================================================================================ FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended April 30, 2004 Commission File Number 0-26230 WESTERN POWER & EQUIPMENT CORP. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 91-1688446 - ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) I.D. number) 6407-B N.E. 117th Avenue, Vancouver, WA 98662 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone no.: 360-253-2346 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 and 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the close of the period covered by this report. Title of Class Number of shares Common Stock Outstanding (par value $.001 per share) 10,130,000 ================================================================================ WESTERN POWER & EQUIPMENT CORP. INDEX PART I. FINANCIAL INFORMATION Page Number Item 1. Financial Statements Condensed Consolidated Balance Sheets April 30, 2004 (Unaudited) and July 31, 2003............. 2 Condensed Consolidated Statements of Operations Three months ended April 30, 2004 (Unaudited) and April 30, 2003 (Unaudited)........................... 3 Condensed Consolidated Statements of Operations Nine months ended April 30, 2004 (Unaudited) and April 30, 2003 (Unaudited)........................... 4 Condensed Consolidated Statements of Cash Flows Nine months ended April 30, 2004 (Unaudited) and April 30, 2003 (Unaudited)........................... 5 Notes to Condensed Consolidated Financial Statements..... 6-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................11-15 Item 3. Quantitative and Qualitative Disclosures about Market Risk.............................................. 15 Item 4. Controls and Procedures.................................. 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings........................................ 16 Item 2. Changes in Securities.................................... 16 Item 3. Defaults Upon Senior Securities.......................... 16 Item 4. Submission of Matters to a Vote of Security Holders...... 16 Item 5. Other Information........................................ 16 Item 6. Exhibits and Reports on Form 8-K......................... 16 SIGNATURES ................................................................ 17 2 ITEM 1. FINANCIAL STATEMENTS -------------------- WESTERN POWER & EQUIPMENT CORP. CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands) April 30, July 31, 2004 2003 -------- -------- (Unaudited) ASSETS (PLEDGED) ---------------- Current assets: Cash and cash equivalents.......................................... $ 8 $ 8 Restricted Cash.................................................... 1,052 400 Accounts receivable, less allowance for doubtful accounts of $772 and $555, respectively.......................... 7,785 9,779 Inventories........................................................ 30,710 27,494 Prepaid expenses................................................... 151 126 -------- -------- Total current assets.......................................... 39,706 37,807 Fixed assets: Property, plant and equipment (net)................................ 2,694 2,843 Rental equipment fleet (net)....................................... 12,332 13,663 -------- -------- Total fixed assets............................................ 15,026 16,506 Other assets........................................................... 131 153 -------- -------- Total assets........................................................... $ 54,863 $ 54,466 ======== ======== LIABILITIES & STOCKHOLDERS' DEFICIT ----------------------------------- Current liabilities: Borrowings under floor plan financing.............................. $ 16,522 10,959 Short-term borrowings.............................................. 28,949 34,566 Convertible debt................................................... 50 63 Accounts payable and accrued expenses.............................. 8,897 8,214 Accrued payroll and vacation....................................... 580 572 Other accrued liabilities.......................................... 1,077 984 Notes Payable...................................................... 8 -- Capital lease obligation........................................... 29 39 -------- -------- Total current liabilities..................................... 56,112 55,397 Long-term liabilities Notes Payable...................................................... 57 -- Capital lease obligation........................................... 861 880 -------- -------- Total long-term liabilities................................... 918 880 -------- -------- Total liabilities...................................................... 57,030 56,277 -------- -------- Stockholders' deficit: Preferred stock-10,000,000 shares authorized; none issued and outstanding...................................... -- -- Common stock-$.001 par value; 20,000,000 shares authorized; 10,260,300 issued and 10,130,000 outstanding..................... 10 10 Additional paid-in capital......................................... 16,933 16,933 Accumulated deficit................................................ (18,266) (17,910) Less common stock in treasury, at cost (130,300 shares)............ (844) (844) -------- -------- Total stockholders' deficit................................... (2,167) (1,811) -------- -------- Total liabilities and stockholders' deficit............................ $ 54,863 $ 54,466 ======== ======== The accompanying notes are an integral part of these condensed consolidated financial statements. 3 WESTERN POWER & EQUIPMENT CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Dollars in thousands, except per share amounts) Three Months Ended April 30, -------------------------- 2004 2003 -------- -------- Net revenue............................................................ $ 26,426 $ 24,772 Cost of revenues (includes depreciation of $935 and $787 respectively). 24,142 21,988 -------- -------- Gross profit........................................................... 2,284 2,784 Selling, general and administrative expenses........................... 2,271 2,022 -------- -------- Operating income....................................................... 13 762 Other income (expense): Interest expense................................................... (645) (746) Other income....................................................... (58) 106 -------- -------- Income before income tax provision..................................... (690) 122 Income tax provision................................................... 12 12 -------- -------- Net(loss) income....................................................... $ (702) $ 110 ======== ======== Average outstanding common shares for basic and diluted earnings per share................................................... 10,130 4,214 ======== ======== Basic and diluted earnings per common share ........................... $ (0.07) $ 0.03 ======== ======== The accompanying notes are an integral part of these condensed consolidated financial statements. 4 WESTERN POWER & EQUIPMENT CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Dollars in thousands, except per share amounts) Nine Months Ended April 30, -------------------------- 2004 2003 -------- -------- Net revenue............................................................ $ 82,119 $ 73,529 Cost of revenues (includes depreciation of $3,538 and $2,535, respectively)....................................................... 73,453 63,854 -------- -------- Gross profit........................................................... 8,666 9,675 Selling, general and administrative expenses........................... 7,021 6,686 -------- -------- Operating income....................................................... 1,645 2,989 Other income (expense): Interest expense................................................... (2,057) (2,543) Other income....................................................... 92 203 -------- -------- Income before income tax provision..................................... (320) 649 Income tax provision................................................... 36 37 -------- -------- Net (loss) income...................................................... $ (356) $ 612 ======== ======== Average outstanding common shares for basic and diluted earnings per share.................................................. 10,130 4,073 ======== ======== Basic and diluted earnings per common share ........................... $ (0.04) $ 0.15 ======== ======== The accompanying notes are an integral part of these condensed consolidated financial statements. 5 WESTERN POWER & EQUIPMENT CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Dollars in thousands) Nine Months Ended April 30, -------------------------- 2004 2003 -------- -------- Cash flows from operating activities: Net income......................................................... $(356) $ 612 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation....................................................... 3,880 4,638 Bad Debts.......................................................... 301 68 Gain on sale of fixed assets and rental equipment.................. (702) (177) Changes in assets and liabilities: Accounts receivable........................................... 1,693 1,669 Restricted Cash............................................... (651) (233) Inventories................................................... (5,082) (4,277) Prepaid expenses and other assets............................. (3) (96) Accounts payable and accrued expenses......................... 683 (448) Accrued payroll and vacation.................................. 7 (175) Other accrued liabilities..................................... 94 170 Income taxes receivable/payable............................... -- 17 -------- -------- Net cash provided by operating activities.............................. (136) 1,768 -------- -------- Cash flows from investing activities: Purchase of fixed assets........................................... (222) (65) Purchases of rental equipment...................................... (4,376) (1,478) Proceeds on sale of fixed assets................................... 8 5 Proceeds on sale of rental equipment............................... 4,757 4,166 -------- -------- Net cash provided by (used in) investing activities 167 2,628 -------- -------- Cash flows from financing activities: Principal payments on capital leases............................... (29) (30) Borrowings on floor-plan financing................................. 5,563 979 Payments on short-term borrowings.................................. (5,617) (5,229) Long-term debt borrowings.......................................... 65 (116) Payments on convertible debt....................................... (13) -- -------- -------- Net cash used in financing activities.................................. (31) (4,396) -------- -------- Decrease in cash and cash equivalents.................................. -- -- Cash and cash equivalents at beginning of period....................... 8 5 -------- -------- Cash and cash equivalents at end of period............................. $ 8 $ 5 ======== ======== The accompanying notes are an integral part of these condensed consolidated financial statements. 6 WESTERN POWER & EQUIPMENT CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements are unaudited and in the opinion of management contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the condensed consolidated balance sheet and the condensed consolidated results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States applicable to interim periods. The results of operations for the quarterly periods ended April 30, 2004 are not necessarily indicative of results that may be expected for any other interim periods or for the full year. This report should be read in conjunction with the Company's consolidated financial statements included in the Annual Report on Form 10-K for the fiscal year ended July 31, 2003 filed with the Securities and Exchange Commission. The accounting policies used in preparing these unaudited condensed consolidated financial statements are consistent with those described in the July 31, 2003 consolidated financial statements. The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has recurring losses and is currently in default on its short-term borrowing facility as discussed in Note 6 of these condensed consolidated financial statements, both of which create substantial doubt about the Company's ability to continue as a going concern. The accompanying unaudited condensed consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. 2. ACCOUNTING POLICIES The accounting policies followed by the Company are set forth in Note 1 to the Company's condensed consolidated financial statements as filed in its Form 10-K for the year ended July 31, 2003. Inventories are stated at the lower or market. During the first quarter of fiscal year 2004 the company adopted Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 addresses certain financial instruments that, under previous guidance, could be accounted for as equity, but now must be classified as liabilities in statements of financial position. These financial instruments include: (1) mandatorily redeemable financial instruments. (2) obligations to repurchase the issuer's equity shares by transferring assets, and (3) obligations to issue a variable number of shares. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. There was no effect on the condensed consolidated financial statements from the adoption of this pronouncement. During the third quarter of fiscal year 2004 the company adopted Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the entity investors in the equity do not have the characteristics of a controlling financial interest or do not have a sufficient equity risk for the entity to finance its activities without additional financial support from 7 other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period ending after March 15, 2004. There was no effect on the condensed consolidated financial statements from the adoption of this pronouncement. 3. EARNINGS OR LOSS PER SHARE Basic net income or loss per share of common stock is computed based on the weighted average number of common shares outstanding during the period. Diluted net income or loss per share of common stock is computed based on the weighted average number of common shares outstanding during the period plus any dilutive securities outstanding (stock options). There were no dilutive securities for the three and nine-month period ended April 30, 2004 and 2003. Total outstanding options as April 30, 2004 totaled 1,600,000. 4. STOCK BASED COMPENSATION During the year ended July 31, 2003, the Company adopted SFAS No. 148, "Accounting for Stock-based Compensation-Transition and Disclosure." This statement amended Statement No. 123, "Accounting for Stock-based Compensation." As permitted under Statement No. 123, the Company continues to apply the Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." As required under Statement No. 148, the following table presents pro- forma net loss and basic and diluted loss per share as if the fair value-based method had been applied to all awards. (in thousands) Three Months Ended Nine Months Ended ---------------------- ---------------------- Periods Ended April 30, 2004 2004 2003 2004 2003 - ---------------------------- -------- -------- -------- -------- Net Income (Loss) $ (702) 110 (356) $ 612 Stock-based employee compensation cost, net of tax effect, under fair value accounting -- -- (83) -- -------------------------------------------------- Pro-forma net income (loss) under Fair Value Method $ (702) 110 (439) $ 612 ================================================== Income (Loss) per share Basic and Diluted $ (.07) .03 (.04) $ .15 Per share stock-based employee compensation cost, net of tax effect, under fair value accounting $ -- -- (.01) $ -- -------------------------------------------------- Pro-forma income (loss) share basic & diluted $ (.07) .03 (.05) $ .15 ================================================== The fair value of each option grant was estimated at the date of grant using the Black-Scholes option valuation model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. During the nine months ended April 30, 2004, the Company granted 440,000 stock options to employees and directors. The exercise price of the stock options was $.35 and vest immediately. The options may be exercised over a period of ten years. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in 8 management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value estimate of its stock options. The total number of stock options outstanding as of April 30, 2004 was 1,600,000. In calculating the fair values of the stock options, the following assumptions were used: Fiscal year Fiscal year 2004 grants 2003 grants ----------- ----------- Dividend yield -- -- Weighted average expected life: 5 years -- Weighted average risk-free interest rate 2.99% -- Expected volatility 60.5% -- 5. INVENTORIES Inventories and consist of the following: April 30, July 31, 2004 2003 ----------- ----------- Equipment (net of reserve allowances of $4,573 and $4,493, respectively): New $ 21,174 $ 15,460 Used 4,326 5,370 Parts (net of reserve allowance of $557 and $378, respectively) 5,210 6,664 ----------- ----------- $ 30,710 $ 27,494 =========== =========== 6. FIXED ASSETS Fixed assets consist of the following: April 30, July 31, 2004 2003 ----------- ----------- Operating property, plant and equipment: Land $ 522 $ 522 Buildings 1,749 1,749 Machinery and equipment 3,135 3,092 Office furniture and fixtures 2,213 2,213 Computer hardware and software 1,533 1,525 Vehicles 1,307 1,226 Leasehold improvements 985 967 ----------- ----------- 11,444 11,294 Less: accumulated depreciation (8,750) (8,451) ----------- ----------- Property, plant, and equipment (net) $ 2,694 $ 2,843 =========== =========== Rental equipment fleet $ 19,456 $ 21,046 Less: accumulated depreciation (7,124) (7,383) ----------- ----------- Rental equipment (net) $ 12,332 $ 13,663 =========== =========== Depreciation and amortization on the property, plant, and equipment are computed using the straight-line method over the estimated useful lives of the assets, ranging from 5 to 20 years. Depreciation on the rental fleet is calculated using the straight-line method over the estimated useful lives, ranging from 3 to 7 years after considering salvage values. 7. SHORT-TERM BORROWINGS The Company has inventory floor plan financing arrangements with Case Credit Corporation, an affiliate of Case, for Case inventory and with other finance 9 companies affiliated with other equipment manufacturers. The terms of these agreements generally include a one-month to twelve-month interest free term followed by a term during which interest is charged. Principal payments are generally due at the earlier of sale of the equipment or twelve to forty-eight months from the invoice date. The Company has an inventory floor plan and operating line of credit through GE Commercial Distribution Finance ("GE"), fka Deutsche Financial Services. The credit facility matured December 31, 2001 and had provided terms with a floating interest rate based on prime with rates between 0.75% under prime to 2.25% over prime depending on the amount of total debt leverage of the Company. Amounts may be advanced to the Company based on its assets, including accounts receivable, parts inventory, new and used equipment inventory, rental fleet, real property, and vehicles. Interest payments on the outstanding balance are due monthly. As of June 21, 2002, the Company entered into a Forbearance Agreement with GE under the terms of which GE raised the interest rate to prime plus 4% while the Company was in technical default and required the Company to pay a $45 fee to GE for the forbearance. In addition, under the terms of the Forbearance Agreement, the Company is required to meet certain financial covenants and meet certain debt reduction schedules. At April 30, 2004, the Company continued to be in technical default of the GE Loan Agreement. The Company has requested but did not receive a waiver from GE. Although GE has not called the debt due to such defaults, there is no guarantee that GE will not require the Company to repay the debt at any time. All floor plan debt is classified as current since the inventory to which it relates is generally sold within twelve months of the invoice date. 8. PRODUCT INFORMATION For the purpose of providing segment information, management believes that all of the Company's operations consist of one segment. However, the Company evaluates performance based on revenue and gross margin of three distinct business categories. Revenue and gross margin by product categories are summarized as follows: Business product category Three Months Ended Nine Months Ended Net Revenues April 30, April 30, -------------------- -------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Equipment Sales $ 17,591 $ 17,684 $ 57,175 $ 50,379 Equipment Rental 1,634 1,032 4,103 4,081 Product Support 7,201 6,056 20,841 19,069 -------- -------- -------- -------- Total $ 26,426 $ 24,772 $ 82,119 $ 73,529 ======== ======== ======== ======== Business product category Three Months Ended Nine Months Ended Gross Margins April 30, April 30, -------------------- -------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Equipment Sales $ 914 $ 1,821 $ 4,469 $ 5,797 Equipment Rental 92 (50) 544 537 Product Support 1,278 1,013 3,653 3,341 -------- -------- -------- -------- Total $ 2,284 $ 2,784 $ 8,666 $ 9,675 ======== ======== ======== ======== 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND LIQUIDITY AND CAPITAL RESOURCES The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-Q. Information included herein relating to projected growth and future results and events constitutes forward-looking statements. Actual results in future periods may differ materially from the forward-looking statements due to a number of risks and uncertainties, including but not limited to fluctuations in the construction, agricultural, and industrial sectors; the success of the Company's restructuring and cost reduction plans; the success of the Company's equipment rental business; rental industry conditions and competitors; competitive pricing; the Company's relationship with its suppliers; relations with the Company's employees; the Company's ability to manage its operating costs; the continued availability of financing; the Company's ability to refinance/restructure its existing debt; governmental regulations and environmental matters; risks associated with regional, national, and world economies; and consummation of the merger and asset purchase transactions. Any forward-looking statements should be considered in light of these factors. Results of Operations - --------------------- The Three Months and Nine months ended April 30, 2004 compared to the Three - --------------------------------------------------------------------------- Months and Nine months ended April 30, 2003. - -------------------------------------------- Revenues for the three-month period ended April 30, 2004 increased 6.7% to $26.4 million compared with $ 24.8 million for the three-month period ended April 30, 2003. For the three-month period ended April 30, 2004 equipment sales decreased by .5%, equipment rental revenues increased by 58.3% and product support revenues increased by 18.9% over the comparative three month period ended April 30, 2003. Revenues for the nine-month period ended April 30, 2004 increased 11.7% to $82.1 million compared with $ 73.5 million for the nine-month period ended April 30, 2003. For the nine-month period ended April 30, 2004 equipment sales were up by 13.5%, rental revenues increased by .5% and product support revenues increased by 9.3% over the nine-month period ended April 30, 2003. Revenues were up from the prior year's comparative periods as a result of improved economic conditions, especially in the Pacific Northwest. The Company's gross profit margin of 8.6% for the three-month period ended April 30, 2004 was lower than the prior year's comparative period margin of 11.2%. Gross margin for equipment sales was 5.2% compared to 10.3% for the prior year's comparative period. Equipment rental gross margin was 5.6% compared to (4.8)% for the prior year's comparative period. Product support gross margin was 17.7% compare to 16.7% for the prior year's comparative period. The Company's total gross profit margin of 10.6% for the nine-month period ended April 30, 2004 was lower than the prior year's comparative period margin of 13.2%. Equipment sales gross margin was 7.8% compared to 11.5% for the prior year's comparative nine month period. Equipment rental gross margin was 13.3% compared to 13.2% for the prior year's comparative nine month period. Product support gross margin was 17.5% compared to 17.5% for the prior year's comparative nine-month period. The decrease in margins is associated with sales of aged equipment with higher net book value after markdowns than that of the prior year and a change in the sales and rental mix of products. There were several large sales to certain customers that also required lower margins in the bidding process. For the three-month period ended April 30, 2004, selling, general, and administrative ("SG&A") expenses as a percentage of sales were 8.6%, slightly higher than the 8.2% for the prior year's third quarter. For the nine-month period ended April 30, 2004, selling, general, and administrative ("SG&A") expenses as a percentage of sales were 8.5%, down from 9.1% for the prior 11 year's nine month period. The decreases from the prior year's comparative periods reflect the Company's continued efforts to reduce operating expenses and increase revenue levels. Interest expense for the three months ended April 30, 2004 of $645,000 was down from $746,000 in the prior year comparative period. Interest expense for the nine months ended April 30, 2004 of $2,057,000 was down from $2,543,000 in the prior year comparative period. These decreases form the prior year's comparative periods are the result of reduced overall inventory levels as well as lower average interest rates and a lower balance on the GE facility. The Company had a net loss for the quarter ended April 30, 2004 of $ 702,000 or $(0.07)per share (basic and diluted) compared with a net income of $110,000 or $0.03 per share (basic and diluted) for the prior year's comparative quarter. The Company had a net loss for the nine months ended April 30, 2004 of $356,000 or $(0.04)per share (basic and diluted) compared with a net income of $612,000 or $0.15 per share (basic and diluted) for the prior year's comparative period. Liquidity and Capital Resources - ------------------------------- The Company's primary needs for liquidity and capital resources are related to its acquisition of inventory for sale and its rental fleet. The Company's primary source of internal liquidity has been from its operations. As more fully described below, the Company's primary sources of external liquidity are equipment inventory floor plan financing arrangements provided to the Company by the manufacturers of the products the Company sells as well as the credit facility with GE more fully described below. Under inventory floor planning arrangements the manufacturers of products sold by the Company provide interest free credit terms on new equipment purchases for periods ranging from one to twelve months, after which interest commences to accrue monthly at rates ranging from zero percent to two percent over the prime rate of interest. Principal payments are typically made under these agreements at scheduled intervals and/or as the equipment is rented, with the balance due at the earlier of a specified date or upon sale of the equipment. At April 30, 2004, the Company was indebted under manufacturer provided floor planning arrangements in the aggregate amount of $ 16,522,000. The Company has an inventory floor plan and operating line of credit with GE which expired on December 31, 2001. The line of credit agreement has not been renewed and the Company is operating under the agreement on a month to month basis. Amounts are advanced against the Company's assets, including accounts receivable, parts, new equipment, rental fleet, and used equipment. The agreement provided for a floating interest rate based on prime with rates between 0.75% under prime to 2.25% over prime depending on the amount of total debt leverage of the Company. The Company uses this borrowing facility to lower flooring related interest expense by using advances under such line to finance inventory purchases in lieu of financing provided by suppliers, to take advantage of cash purchase discounts from its suppliers, to provide operating capital for further growth. Borrowings are collateralized by the Company's assets, including accounts receivable, parts inventory, new and used equipment inventory and rental equipment. As of April 30, 2004, approximately $28,949,000 was outstanding under the GE credit facility. On June 21, 2002, the Company entered into a Forbearance Agreement with GE under the terms of which GE raised the interest rate to prime plus 4% while the Company is in default and required the Company to pay a $45,000 fee to GE for the forbearance. In addition, under the terms of the Forbearance Agreement, the Company is required to meet certain financial covenants and meet certain debt reduction schedules. At April 30, 2004, the Company was in technical default of the GE Loan Agreement. The Company has requested, but has not obtained a waiver. Although GE has not called the debt due to such 12 defaults, there is no guarantee that GE will not require the Company to repay the debt at any time in full. During the nine months ended April 30, 2004 the Company had positive cash flow from operating activities during the year of $5,187,000. The Company's cash flow from operating activities consisted primarily of a reduction of accounts receivable of $1,693,000, depreciation of $3,880,000, gain on sales of fixed assets and rental equipment of $702,000 and a decrease in inventories of $5,082,000. Purchases of fixed assets during the period were related mainly to the ongoing replacement of aged operating assets and rental sold during the period. The Company paid down its short-term financing by $5,617,000 during the nine month period ending April 30,2004. The Company's cash and cash equivalents was approximately $8,000 as of April 30, 2004. The Company's current level and anticipated available cash flow will not be sufficient to support the Company's operations during the next twelve months. The Company must have continued availability of borrowing from its current lender GE or it cannot fund current levels of operations. Under the existing credit facility with GE, GE is entitled to all cash collections from the Company's accounts receivable, which are applied as they are received by GE against the total amount due GE from the Company under the credit facility. Since the Company has essentially no cash flow other than from accounts receivable (which are remitted to GE), the Company cannot fund operations without continued borrowing from GE. If GE decided to stop making borrowing available to the Company, the Company would immediately be unable to continue its operations. The Company currently has no alternative sources of liquidity/borrowing available to it to meet its operating obligations. Although the Company and GE are in negotiations to extend or renew the credit facility, there can be no assurance that the Company will be able to successfully negotiate an acceptable extension or renewal of the expired GE credit facility or that GE will continue to make borrowing available to the Company. The Company continues to investigate alternative sources of financing and/or capital infusion in an effort to meet its operational needs. However, if GE decided to stop lending to the Company, the Company would have to discontinue its operations immediately. Off-Balance Sheet Arrangements - ------------------------------ The Company's off balance sheet arrangements are principally lease arrangements associated with the retail stores and the corporate office. General Economic Conditions - --------------------------- Controlling inventory is a key ingredient to the success of an equipment distributor because the equipment is characterized by long order cycles, high ticket prices, and the related exposure to "flooring" interest. The Company's interest expense may increase if inventory is too high or interest rates rise. The Company manages its inventory through Company-wide information and inventory sharing systems wherein all locations have access to the Company's entire inventory. In addition, the Company closely monitors inventory turnover by product categories and places equipment orders based upon targeted turn ratios. All of the products and services provided by the Company are either capital equipment or included in capital equipment, which are used in the construction, industrial, and agricultural sectors. Accordingly, the Company's sales are affected by inflation or increased interest rates which tend to hold down new construction, and consequently adversely affect demand for the equipment sold and rented by the Company. In addition, although agricultural equipment sales are less than 2% of the Company's total revenues, factors adversely affecting the farming and commodity markets also can adversely affect the Company's agricultural equipment related business. 13 The Company's business can also be affected by general economic conditions in its geographic markets as well as general national and global economic conditions that affect the construction, industrial, and agricultural sectors. A further erosion in North American and/or other countries' economies could adversely affect the Company's business. Although the principal products sold, rented, and serviced by the Company are manufactured by Case, the Company also sells, rents, and services equipment and sells related parts (e.g., tires, trailers, and compaction equipment) manufactured by others. Approximately 50% of the Company's net sales for the nine months ended April 30, 2004 resulted from sales, rental, and servicing of products manufactured by companies other than Case. That compares with a figure of 50% for the fiscal year ended July 31, 2003. Manufacturers other than Case represented by the Company offer various levels of supplies and marketing support along with purchase terms which vary from cash upon delivery to interest-free, 12-month flooring. The Company purchases its equipment and parts inventory from Case and other manufacturers. No supplier other than Case accounted for more than 10% of such inventory purchases during the nine months ended April 30, 2004. While maintaining its commitment to Case to primarily purchase Case Equipment and parts as an authorized Case dealer, the Company plans to expand the number of products and increase the aggregate dollar value of those products which the Company purchases from manufacturers other than Case in the future. The generally soft economic conditions in the equipment market, particularly in the northwest, have contributed to a decline in equipment sales in prior years. A further softening in the industry could severely affect the Company's sales and profitability. Market specific factors could also adversely affect one or more of the Company's target markets and/or products. The Company expects the construction equipment market in its store locations to remain flat or slightly down over the next 6 to 12 months. Recent Accounting Pronouncements - -------------------------------- The following pronouncements have been issued by the Financial Accounting Standards Board ("FASB"). In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the entity investors in the equity do not have the characteristics of a controlling financial interest or do not have a sufficient equity risk for the entity to finance its activities without additional financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period ending after March 15, 2004. There was no effect on the condensed consolidated financial statements from the adoption of this pronouncement. Item 3. Quantitative And Qualitative Disclosures About Market Risk The Company is exposed to market risk from changes in interest rates. Market risk is the potential loss arising from adverse changes in market rates and prices such as interest rates. For fixed rate debt, interest rate changes affect the fair value of financial instruments but do not impact earnings or cash flows. Conversely for floating rate debt, interest rate changes generally do not affect the fair market value but do impact future earnings and cash flows, assuming other factors are held constant. At April 30, 2004, the 14 Company had variable rate floor plan payables, notes payable, and short-term debt of approximately $39.7 million. Holding other variables constant, the pre-tax earnings and cash flow impact for the next year resulting from a one percentage point increase in interest rates would be approximately $0.4 million. The Company's policy is not to enter into derivatives or other financial instruments for trading or speculative purposes. Item 4. Controls and Procedures Based on their evaluation as of the date of the end of the period covered by this Form 10-Q, our management, with the participation of our Chief Executive Office and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as required by Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms. Changes in Internal Controls - ---------------------------- There were no significant changes in our internal controls over financial reporting that occurred during the nine months ended April 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on the Effectiveness of Controls - -------------------------------------------- We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. 15 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ----------------- The Company is involved in various legal proceedings which are incidental to the industry and for which certain matters are covered in whole or in part by insurance or, otherwise, the Company has recorded accruals for estimated settlements. Management believes that any liability which may result from these proceedings will not have a material adverse effect on the Company's business, results of operations, and financial condition. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ----------------------------------------- None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES ------------------------------- As of April 30, 2004, the Company was in technical default of the financial covenants in the GE Forbearance Agreement. The Company has not received a waiver of such defaults from GE and although GE has not called the loan, there is no guarantee that it will not do so in the future. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- None. ITEM 5. OTHER INFORMATION ----------------- None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- (a) Exhibits Exhibit 31 Rule 13a-14(a)/15d-14(a) Certification Exhibit 32.1 Certification by the Chief Executive Officer Relating to a Periodic Repost Containing Financial Statements. * Exhibit 32.2 Certification by the Chief Financial Officer Relating to a Periodic Report Containing Financial Statements. * (b) Reports on Form 8-K None. * The Exhibit attached to this Form 10-Q shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 (the "Exchange Act") or otherwise subject to liability under that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as expressly set forth by specific reference in such filing. 16 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WESTERN POWER & EQUIPMENT CORP. June 14, 2004 By: /s/Mark J. Wright ----------------------------- Mark J. Wright Vice President of Finance and Chief Financial Officer 17