UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For quarterly period ended July 31, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number: 000-28307
NESCO INDUSTRIES, INC.
----------------------
(Exact name of Small Business Issuer as specified in its charter)
Nevada 13-3709558
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification Number)
305 Madison Avenue, Suite 4510
New York, New York 10165
------------------------
(Address of principal executive offices)
(212) 986-0886
--------------
(Issuer's telephone number including area code)
Check whether the Issuer (1) filed all reports required to be filed by section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months and (2) has been subject to such filing requirements for the past 90
days.
Yes |X| No |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12B-2 of the Exchange Act).
Yes |_| NO |X|
State the number of shares outstanding of each of the Issuer's classes of common
equity as of the latest practicable date:
Class Outstanding at August 15, 2006
------------ ------------------------------
Common Stock 20,136,225
Transitional Small Business Disclosure Format: Yes |_| No |X|
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
----
Part I - Financial Information
Item 1. Interim Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheet........................ 1
Condensed Consolidated Statements of Operations............. 2
Condensed Consolidated Statements of Cash Flows............. 3
Condensed Consolidated Statement of Stockholders' Deficit... 4
Notes to Unaudited Condensed Consolidated Financial
Statements................................................ 5 - 13
Item 2. Management's Discussion and Analysis or Plan of
Operations................................................ 14 - 17
Item 3. Controls and Procedures..................................... 18
Part II. - Other Information............................................ 19
Signatures.............................................................. 20
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
July 31,
2006
----
(unaudited)
-----------
ASSETS
Current assets
Cash $ 21,000
Accounts receivable 142,000
Inventories 202,000
Prepaid expenses and other current assets 15,000
-----------
Total current assets 380,000
Property and equipment, net of accumulated depreciation
and amortization of approximately $1,876,000 1,036,000
Other assets - deposits and other 49,000
-----------
$ 1,465,000
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Current portion of note payable to Dicon $ 83,000
Secured accounts receivable and purchase order financing,
including $167,000 payable to a related party 173,000
Subsidiary senior secured notes payable and interest, including
$168,000 payable to related parties 833,000
Convertible debentures, including interest and penalties, in default
($3,223,000 is secured by the assets of the Company and another
$2,622,000 is payable to related parties and current or former officers) 6,689,000
Note and interest payable, in default 720,000
Customer deposits 875,000
Accounts payable and accrued expenses 1,112,000
Stock to be issued 190,000
Due to related party and affiliates 545,000
-----------
Total current liabilities 11,220,000
-----------
Non-current liabilities
Note payable to Dicon 250,000
Deferred sublease income 59,000
-----------
Total non-current liabilities 309,000
-----------
Commitments and contingencies
Stockholders' deficit
Series A convertible preferred stock, $.001 par value, authorized
850,000 shares, 67,000 issued and outstanding --
Series B convertible preferred stock, $.001 par value, authorized
150,000 shares, 117,055 issued and outstanding --
Common stock, $.001 par value, authorized 25,000,000 shares,
20,136,225 issued and outstanding 20,000
Additional paid-in-capital 14,396,000
Accumulated deficit (24,480,000)
-----------
Total stockholders' deficit (10,064,000)
-----------
$ 1,465,000
===========
See notes to unaudited condensed consolidated financial statements.
1
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended July 31,
---------------------------
2006 2005
---- ----
(unaudited) (unaudited)
Revenues $ 391,000 $ 386,000
Cost of revenues 617,000 246,000
-----------------------------
Gross profit (loss) (226,000) 140,000
-----------------------------
Operating expenses -
General and administrative 274,000 278,000
Stock compensation charge 7,000 35,000
-----------------------------
Total operating costs 281,000 313,000
-----------------------------
Loss from operations (507,000) (173,000)
-----------------------------
Other income (expenses)
Sublease income 12,000 12,000
Amortization of debt discount -- (702,000)
Interest and other expense (94,000) (78,000)
Interest expense, related parties (47,000) (43,000)
Amortization of financing costs -- (126,000)
Penalties under registration rights agreement (163,000) (92,000)
-----------------------------
(292,000) (1,029,000)
-----------------------------
Net loss $ (799,000) $ (1,202,000)
-----------------------------
Weighted average common shares
Basic and diluted 19,485,000 17,467,000
-----------------------------
Net loss per common share
Basic and diluted $ (0.04) $ (0.07)
-----------------------------
See notes to unaudited condensed consolidated financial statements.
2
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months Ended July 31,
---------------------------
2006 2005
---- ----
(unaudited) (unaudited)
Cash flows from operating activities
Net loss $ (799,000) $(1,202,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Stock and warrants issued for services 7,000 35,000
Depreciation and amortization 56,000 42,000
Amortization of debt discount -- 702,000
Amortization of financing costs -- 126,000
Changes in operating assets and liabilities:
Accounts receivable (57,000) (100,000)
Inventories (102,000) (10,000)
Prepaid expenses and other current assets 4,000 28,000
Accrued penalties and interest (included in Convertible debentures) 163,000 --
Customer deposits 35,000 --
Accounts payable, accrued expenses and other 224,000 177,000
Interest payable 191,000 113,000
Due to affiliates 39,000 68,000
Deferred sublease income (12,000) (12,000)
---------------------------
Net cash used in operating activities (251,000) (33,000)
---------------------------
Cash flows from investing activities
Purchase of equipment (130,000) --
---------------------------
Net cash used in investing activities (130,000) --
---------------------------
Cash flows from financing activities
Proceeds from issuance of subsidiary senior secured notes 325,000 --
Proceeds from accounts receivable financing 194,000 --
Payments of accounts receivable financing (144,000) --
Payments from affiliate -- 30,000
---------------------------
Net cash provided by financing activities 375,000 30,000
---------------------------
Net decrease in cash (6,000) (3,000)
Cash
Beginning of period 27,000 22,000
---------------------------
End of period $ 21,000 $ 19,000
---------------------------
Supplemental disclosure of cash flow information,
Cash paid during the period for interest $ -- $ 1,000
---------------------------
Supplemental disclosure of non-cash investing and financing
activities:
Note payable to Dicon for purchase of equipment $ 330,000 $ --
---------------------------
Reclassify expired stock repurchase obligation to equity $ 330,000 $ --
---------------------------
Stock issued for interest payment on convertible debentures $ -- $ 93,000
---------------------------
See notes to unaudited condensed consolidated financial statements.
3
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
Three months ended July 31, 2006
Nesco
Series A Series B
Convertible Convertible
Preferred Stock Preferred Stock Common Stock Additional
------------------- ------------------ ------------------------ Paid-in Accumulated
Shares Amount Shares Amount Shares Amount Capital Deficit
-------- ------- ------- ------- ---------- ---------- ------------ ------------
Balances, May 1, 2006 67,000 -- 117,055 -- 17,736,225 18,000 14,061,000 (23,681,000)
Expiration of share
repurchase obligation 2,400,000 2,000 328,000 0
Stock compensation
charge -- -- -- 7,000 0
Net loss (799,000)
----------------------------------------------------------------------------------------------------
Balances, July 31, 2006,
unaudited 67,000 $ -- 117,055 $ -- 20,136,225 $ 20,000 $ 14,396,000 $(24,480,000)
====================================================================================================
See notes to unaudited condensed consolidated financial statements.
4
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The accompanying interim condensed consolidated financial statements and the
accompanying notes included herein have been prepared by the Company without
audit, in accordance with the instructions for Form 10-QSB pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC") and therefore
do not include all information and notes normally provided in the annual
consolidated financial statements. These interim condensed consolidated
financial statements should, therefore, be read in conjunction with the audited
consolidated financial statements and the notes thereto of the Company for the
year ended April 30, 2006. These statements reflect all adjustments which are of
a normal recurring nature and which, in the opinion of management, are necessary
for a fair statement of the results for the three months ended July 31, 2006 and
2005. The results of operations for the three months ended July 31, 2006 and
2005 are not necessarily indicative of the results for the full year.
Note 2. Discussion of the Company's Activities; Liquidity and Going Concern
Organization - Nesco Industries, Inc. (hereinafter referred to as "Nesco" or,
together with its wholly-owned subsidiaries, the "Company") is a Nevada
corporation whose principal business is conducted through its wholly-owned
subsidiaries, Hydrogel Design Systems, Inc. ("HDS") and, since January 2006,
Foam Manufacturing, Inc. ("FMI"). HDS is engaged in the manufacturing,
marketing, selling and distribution of hydrogel, an aqueous polymer-based
radiation ionized gel, which is used in various medical and cosmetic consumer
products. FMI is engaged in the manufacture and sale of patented hydrophilic
urethane foam products, polyurethane gels and moisture managed foam footwear
inserts for use in the cosmetic, medical, and household markets. The Company
acquired the rights to produce the FMI products during October 2005, by
agreement granting it the exclusive rights to manufacture and distribute these
products in North America as described further in Note 4 to the Company's
consolidated financial statements included in its Annual Report on Form 10-KSB.
Liquidity and Going Concern - At July 31, 2006, the Company had cash of
approximately $21,000, an accumulated deficit of approximately $24,480,000, a
working capital deficit of approximately $10,840,000 and, for the three months
then ended, incurred a net loss of approximately $799,000 and used approximately
$381,000 of cash in operations and investing activities. Additionally, at July
31, 2006, approximately $7,409,000 of debt (including interest and penalties) is
in default and notes payable of approximately $833,000 (including interest) at
July 31, 2006 become due on October 31, 2006. These factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern.
The Company's plan to deal with this uncertainty is to raise capital, attempt to
negotiate an extension of, or refinance, the convertible debt and note payable
and to improve operations through its ongoing activities and the new activities
of FMI (which has not yet achieved profitability). However, there can be no
assurance that managements' plan to raise capital or improve operations can
result in the Company's continued operation as a going concern.
The accompanying interim condensed consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America, which contemplate continuation of the Company as a
going concern. The interim condensed consolidated financial statements do not
include any adjustments relating to the recoverability and classification of
recorded asset amounts or amounts and classification of liabilities that might
be necessary should the Company be unable to continue in existence.
Note 3. Manufacturing Agreement and Related Activities
On October 3, 2005, the Company entered into a manufacturing agreement (the
"Agreement") with an entity affiliated with a director of the Company ("Dicon")
as described in its Annual Report on Form 10-KSB for the year ended April 30,
2006. Pursuant to that agreement, the Company had the right to purchase certain
"second line" equipment from Dicon. In June 2006, the Company paid $50,000 in
cash and executed a three year note payable to Dicon for $330,000 in connection
with the purchase of such equipment.
The Company has been purchasing a significant amount of its materials
requirements under the Agreement with Dicon directly from Dicon. As such, the
Company owes Dicon approximately $215,000 at July 31, 2006. Dicon has allowed
the Company to pay under extended credit terms due to the early start-up of
production to date.
5
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As of July 31, 2006, such "second line" equipment was not yet operational as
electrical and other work necessary to its installation has not been completed.
Note 4. Short Term Financing
Subsidiary Senior Secured Notes - During the three months ended July 31, 2006,
the Company raised approximately $325,000 by issuing additional 11% per annum
subsidiary senior secured notes of FMI pursuant to a note purchase agreement as
amended and restated on February 1, 2006. Such amount raises the total amount
outstanding under such agreement to approximately $805,000. Such subsidiary
senior secured notes are secured by all the assets of FMI and, as amended in
September 2006, are due on the earlier of October 31, 2006 or the completion of
a financing of at least $500,000. The notes were issued to directors and other
related parties as well as third parties. $100,000 of the amounts borrowed from
the initial investor in the senior secured notes may be converted into
convertible debt and warrants upon the completion of a proposed financing. Any
debt discount associated with such convertible and warrant features will be
recognized once the final terms of the proposed financing are determined.
Accounts Receivable Financing - Beginning in November 2005, the Company began
raising short-term financing by accounts receivable financing. Under this
program, specific accounts receivable are sold at a discount and the Company
retains the right to repurchase the accounts, subject to a 2% per month
financing charge. Additionally, beginning in April 2006, borrowings under this
arrangement were extended to customer purchase orders. The Company records this
as a financing transaction in which the receivables sold are carried on the
condensed consolidated balance sheet and the amount of the repayment is
reflected as a short-term debt. At July 31, 2006, approximately $167,000 of this
liability was payable to a related party.
Note 5. Long-Term Debt
Convertible Debentures, Including Interest and Penalties Payable, in Default
The Company has the following convertible debentures outstanding at July 31,
2006:
Face Registration Accrued
Due date amount penalties interest Total
-------- ------ --------- -------- -----
Senior secured parties December 1, 2005 $2,295,000 $711,000 $217,000 $3,223,000
Officers and related parties December 31, 2005 2,111,000 -- 512,000 2,623,000
Other third parties December 31, 2005 625,000 -- 218,000 843,000
---------- -------- -------- ----------
Subtotal $5,031,000 $711,000 $947,000 $6,689,000
========== ======== ======== ==========
The original debt discount and amortization of debt discount for the three
months ended July 31, 2006 and 2005 and annual interest expense on these
instruments follows:
Amortization
3 months ended July 31
Original Debt ----------------------- Quarterly
Due to Discount 2006 2005 Interest
- ------ -------- ---- ---- --------
Senior secured parties $2,112,000 $ -- $ 409,000 $ 46,000
Officers and related parties 1,287,000 -- 203,000 42,000
Other third parties 571,000 -- 90,000 13,000
---------- ---------- ---------- ----------
Total $3,970,000 $ -- $ 702,000 $ 101,000
========== ========== ========== ==========
The debt discount has been fully amortized as of December 31, 2005.
6
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The conversion features and related warrant exercise prices are as follows:
Total shares Total shares
Conversion Warrant issuable on issuable under
Description price price conversion warrants
- ----------- ----- ----- ---------- --------
Senior secured parties $0.15 $0.25 15,300,000 15,300,000
Officers and related parties $0.08 - $0.15 $0.15 21,050,747 2,111,230
Other third parties $0.08 $0.15 7,500,000 625,000
---------- ----------
Total 43,850,747 18,036,230
========== ==========
These convertible debentures were not paid at their maturity dates in December
2005 and are therefore now in default. The Company is having discussions with
the holders regarding an extension of the term of the debt.
Additional information about the convertible debentures listed above follows:
Convertible Debentures - Senior Secured Parties - In June 2004 the Company
borrowed $100,000 under bridge loans bearing interest at 8%. The debt holders
were also granted warrants to acquire 666,667 common shares at $0.15 per share.
These loans were later converted into convertible debentures in connection with
the investment banking agreement discussed below. The fair value of the bridge
loan warrants of approximately $40,000 was charged to debt discount in a prior
fiscal year.
Pursuant to an investment banking agreement entered into on July 1, 2004 with
Sloan Securities Corp., the Company sold $2,295,000 principal amount of the
Company's 8% senior secured convertible notes due December 1, 2005. Interest on
such senior secured convertible notes is payable semi-annually on December 1 and
June 1, either in cash or common stock, and such notes are convertible into
15,300,000 shares of common stock at $0.15 per share. The notes are secured by
all of the assets of the Company. The notes were issued with a five-year warrant
to purchase 1 share of the Company's common stock at $0.25 per share for each
share of common stock issuable upon conversion of the senior secured convertible
notes. Approximately $1,108,000 of the proceeds was attributed to the fair value
of the warrants and $1,004,000 to the intrinsic value of the beneficial
conversion feature of the convertible debt, with the remaining balance of
$183,000 recorded as long-term debt. On December 1, 2004, the Company issued
390,305 shares of common stock as payment for the interest due in the aggregate
of approximately $59,000. In June 2005, the Company issued 618,815 shares of
common stock as payment for the interest due in the aggregate of approximately
$93,000.
In connection with these notes and a related registration rights agreement, the
Company was required to file a registration statement to register the common
stock issuable upon the conversion of the notes and exercise of the warrants no
later than November 27, 2005, 60 days after the completion of the financing. The
Company did not file the required registration statement until January 27, 2005
and damages in the amount of approximately $92,000 (2% per month of the
aggregate purchase price) were required to be paid in cash under the terms of
the agreement. The holders of the notes agreed to accept this payment in the
aggregate of approximately $92,000 in common stock (556,865 shares) of the
Company. The fair value of the shares due has been charged to operations and
this expense is included in current liabilities as these shares have not been
issued as of July 31, 2006. In addition, the Company was required to have the
registration statement declared effective no later than June 27, 2005. As the
registration statement has not been declared effective, penalties in the amount
of 2% per month of the aggregate purchase price are required to be paid in cash
under the terms of the agreement. Interest accrues on the unpaid penalties at
the rate of 18% per annum for each month that they are unpaid. Penalties and
interest charged to operations for the three months ended July 31, 2006 and
total penalties and interest outstanding at July 31, 2006 are approximately
$163,000 and $711,000 respectively.
Financing fees in connection with this agreement approximated $285,000. In
addition, the Company issued warrants to a broker to acquire 5,052,600 shares of
Nesco common stock at an exercise price of $0.15 per share. Such warrants had a
fair value at the date of issuance of approximately $407,000. These fees and
warrant costs were charged to operations as deferred finance costs over the term
of the convertible notes including approximately $42,000 in the three months
ended July 31, 2005.
7
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Convertible Debentures - Officers and Related Party -
Related Party - As of April 30, 2004, a related party had loaned HDS an
aggregate of $1,308,000. HDS issued a series of convertible debentures in
connection with these loans between the period of October 12, 1999 and August 7,
2003. On April 19, 2004, the related party agreed, upon consummation of the 2004
share exchange agreement with Nesco (the "Share Exchange"), to extend the due
dates of these debentures until December 31, 2005 and to exchange these
debentures for 8% convertible debt of Nesco based on the same ratios in the
Share Exchange (a ratio of approximately 9 Nesco common shares for 1 common
share of HDS stock and 36 Nesco common shares for 1 preferred share of HDS
stock). On May 25, 2004 the exchange was completed. In consideration for an
extension and exchange of the debt, the debt holder was also granted a warrant
to acquire one share of Nesco common stock at an exercise price of $0.15 for a
term of five years for each dollar of HDS debt. Of the total $1,308,000 debt
exchanged, approximately $75,000 was attributed to the fair value of the
warrants, $1,121,000 was attributed to the intrinsic value of the beneficial
conversion feature and the remaining $112,000 was recorded as a long-term debt.
In addition, in May 2004 this party exchanged an aggregate of 331,500 options
and warrants of HDS for an aggregate of 10,566,000 warrants of Nesco based on
the same ratios in the Share Exchange. These options/warrants are currently
exercisable at prices that range between $0.08 -$0.39 and expire between six and
seven years. Compensation expense approximating $889,000 was recorded on May 25,
2004 for the increase in the fair value of these vested HDS options/warrants as
a result of the exchange. The increase in the fair value was estimated on the
date of the share exchange using the Black-Scholes option pricing model with the
following assumptions: no dividend yield, expected volatility of 59%, risk-free
interest rate of 1.38% and two to three-year expected lives.
Officers - As of April 30, 2004, HDS had outstanding debt due to two officers in
the aggregate of approximately $803,000, which was comprised of approximately
$552,000 in unpaid payroll and $251,000 in net notes payable including accrued
interest. In April 2004, the officers agreed to exchange this debt for 8%
convertible debentures of Nesco in connection with the Share Exchange in May
2004. This debt is convertible into common shares of Nesco at approximately
$0.15 per share (the market price on the date of exchange). In consideration for
an extension and exchange of the debt, the debt holders were also granted a
warrant to acquire one share of Nesco common stock at an exercise price of $0.15
for a term of five years for each dollar of HDS debt. Of the total of
approximately $803,000 in debt, approximately $46,000 was attributed to the fair
value of the warrants, approximately $46,000 was attributed to the intrinsic
value of the beneficial conversion feature and the remaining balance of
approximately $711,000 was recorded as long-term debt. In December 2005, one of
these officers resigned from the Company.
In addition, one of the officers exchanged an aggregate of 133,334 options of
HDS for an aggregate of 1,200,000 warrants of Nesco based on the same ratios in
the Share Exchange. These options were exercisable at $0.39 per share until they
expired in January 2006. Compensation expense approximating $23,000 was recorded
on May 25, 2004 for the increase in the fair value of these vested HDS
options/warrants as a result of the exchange.
The increase in the fair value of warrants and options in connection with the
above debentures was estimated on the date of the Share Exchange using the
Black-Scholes option pricing model with the following assumptions: no dividend
yield, expected volatility of 59%, risk-free interest rate of 1.38% and two to
three-year expected lives.
Convertible Debentures - Other Third Parties - As of April 30, 2004, HDS had
outstanding 8% convertible debentures in the aggregate of $625,000, of which
$325,000 were issued to a broker and $300,000 were issued to a series of
investors in connection with a private placement in 2002. The debentures were
due on October 31, 2003. On April 19, 2004, the debt holders agreed to exchange
these debentures for 8% convertible debt of Nesco due on December 31, 2005 based
on the same ratios in the Share Exchange (a ratio of approximately 9 Nesco
common shares for 1 common share of HDS stock and 36 Nesco common shares for 1
preferred share of HDS stock). On May 25, 2004 the exchange was completed. This
debt is convertible at approximately $0.08 per share into an aggregate of
approximately 7,500,000 shares of Nesco. In consideration for the extension and
exchange of the debt, the debt holders were also granted a warrant to acquire
one share of Nesco common stock at an exercise price of $0.15 for a term of five
years for each dollar of HDS debt for an aggregate of the issuance of 625,000
warrants. Of the approximately $625,000 of debt exchanged, approximately $36,000
was attributed to the fair value of the warrants, approximately $536,000 was
attributed to the intrinsic value of the beneficial conversion feature and the
remaining balance of $53,000 was recorded as long-term debt.
8
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In addition, these parties, inclusive of broker warrants, exchanged an aggregate
of 431,619 options and warrants of HDS for an aggregate of 11,015,820 warrants
of Nesco based on the same ratios in the Share Exchange. These options/warrants
are currently exercisable at prices that range between $0.08 -$0.39 and expire
between six and seven years. Compensation expense approximating $872,000 was
recorded on May 25, 2004 for the increase in the fair value of these vested HDS
options/warrants as a result of the exchange.
The increase in the fair value of warrants and options in connection with the
above debentures was estimated on the date of the share exchange using the
Black-Scholes option pricing model with the following assumptions: no dividend
yield, expected volatility of 59%, risk-free interest rate of 1.38% and two to
three-year expected lives.
Note and Interest Payable, in default - On January 24, 1997, HDS entered into a
financing agreement with a customer for the purchase of $600,000 of
manufacturing equipment from a third party. The agreement consisted of a
promissory note in the amount of $600,000 bearing interest at 8% per annum and
principal and interest due between three (3) and six (6) years from the
anniversary date, depending upon the amount of product the customer ordered from
the Company. The note has been amended several times, the most recent of which
was on April 21, 2004. In that amendment, the lender agreed to amend and restate
the note in the amount of $793,053 upon the completion of the Share Exchange
with Nesco which occurred on April 29, 2004. The amended note bore interest at
11%, per annum (the default rate) until an aggregate interest payment of $84,000
was made on July 27, 2004. Thereafter, interest forward until the maturity date,
December 31, 2005, is at 8%, per annum payable at maturity. In addition, the
lender agreed to release its security position on the collateral 90 days after
receipt, on August 13, 2004, of a payment of $200,000 against the principal
balance. The balance due on the note at July 31, 2006 is approximately $720,000
consisting of approximately $555,000 in principal and $165,000 of accrued
interest.
This note was not paid on the amended maturity date of December 31, 2005 and is
now in default. The Company intends to attempt to negotiate an extension of the
term of the debt. Interest expense approximated $11,000 for each of the three
months ended July 31, 2006.
Note Payable to Dicon - On June 23, 2006, the Company executed a secured note
payable to Dicon for $330,000 in connection with the purchase of certain
equipment. The note bears interest at the prevailing prime rate, adjusted
quarterly starting in December 2006, plus 1.5%. Monthly payments of principal
and interest become due beginning in September 2006 and continue until maturity
at August 31, 2009. Prime rate for the first payment was agreed to be 8% and the
initial monthly payments will be approximately $11,000. The Company granted
Dicon a first security interest in the underlying equipment which was purchased
for a total price of $380,000.
In accordance with EITF 00-19 "Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock" the Company has
determined that the value of its derivative instruments have an immaterial
value.
Note 6. Customer Deposits
At July 31, 2006, approximately $831,000 of the $875,000 of customer deposits
represents deposits from one customer to be applied against future purchase
orders. The deposit is non-refundable but applicable to future purchases from
the Company until December 31, 2009. To the extent that any portion of the
deposits is not used for purchases by the end of calendar year 2009, the
deposits will be forfeited.
Note 7. Due to Affiliates
Due to affiliates at July 31, 2006 of approximately $545,000 consists primarily
of temporary advances ($240,000) due to an entity owned by a related party and
unpaid rent and real estate taxes ($305,000) on our principal manufacturing
facility due to an entity majority-owned by a related party of the Company.
9
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 8. Stockholders' Deficit
May 25, 2004 Share Exchange - On May 25, 2004, HDS consummated a Share Exchange
with Nesco whereby HDS became a majority-owned subsidiary of Nesco, and the
holders of HDS common stock and debt acquired a majority interest of Nesco as
described in the Company's Annual Report of Form 10-KSB for the year ended April
30, 2006. The Company had intended to issue shares of its common stock in
exchange for the equity securities of HDS in certain ratios as provided for in
the exchange agreement. However, the Company did not have the required number of
authorized shares of common stock to complete the exchange on this basis. As
such, it agreed to issue shares of its newly designated Series B Preferred Stock
instead of common stock. Upon filing of a Certificate of Amendment to the
Certificate of Incorporation to increase the number of shares of common stock
which the Company is authorized to issue, each share of the Series B Preferred
Stock will be automatically converted into shares of common stock. Such
amendment requires action by, or notification to, shareholders, which
notification has been reflected in a November 16, 2004 preliminary information
statement filed with the SEC. The information statement cannot be completed
until all of the comments from the SEC are addressed and all required filings
are brought up to current status. Upon completion of this process, the Company
will file the Certificate of Amendment and issue the common stock.
As part of the Share Exchange transaction, Nesco conditionally transferred its
three wholly owned subsidiaries to a consultant and interim officer of Nesco who
resigned his position as officer at the time of the transfer. The transferee
assumed all liabilities and obligations with respect to these subsidiaries and
agreed to indemnify Nesco against any claims and, in exchange therefore,
received 3,000,000 shares of common stock of Nesco and certain related
registration rights. As additional consideration for the indemnification by the
transferee, Nesco agreed that if the transferee could not in good faith resell
the shares of common stock in an arm's length transaction during, as amended,
the twenty-four month period immediately following the closing for a price equal
to the lesser of (i) all liabilities resulting from the agreement between NAC
and its labor union plus legal fees or (ii) $330,000, then the Company will
repurchase from the transferee 2,400,000 of the common shares at that amount
upon written notice from the transferee requesting such. Such repurchase right
expired unexercised on May 25, 2006. As such, the Company's obligation to
repurchase the 2,400,000 common shares was included in current liabilities at an
aggregate of $330,000 (the maximum amount the Company would be required to pay
in the event of redemption) until the expiration of this obligation on May 25,
2006 at which time the liability was reclassified to common stock and additional
paid-in-capital.
Loss per Share - Basic loss per share excludes dilution and is calculated by
dividing the net loss attributable to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted loss per
share reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock
and resulted in the issuance of common stock. Because the Company incurred a net
loss, diluted net loss per share was the same as basic net loss per share for
the three months ended July 31, 2006 and 2005, since the effect of any
potentially dilutive securities would be antidilutive.
The loss per common share at July 31, 2005 includes the current outstanding
common shares in the aggregate of 20,136,225 shares less the 2,400,000 shares
which were subject to redemption (see "May 25, 2004 Share Exchange" above). At
July 31, 2006, such 2,400,000 are no longer subject to redemption and are
therefore included, subsequent to May 25, 2004, in the calculation of loss per
share. The loss per share for the three months ended July 31, 2006 and 2005 does
not include 117,055 and 116,687 shares, respectively, of Series B preferred
shares which will be converted into 87,791,250 and 87,515,250 common shares,
respectively, 67,000 shares of Series A preferred shares which will be converted
into 2,010,000 common shares, and 2,916,308 common shares for the prior HDS
common and preferred holders who have not yet exchanged their shares. Although
the Series A and Series B preferred shares will be automatically exchanged for
common shares upon the filing of a Certificate of Amendment to the Certificate
of Incorporation to increase the number of shares of common stock which the
Company is authorized to issue, they have been excluded from loss per common
share, in accordance with the Emerging Issues Task Force ("EITF") 03-6 as these
securities have no contractual obligation to share in the losses of the Company.
The following supplemental pro forma information is presented to illustrate the
effects of the conversion of Series A and Series B preferred stock to common
stock for the three months ended July 31, 2006 and 2005:
10
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three months ended July 31,
---------------------------
2006 2005
---- ----
Net Loss $ (799,000) $ (1,202,000)
Weighed average common shares
Outstanding, Basic and diluted 110,268,000 109,910,000
Loss per common share, basic and diluted $ (.01) $ (.01)
The loss per common share does not include an aggregate of 56,436,304 warrants
and options outstanding and 43,850,747 shares issuable under the terms of
convertible debt. The effect of these securities would be antidilutive.
Stock Based Compensation - The Company has a stock-based employee compensation
plan. Prior to May 1, 2006, the Company used the intrinsic value method set
forth in APB Opinion 25, "Accounting for Stock Issued to Employees", and related
Interpretations in accounting for its plans. The following table illustrates the
effect on net loss and loss per share for the three months ended July 31, 2006
and 2005 as if the Company had applied the disclosure only fair value
recognition provisions of FASB Statement 123, "Accounting for Stock-Based
Compensation".
Three months ended
July 31,
2005
----
Net loss, as reported $(1,202,000)
Add: Total stock-based employee compensation
expense determined under fair value based
method, net of related tax effects 15,000
-----------
Pro forma net loss $(1,217,000)
===========
Net loss as reported $ (0.07)
===========
Pro-forma net loss per share $ (0.07)
===========
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." SFAS No.
123R is a revision of SFAS No. 123, "Accounting for Stock Based Compensation,"
and supersedes APB No. 25. Among other items, SFAS No. 123R eliminates the use
of APB No. 25 and the intrinsic value method of accounting, and requires
companies to recognize the cost of employee services received in exchange for
awards of equity instruments in the financial statements based on the grant date
fair value of those awards. The effective date of SFAS No. 123R for the Company
is May 1, 2006. The Company has elected to adopt SFAS No. 123R using the
"modified prospective" method. Under the "modified prospective" method,
compensation cost is recognized in the consolidated financial statements
beginning with the effective date, based on the requirements of SFAS No. 123R
for all share-based payments granted after that date and all unvested
share-based payments granted before the effective date, and based on the
requirements of SFAS No. 123 for all unvested awards granted prior to the
effective date of SFAS No. 123R.
11
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 9. Significant Customers
Customers accounting for 10% or more of revenue for the three months ended July
31, 2006 and 2005 are as follows:
Three Months
July 31,
------------------
2006 2005
---- ----
Customer A 44% 0%
Customer B 17% 6%
Customer C 13% 24%
Customer D 3% 43%
-- --
77% 73%
== ==
Accounts receivable from these customers aggregated approximately $66,000 at
July 31, 2006.
Note 10. Commitments and Contingencies
Employment Agreement
On May 19, 2004, as amended on November 22, 2004, the Company entered into a
three-year employment agreement with an officer calling for annual compensation
of $120,000 until December 31, 2004, $200,000 effective January 1, 2005 and 10%
increases each year on December 31, during the term of the agreement. See the
Company's Annual Report on Form 10-KSB for the year ended April 30, 2006 for a
more complete description of this agreement including bonus and stock option
provisions. Beginning in October 2005, the Company ceased making payments on
this agreement due to its cash deficiency. Services continue to be provided and
accruals continue to be made for unpaid compensation. At July 31, 2006,
approximately $160,000 was included in accounts payable and accrued expenses for
unpaid compensation under such employment agreement.
Consulting Agreements
On May 25, 2004, the Company entered into a two-year consulting agreement with
an affiliate of an interim officer and consultant of the Company which provided
for the issuance of 2,000,000 shares of common stock and a minimum monthly
consulting fee of $7,500 to be credited against any other cash fees earned under
the terms of the agreement. The agreement also provides for certain transaction
fees to be paid to the consultant based on sales and contracts with strategic
alliances. The fair value of the 2,000,000 shares of common stock ($300,000) was
charged to operations in the quarter ended July 31, 2004. Unpaid fees at July
31, 2006 of approximately $35,000 are included in accounts payable and accrued
expenses.
On May 25, 2004, the Company entered into a one-year advisory services agreement
which provided for the issuance of 681,667 shares of common stock and a minimum
monthly consulting fee of $6,250 to be credited against any other cash fees
earned under the terms of the agreement. The agreement also provides for certain
transaction fees to be paid to the consultant based on sales and contracts with
strategic alliances. The fair value of the shares (approximately $102,000) was
charged to operations in the quarter ended July 31, 2004. On December 17, 2004,
the Company terminated the agreement which was cancelable by either party after
six months. On January 5, 2005, the Company issued an aggregate of 908.89 shares
of Series B Preferred shares (convertible into 681,667 common shares) as per the
agreement.
On November 1, 2004, the Company entered into a one-year advisory services
agreement which provides for compensation of $10,000 per month, of which $1,800
shall by payable in cash and $8,200 shall be payable, at the Company's
discretion, in cash or in common stock of the Company. The common stock payment
shall be based each month on the closing bid price of the Company's common stock
on the first day of the month for which payment is due. The consultant shall
have customary piggyback registration rights with respect to any shares issued
under this agreement. The fair value of the shares due under the agreement
(approximately $98,000, calculated on a monthly basis to be 1,100,837 shares)
has been charged to operations and this amount is included in current
liabilities as these shares have not been issued at July 31, 2006. This
agreement expired at the end of its term on November 1, 2005.
12
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On November 15, 2004, the Company entered into a one-year consulting agreement
for research and public relations services which provided for the issuance of
276,000 shares of restricted common stock and a one-time consulting fee of $500.
The fair value of the shares due under the agreement (approximately $47,000
based on the market price of $.17 on the date of the agreement) was charged to
operations in the fiscal year ended April 30, 2005 and this expense was included
in current liabilities as these shares had not been issued. In December 2005,
the Company issued 368 shares of Series B Preferred shares in settlement of
approximately $47,000 of this common stock to be issued. Such shares are
convertible into 276,000 shares of common stock of the Company.
On December 20, 2004, the Company entered into a one-year advisory services
agreement which provides for compensation in the form of a five year warrant to
purchase 204,000 shares of the common stock of the Company at an exercise price
of $.15. The warrants vest at the rate of 1/3 immediately, 1/3 on the six month
anniversary of the agreement and 1/3 one year from the date of the agreement.
The fair value of the warrants vested (approximately $20,000) were charged to
operations in the aggregate of approximately $10,000 in the prior fiscal year,
approximately $10,000 each in the quarters ended July 31, 2005 and January 31,
2006.
Litigation
Except for the claims against former subsidiaries of Nesco, as described in the
Company's April 30, 2006 10-KSB filing, the Company and its subsidiaries were
not involved in any other material legal proceedings during the three months
ended July 31, 2006.
The NAC entities, formerly subsidiaries of Nesco, are subject to a number of
claims and alleged violations. Pursuant to the stock purchase and assumption
agreement dated as of April 29, 2004, and completed as part of the terms of the
share exchange agreement with HDS on May 25, 2004, between Nesco and NAC
Calabria Acquisition Corporation (the "Purchaser"), the Purchaser became
responsible for all liabilities of our previous business conducted by the NAC
Entities.
13
Item. 2 Management's Discussion and Analysis or Plan of Operation
Forward Looking Statements
Some of the statements contained in this report discuss our plans and strategies
for our business and information concerning the ability of the Company to
service its obligations and other financial commitments as they become due or
state other forward-looking statements as this term is defined in the Private
Securities Litigation Reform Act of 1995 (the "Act"). Statements that are not
statements of historical facts may be deemed to be forward-looking statements.
The words "anticipate," "believe," "estimate," "expect," "plan," "intend,"
"should," "seek," "will," and similar expressions are intended to identify these
forward-looking statements, but are not the exclusive means of identifying them.
These forward-looking statements reflect the current views of our management.
However, various risks, uncertainties and contingencies could cause our actual
results, performance or achievements to differ materially from those expressed
in, or implied by, these statements. Our business is subject to many risks
including:
Financial Risks
o We have a limited operating history and we anticipate continued
losses.
o Our financial condition raises substantial doubt about our ability
to continue as a going concern.
o We currently have significant amounts of debt in default.
Risks Related to our Business
o We are dependent on proprietary know-how. We hold limited patents.
o We are dependent on the services of key personnel the loss of which
would have a material adverse effect on our operations.
o We are dependent on outside suppliers for raw materials.
o Our Foam Manufacturing Inc. operations were recently started and
have all the attendant risks of any start-up operation.
Risks Related to Our Industry
o We are subject to governmental regulations.
o Our products are subject to obsolescence; competition in the medical
products field is intense and we represent a very small presence.
o Our products risk exposure to product liability claims.
Other Risks
o Recent trading in our stock has been limited, so investors may not
be able to sell as much stock as they want at prevailing market
prices.
o Future sales of shares of our common stock, including sales of
shares which are convertible into common stock may negatively affect
our stock price.
o Our common stock may be affected by limited trading volume and may
fluctuate significantly which may affect the value of our shares of
common stock.
o Our common stock is deemed to be "Penny Stock" which may make it
more difficult for investors to sell their shares.
For a more complete listing and description of these and other risks that the
Company faces please see our Annual Report on Form 10-KSB. The forward looking
statements are qualified in their entirety by these cautionary statements, which
are being made pursuant to the provisions of the Act and with the intention of
obtaining the benefits of the "safe harbor" provisions of the Act. The Company
cautions investors that any forward-looking statements it makes are not
guarantees of future performance and that actual results may differ materially
from those in the forward-looking statements. We assume no obligation to update
any forward-looking statements contained in this report, whether as a result of
new information, future events or otherwise. Any investment in our common stock
involves a high degree of risk.
Overview, Background and History; Share Exchange Agreement
Nesco Industries, Inc. (hereinafter referred to as "Nesco" or, together with its
wholly-owned subsidiaries, the "Company") is a Nevada corporation whose
principal business is conducted through its wholly-owned subsidiaries, Hydrogel
Design Systems, Inc. ("HDS") and, since January 2006, Foam Manufacturing, Inc.
("FMI"). HDS is engaged in the manufacturing, marketing, selling and
distribution of hydrogel, an aqueous polymer-based radiation ionized gel, which
is used in various medical and cosmetic consumer products. FMI is engaged in the
manufacture and sale of patented hydrophilic urethane foam products,
14
polyurethane gels and moisture managed foam footwear inserts for use in the
cosmetic, medical, and household markets. The Company acquired the rights to
produce the FMI products during October 2005, when it entered into an agreement
which grants it the exclusive rights to manufacture and distribute these
products in North America as described further in the Company's Annual Report on
Form 10-KSB. Between January 2006 and April 2006, FMI's activities consisted of
start-up activities and in April 2006 FMI made its first shipment to a customer.
The Company expects FMI's operations to constitute a significant portion of its
revenues going forward and FMI has a significant customer.
Prior to April 29, 2004, Nesco was a "shell company" having ceased business
operations and become inactive in May 2003. Prior to May 2003, Nesco was a
provider of asbestos abatement and indoor air quality testing, monitoring and
remediation services. Nesco provided services through its wholly-owned
subsidiary National Abatement Corporation ("NAC") and other wholly-owned
subsidiaries including NAC/Indoor Air Professionals, Inc. ("IAP") and NAC
Environmental Services, Inc. ("NACE").
On April 29, 2004, Nesco entered into a share exchange agreement with HDS, a
Delaware privately held corporation, whereby HDS became a majority-owned
subsidiary of Nesco and the holders of HDS common stock and debt acquired a
majority interest of Nesco. This exchange (the "Share Exchange") was completed
on May 25, 2004. The accounting for the transaction, commonly called a reverse
acquisition, resulted in a recapitalization of HDS, which was treated as the
accounting acquirer. The acquired assets and assumed liabilities of Nesco were
carried forward at their historical values which approximated fair value (with
the exception of deferred liabilities for which there was no legal continuing
obligation, which were not recorded). HDS's historical financial statements were
carried forward as those of the combined entity.
The Company had intended to issue shares of its common stock in exchange for the
equity securities of HDS in certain ratios as provided for in the Share
Exchange. However, the Company did not have the required number of authorized
shares of common stock to complete the exchange on this basis. As such, it
agreed to issue shares of its newly designated Series B Preferred Stock instead
of common stock. Upon filing of a Certificate of Amendment to the Certificate of
Incorporation to increase the number of shares of common stock which the Company
is authorized to issue, each share of the Series B Preferred Stock will be
automatically converted into shares of common stock. On November 16, 2004 the
Company filed a preliminary information statement with the SEC. Various comment
letters have been exchanged with the SEC. The information statement can be
completed after the filing of an amended information statement and review by the
SEC. Upon completion of this process, the Company will file the Certificate of
Amendment and issue the common stock.
As part of this transaction, Nesco conditionally transferred its three
wholly-owned subsidiaries, NAC, IAP and NACE, to a consultant and interim
officer of Nesco who resigned his position as officer at the time of the
transfer. The transferee assumed all liabilities and obligations with respect to
these subsidiaries and agreed to indemnify the Company against any claims and,
in exchange therefore, received 3,000,000 shares of common stock of the Company
and certain related registration rights. As additional consideration for the
indemnification by the transferee, the Company agreed that if the transferee
cannot in good faith resell the shares of common stock in an arm's length
transaction during, as amended, the twenty four month period immediately
following the closing for a price equal to the lesser of (i) all liabilities
resulting from the agreement between NAC and its labor union plus legal fees or
(ii) $330,000, then the Company will repurchase from the transferee 2,400,000 of
the common shares at that amount upon written notice from the transferee
requesting such. The repurchase of the 2,400,000 common shares, which are
subject to redemption by the transferee, have been included in current
liabilities at an aggregate of $330,000, the maximum amount the Company would be
required to pay in the event of redemption, until such obligation expired on May
26, 2006, at which time the shares were reclassified to common stock and
additional paid in capital.
15
Results of Operations
Three months ended July 31, 2006 compared to the three months ended July 31,
2005
Results of operations for the three months ended July 31, 2006 reflect the
following changes from the prior period:
July 31,
--------
2006 2005 Change
---- ---- ------
Sales $ 391,000 $ 386,000 $ 5,000
Gross profit (loss) (226,000) 140,000 (366,000)
Stock compensation charge 7,000 35,000 (28,000)
Other operating expenses 264,000 278,000 (14,000)
Loss from operations (507,000) (173,000) 327,000
Other expense (292,000) (1,029,000) (737,000)
Net loss ($ 799,000) ($1,202,000) ($ 403,000)
Revenues in the three months ended July 31, 2006 consisted of approximately
$237,000 of sales of HDS products and approximately $154,000 of FMI products. No
FMI products were sold in the three months ended July 31, 2005. The decrease in
HDS sales of approximately $149,000 (39%) results from sales to one significant
customer in the three months ended July 31, 2005 which did not recur in the
three months ended July 31, 2006. This shortfall was more than offset by initial
sales of MFI products.
Gross profit was negatively impacted by operating losses at FMI of approximately
$203,000 as a result of: (a) start-up activities, (b) fixed costs, such as
occupancy, being spread over a low volume of revenue and (c) materials useage
and labor expenses that reflect start-up production not volume production, among
other factors. Additionally, gross profit on HDS products was negatively
affected by HDS's fixed overhead costs being spread over approximately $149,000
lower sales volume.
Changes in stock compensation charge and other operating expenses were not
significant but do reflect some reduction of corporate overhead expenses offset
by some added operating costs related to FMI products. The decrease in other
expense reflects principally the reduction in amortization of debt discount and
financing costs of $828,000 in the three months ended July 31, 2006 due to such
costs being fully amortized as of December 31, 2005. This reduction was
partially offset by: (a) an increase in interest expense of approximately
$20,000, in the three months ended July 31, 2006 due to higher debt levels and
(b) liquidated damages of approximately $163,000 in the three months ended July
31, 2006 associated with the Company's failure to perform under a registration
rights agreement vs. approximately $92,000 in other penalties in the three
months ended July 31, 2005.
Trends
The Company's historical revenue run rate is not at a level of profitable
operations. The high fixed costs of maintaining a Good Manufacturing Practices
("GMP") manufacturing facility (including FDA regulated medical device
manufacturing) and trained staff, operations continued to, and would likely
continue to generate operating losses, in the absence of increased revenues.
Revenue levels are highly dependant on the stage of development of customer
projects. Customers order sporadically or in small production runs of items
while they perform testing and market analysis. It is difficult to assess when
large scale production orders may be received although several are being
actively pursued. Revenue levels would need to increase significantly or other
synergies would have to be developed for the business to generate operating
income.
One strategic effort to increase revenue is the October 2005 manufacturing
agreement with Dicon. In the Dicon Agreement we have acquired rights to produce
and distribute, in North America, patented hydrophilic urethane foam products,
polyurethane gels and moisture managed foam footwear inserts that have
characteristics that are somewhat similar to our HDS products. Further, these
new products address many of the same markets, customers and end users as the
HDS products, namely cosmetic, medical, and household markets. Furthermore,
there are production similarities between the manufacturing processes for these
new products and the HDS manufacturing processes. We have opened a manufacturing
facility for production of these new products within close proximity to our
16
existing HDS manufacturing facility. Therefore, our strategy in acquiring the
rights under the Dicon Agreement is to achieve revenue growth as well as
production, management and marketing synergies with our HDS business. The
Company started selling these new products under the Dicon Agreement in the last
week of April 2006. Sales from the last week of April 2006 through July 31, 2006
have aggregated approximately $181,000. During July 2006, the Company added an
additional $380,000 of equipment to produce the Dicon Agreement products which
equipment could become operational during the second fiscal quarter ending
October 31, 2006. The start date for operations of this additional equipment is
dependent on, among other things, completion of additional electrical work (and
related approvals) which is still being evaluated, as well as the constraints of
cash. It is expected that this additional equipment would add additional
production and sales capacity. Currently, Dicon is the significant customer for
these new products until the Company can generate its own sales and marketing
opportunities.
There are new risks and uncertainties associated with FMI including the risks of
start-up manufacturing and sales and the fact that financing for the purchase of
assets has largely been provided by a bridge loan that matures, as amended, on
October 31, 2006 and is secured by all of the FMI assets.
Liquidity, Capital Resources and Going Concern
The Company's liquidity at July 31, 2006 compared to April 30, 2006 is as
follows:
July 31, April 30,
2006 2006 Change
---- ---- ------
Cash $ 21,000 $ 27,000 ($ 6,000)
----------- ----------- ---------
Deficit in working capital $10,840,000 $10,214,000 $ 626,000
----------- ----------- ---------
Liabilities in excess of assets $10,064,000 $ 9,602,000 $ 462,000
----------- ----------- ---------
In December 2005, approximately $5,031,000 face amount of convertible notes and
approximately $555,000 face amount of notes payable became due and were not
paid. These amounts are now in default and, together with interest and
penalties, aggregate approximately $7,409,000. The Company intends to attempt to
negotiate an extension of the term of, or refinance, each of these debts.
Net cash used in operating and investing activities in the three months ended
July 31, 2006 was approximately $381,000. These expenditures were largely funded
by accounts receivable financing of approximately $51,000 and the issuance of
additional subsidiary senior secured notes of approximately $325,000. The
Company continues to experience losses from operations subsequent to July 31,
2006. The Company's subsidiary senior secured notes are due, as amended, on
October 31, 2006 and the Company does not have the means to pay that debt. All
of these factors, among others, indicate that the Company may be unable to
continue operations as a going concern.
The Company currently does not have the liquidity or financing available to it
to fund its operations for the next 12 months without additional capital being
raised and/or forbearance from creditors. In the three months ended July 31,
2006, the following items impacted liquidity negatively:
o Losses from operations of approximately $500,000
o Penalties and liquidated damages accrued of approximately $163,000
related to certain debt agreements
o Approximately $83,000 of current portion of new non-current debt for
purchase of equipment for the FMI products
The Company needs additional time to address its significant liquidity shortage
over a longer term. Over that longer term, the Company will attempt to improve
its liquidity through a combination of measures including: (a) renegotiating the
term of, or refinancing existing indebtedness if possible, (b) increasing
revenues at its Hydrogel operation, (c) increasing Company wide revenues by the
manufacture and sale of the FMI products, (d) raising a significant amount of
capital on a more permanent basis and (e) other measures.
Commitments for capital expenditures -
In June 2006, the Company purchased certain "second line" equipment as
contemplated under the Dicon Agreement for $380,000. Such amount was paid
$50,000 in cash and $330,000 under a three year note with interest at prime plus
17
1.5% per annum. The installation and operation of such equipment implies the
additional expenditure on equipment and leasehold improvements of more than
$175,000. There are no other material commitments for capital expenditures. Item
3. Controls and Procedures
Disclosure Controls and Procedures. The Company's limited cash resources have
inhibited the Company's efforts to devote the resources necessary to file its
periodic reports with the SEC in a timely fashion during significant periods of
2005 and into 2006. In addition, after considering comments received from the
Securities and Exchange Commission, the Company's management and audit committee
concluded that the Company needed to restate its Form 10-QSB for the quarter
ended July 31, 2005 and its Form 10-KSB for the year ended April 30, 2005 to
correct errors in the application of accounting principles with respect to the
accounting for deferred stock issuance costs in the original such filings. The
material weaknesses related to the issues described above are being remediated
as a result of processes being implemented by the Company, consulting resources
being devoted to financial reporting, and raising capital which permits the
Company to apply additional resources to its financial reporting and disclosure
obligations.
We carried out an evaluation, under the supervision and with the participation
of the our management, including our Chief Executive Officer and Chief Financial
Officer (who are the same person), of the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the
"Exchange Act")). Controls over: (a) the application of accounting policies and
(b) timely preparation and filing of periodic reports, are within the scope of
internal controls. Based on an evaluation performed, the Company's principal
executive officer and principal financial officer (who are the same person), has
concluded that the disclosure controls and procedures were not effective as of
April 30, 2005, to provide reasonable assurance of the achievement of these
objectives stated above. Changes were implemented to address this deficiency as
described below and as a result of an evaluation performed, the Company's
principal executive and principal financial officer have concluded that the
disclosure controls and procedures were effective as of July 31, 2006 to provide
reasonable assurance of the achievement of these objectives stated above.
Internal Controls over Financial Reporting. Changes have been implemented in the
Company's internal control over financial reporting during the fiscal year ended
April 30, 2006 and the quarter ended July 31, 2006, that has materially
affected, or is reasonably likely to materially affect, the Company's control
over financial reporting including the following (a) in January 2006, the
Company's Chief Financial Officer resigned, (b) additional capital has been
raised which has in part been devoted to improving the Company's internal
controls, (c) in March 2006, the Company retained a financial reporting
consultant to assist it with its SEC reporting and compliance, (d) processes and
procedures over financial reporting have been improved and as a result, (e) the
Company is now current with its reporting to the SEC.
Inherent Limitations on Effectiveness of Internal Controls
The Company's management, including the chief executive officer and chief
financial officer (who are the same person), do not expect that our Disclosure
Controls or our internal control over financial reporting will prevent or detect
all errors and all fraud that could occur. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that
the control system's objectives will be met. The design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Further, because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not
occur or that all control issues and instances of fraud, if any, within the
company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur
because of simple error or mistake. Controls can also be circumvented by the
individual acts of some persons, by collusion of two or more people, or by
management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Projections of any evaluation of
controls effectiveness to future periods are subject to risks. Over time,
controls may become inadequate because of changes in conditions or deterioration
in the degree of compliance with policies or procedures.
18
PART II- OTHER INFORMATION
Item 1. - Legal Proceedings
During August 2006, the Company was served with a judgment filed with the Clerk
of Southern District of New York on March 13, 2006 in the amount of $227,126.02
in favor of Universal Bonding Insurance Company as Defendant/Judgment Creditor,
and against the Company and its former subsidiary National Abatement Corp. who
were all named as Defendants/Judgment Debtors in a matter entitled Trustees of
the Mason Tenders District Council Welfare Fund, Pension Fund, Annuity Fund and
Training Program Fund and Manson Tenders District Council of Greater New York,
by its business manager, Robert Bonanza against National Abatement Corp., Nesco
Industries Inc. and Universal Bonding Insurance Company.
The Company believes that such matter, which is related to business matters
prior to its merger in 2004, is covered by the indemnification provided under
the share exchange agreement executed in 2004. The Company is presently
communicating with counsel, the Judgment creditor and the indemnifying party
with respect to this matter.
Item 2. - Unregistered Sale of Equity Securities and Use of Proceeds .
Not applicable.
Item 3. - Defaults Upon Senior Securities.
See Note 5 to unaudited Condensed Consolidated Financial Statements for a
discussion of continuing defaults in certain debt, including convertible
debentures.
Item 4. - Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. - Other Information.
Not applicable.
Item 6. - Exhibits
Exhibits:
Exhibit 31 - Certification of Principal Executive and Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32 - Certification of Principal Executive and Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
19
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned there unto duly authorized.
NESCO INDUSTRIES, INC.
By: /s/ Matthew L. Harriton
-----------------------------
Matthew L. Harriton
President and Chief
Executive Officer
Dated: September 11, 2006
20
INDEX TO EXHIBITS
No. Description
--- -----------
10.1 Letter dated as of July 31, 2006 between the Company and Chicago
Investments Inc. as agent for the noteholders, extending the maturity
date of certain senior secured subsidiary notes payable from July 31,
2006 to October 31, 2006.
31.1 Certification of Principal Executive Officer and Principal Financial
Officer pursuant to Exchange Act Rule 13a - 14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer and Principal Financial
Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
21