment. This growth is expected to create the demand for increasing investment
in working capital. This investment in working capital may require additional
debt or equity financing.
Over the next 12 months, the Company plans to hire additional employees in all
of its segments; however, the hiring of these employees will be approximately
correlated with an increase in operating revenue. The Company expects to fund
current operations and other cash expenditures through the use of available
cash, cash from operations, funds available under its credit facilities and
possible new debt or equity sources. The Company believes that there will be
sufficient funds from current cash, operations and available financing to fund
operations and cash expenditures for the foreseeable future.
Available for sale investments
All marketable securities are included in the Company's balance sheet at current
fair market value. There were no realized gains or losses from the sale of
available-for-sale securities for the three months ended November 30, 2005.
There was ($29) of realized losses for the three months ended November 30, 2004.
There were unrealized losses of $142 and $22 as of November 30, 2005 and 2004,
respectively. There were no other-than-termporary impairment charges recognized.
While the Company is carrying the investments at their amortized costs, the
Company loaned $800 from the available for sale investment account during the
quarter for working capital requirements.
TRANSACTIONS WITH RELATED PARTIES
Transactions with related parties occurred in the normal course of operations
and are measured at the agreed amount, which is the amount of consideration
established and agreed to by the related parties (Refer to Note 13 of the
accompanying consolidated financial statements).
34
The Company maintains various equipment and office leases with related
stockholders of the Company. Related party transactions in the three month
period ended November 30, 2005 and 2004 totaled $229 and $148, respectively. The
increase is due to one additional related party operating lease and due to fair
value rent increases as stated in each respective agreement.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table summarizes our contractual obligations as of November 30,
2005:
Payments Due By
-----------------------------------------------------------
Less than 1 More than 5
Total year 1-2 years 3-5 years years
------- ----------- --------- --------- -----------
Contractual obligation
Long-term debt and capital lease obligations $14,310 $2,663 $ 7,363 $4,284 $ --
Operating lease 4,727 1,205 2,482 702 338
------- ------ ------- ------ ----
Total $19,037 $3,868 $ 9,845 $4,986 $338
======= ====== ======= ====== ====
Operating leases represent the total future minimum lease payments.
OFF BALANCE SHEET ARRANGEMENTS
The Company does not have any material off balance sheet arrangements that have
or are reasonably likely to have a current or future effect on the Company's
financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources that
are material to investors. The Company will continue to evaluate what effect, if
any, the recognition and measurement provisions will have on its consolidated
financial statements and related disclosures in future periods.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain market risks arising from adverse changes in
interest rates, primarily due to the potential effect of such changes on our
variable rate line of credit and convertible term note as described in Note 9 to
the consolidated financial statements. Approximately 98% of the Company's debt
as of November 30, 2005 bears interest at variable rates. Based on amounts
outstanding at November 30, 2005, if the interest rate on the Company's variable
debt were to increase by 1.0%, annual interest expense would be higher by
approximately $289.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the reports we file pursuant
to the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms and that
such information is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosures. The
Company's management, including the Chief Executive Officer and Chief Financial
Officer, does not expect the disclosure controls and procedures or internal
controls can prevent all error and all fraud. The Company's management also
recognizes that, because the design of any system of controls is based in part
upon certain assumptions about the likelihood of future events and also is
subject to other inherent limitations, any controls and procedures, no matter
how well designed and operated, can provide only reasonable, and not absolute,
assurance of achieving the desired objectives.
The Company carries out ongoing procedures under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, to evaluate the
35
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on this evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of the period covered by this report. There have
been no significant changes in the Company's internal controls over financial
reporting or in other factors that are reasonably likely to significantly affect
internal controls over financial reporting.
PART II--OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS.
The Company is not involved in any legal proceedings or claims that management
believes will have a material adverse effect on the Company's business or
financial condition.
ITEM 1A. RISK FACTORS
There have been no material changes with regard to the risk factors previously
disclosed in our most recent Annual Report on form 10-KSB.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION.
None
ITEM 6. EXHIBITS
The following exhibits are included herein:
Exhibits
31.1 Rule 15d-14(a) Certification of CEO
31.2 Rule 15d-14(a) Certification of CFO
32.1 Section 1350 Certification of CEO
32.2 Section 1350 Certification of CFO
36
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Fortune Diversified Industries, Inc.
(Registrant)
Date: January 13, 2006 By: /s/ John F. Fisbeck
------------------------------------
John F. Fisbeck,
Chief Executive Officer
Date: January 13, 2006 By: /s/ Amy Gallo
-----------------------------------
Amy Gallo,
Chief Financial Officer
37