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 October 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 December 5, 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 - 11
Item 2. Management's Discussion and Analysis or Plan of
Operations............................................... 12 - 16
Item 3. Controls and Procedures.................................. 17
Part II. - Other Information........................................... 18
Item 1. Legal proceedings........................................
Item 3. Defaults upon senior securities..........................
Item 6. Exhibits.................................................
Signatures............................................................. 19
All items which are not applicable or to which the answer is negative have been
omitted from this report.
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
================================================================================
October 31,
2006
------------
(unaudited)
------------
ASSETS
Current assets
Cash $ 27,000
Accounts receivable 177,000
Inventories 206,000
Prepaid expenses and other current assets 15,000
------------
Total current assets 425,000
Property and equipment, net of accumulated depreciation
and amortization of approximately $1,930,000 1,011,000
Other assets - deposits and other 43,000
------------
$ 1,479,000
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Current portion of note payable to Dicon $ 83,000
Secured accounts receivable and purchase order financing,
including $183,000 payable to a related party 188,000
Subsidiary senior secured notes payable and interest, including
$200,000 payable to related parties 981,000
Convertible debentures, including interest and penalties, in default
($3,439,000 is secured by the assets of the Company and another
$2,665,000 is payable to related parties and current or former officers) 6,960,000
Note and interest payable, in default 732,000
Customer deposits 901,000
Accounts payable and accrued expenses 1,528,000
Stock to be issued 190,000
Due to related party and affiliates 598,000
------------
Total current liabilities 12,161,000
------------
Non-current liabilities
Note payable to Dicon 234,000
Deferred sublease income 47,000
------------
Total non-current liabilities 281,000
------------
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 14,402,000
Accumulated deficit (25,385,000)
------------
Total stockholders' deficit (10,963,000)
------------
$ 1,479,000
============
See notes to unaudited condensed consolidated financial statements.
1
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
================================================================================
Six Months Ended October 31, Three Months Ended October 31,
---------------------------- ------------------------------
2006 2005 2006 2005
(unaudited) (unaudited) (unaudited) (unaudited)
- --------------------------------------------------------------------------------------------------------
Revenues $ 895,000 $ 633,000 $ 504,000 $ 247,000
Cost of revenues 1,365,000 527,000 748,000 281,000
---------------------------------------------------------------
Gross profit (loss) (470,000) 106,000 (244,000) (34,000)
---------------------------------------------------------------
Operating expenses
General and administrative 622,000 663,000 348,000 350,000
Stock-based compensation charge 13,000 -- 7,000 --
---------------------------------------------------------------
Total operating costs 635,000 663,000 355,000 350,000
---------------------------------------------------------------
Loss from operations (1,105,000) (557,000) (599,000) (384,000)
---------------------------------------------------------------
Other income (expenses)
Sublease income 23,000 23,000 12,000 12,000
Amortization of debt discount -- (1,403,000) -- (702,000)
Interest and other expense (196,000) (152,000) (103,000) (74,000)
Interest expense, related parties (94,000) (85,000) (47,000) (42,000)
Amortization of financing costs -- (253,000) -- (126,000)
Penalties under registration rights
agreement (332,000) (242,000) (169,000) (151,000)
---------------------------------------------------------------
(599,000) (2,112,000) (307,000) (1,083,000)
---------------------------------------------------------------
Net loss $ (1,704,000) $ (2,669,000) $ (906,000) $ (1,467,000)
===============================================================
Weighted average common shares
Basic and diluted 19,810,000 17,600,000 20,136,000 17,700,000
---------------------------------------------------------------
Net loss per common share
Basic and diluted $ (0.09) $ (0.15) $ (0.04) $ (0.08)
===============================================================
See notes to unaudited condensed consolidated financial statements.
2
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================
Six months Ended October 31,
----------------------------
2006 2005
----------- -----------
(unaudited) (unaudited)
Cash flows from operating activities
Net loss $(1,704,000) $(2,669,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Stock-based compensation charge 13,000 --
Depreciation and amortization 104,000 88,000
Amortization of debt discount -- 1,403,000
Amortization of financing costs -- 253,000
Changes in operating assets and liabilities:
Accounts receivable (92,000) 6,000
Inventories (106,000) (7,000)
Prepaid expenses and other current assets 4,000 26,000
Accrued penalties and interest (included in convertible debentures) 332,000 --
Customer deposits 54,000 --
Accounts payable, accrued expenses and other 667,000 535,000
Interest payable 269,000 111,000
Due to affiliates 92,000 106,000
Deferred sublease income (23,000) (23,000)
---------------------------
Net cash used in operating activities (390,000) (171,000)
---------------------------
Cash flows from investing activities
Purchase of equipment (146,000) --
---------------------------
Net cash used in investing activities (146,000) --
---------------------------
Cash flows from financing activities
Proceeds from issuance of subsidiary senior secured notes 450,000 --
Proceeds from accounts receivable financing 372,000 --
Payments of accounts receivable financing (286,000) --
Payments from affiliate -- 165,000
---------------------------
Net cash provided by financing activities 536,000 165,000
---------------------------
Net decrease in cash -- (6,000)
Cash
Beginning of period 27,000 22,000
---------------------------
End of period $ 27,000 $ 16,000
===========================
Supplemental disclosure of cash flow information,
Cash paid during the period for interest $ -- $ --
===========================
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
================================================================================
Six months ended October 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
Stock compensation charge -- -- -- 13,000
Net loss (1,704,000)
---------------------------------------------------------------------------------------------------
Balances, October 31, 2006,
(unaudited) 67,000 $ -- 117,055 $ -- 20,136,225 $ 20,000 $ 14,402,000 $(25,385,000)
===================================================================================================
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 presentation of the results for the three and six months ended
October 31, 2006 and 2005. The results of operations for the three and six
months ended October 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
for the year ended April 30, 2006.
Liquidity and Going Concern - At October 31, 2006, the Company had cash of
approximately $27,000, an accumulated deficit of approximately $25,385,000, a
working capital deficit of approximately $11,736,000 and, for the six months
then ended, incurred a net loss of approximately $1,704,000 and used
approximately $536,000 of cash in operations and investing activities.
Additionally, at October 31, 2006, approximately $7,692,000 of debt (including
interest and penalties) is in default and notes payable of approximately
$981,000 (including accrued interest) at October 31, 2006 become due on January
31, 2007. 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. See also, "Proposed Restructuree in
November 2006" in Note 5.
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 and Concentrations
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. As of October 31, 2006, such "second line"
equipment was not yet operational as electrical and other work necessary to its
installation has not been completed.
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 $240,000 for materials at October 31, 2006.
5
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Dicon has allowed the Company to pay under extended credit terms due to the
early start-up of production to date. Additionally, Dicon is FMI's main customer
constituting approximately 98% of FMI's approximately $434,000 sales, and
approximately 48% of consolidated sales, in the six months ended October 31,
2006. Amounts receivable from Dicon are approximately $20,000 at October 31,
2006. Customer deposits includes approximately $61,000 for amounts advanced by
Dicon for products billed but not yet shipped at October 31, 2006.
Note 4. Short Term Financing
Subsidiary Senior Secured Notes - During the six months ended October 31, 2006,
the Company raised approximately $450,000 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 $930,000. Such subsidiary
senior secured notes are secured by all the assets of FMI and, as amended in
October 2006, are due on the earlier of January 31, 2007 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 any 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 October 31, 2006, approximately $183,000 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 October 31,
2006:
Face Registration Accrued
Due date amount penalties interest Total
----------------- ------------- ------------- ------------- -------------
Senior secured parties December 1, 2005 $ 2,295,000 $ 880,000 $ 264,000 $ 3,439,000
Officers and related parties December 31, 2005 2,111,000 -- 554,000 2,665,000
Other third parties December 31, 2005 625,000 -- 231,000 856,000
------------- ------------- ------------- -------------
Subtotal $ 5,031,000 $ 880,000 $ 1,049,000 $ 6,960,000
============= ============= ============= =============
The registration penalties accrue at 2% per month, plus interest on the unpaid
penalties at 18% per annum, due to the Company's failure to satisfy certain
registration rights obligations to the senior secured parties. See also
"Proposed Restructure in November 2006" below.
The original debt discount and quarterly amortization of debt discount (in the
three and six months ended October 31, 2005) and interest expense on these
instruments follows:
Original Debt Quarterly
------------- ----------------------------
Due to Discount Amortization 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
============ ============ ============
6
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The debt discount has been fully amortized as of December 31, 2005 and so there
is no amortization in the six months ended October 31, 2006.
Financing fees aggregating approximately $285,000, and warrants with a fair
value of approximately $407,000 at date of issuance, were incurred in connection
with the convertible debentures issued to the senior secured parties. Such costs
were amortized to operations at the rate of approximately $126,000 per quarter
through December 1, 2005, the maturity date of the debt.
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
============== ==============
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. Certain registration
rights penalties due at January 27, 2005 in the amount of approximately $92,000
were settled with the Company's agreement to issue 556,865 shares of its common
stock. Such amount is included in current liabilities with common stock to be
issued on the condensed consolidated balance sheet.
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 as described below.
Proposed restructure in November 2006 - During November 2006, the Company
reached agreement with holders representing more than 50% of the outstanding
balance due to the senior secured parties to restructure the convertible notes
under the following principal terms: (a) cash payment of 80% of the outstanding
principal, (b) repayment of the remaining outstanding amount in stock using a
valuation of $0.02 per share at such time as the authorized capital of the
Company has been increased, (c) no further accrual of interest and registration
rights penalties as of November 1, 2006 and (d) the existing warrant exercise
price would be reduced from $0.25 to $0.025. Under the original loan with the
senior secured parties, agreement of holders of more than 50% of the outstanding
amount is necessary to cause certain amendments to the loan documents. This
agreement is subject to closing prior to January 31, 2007, after which date such
agreement would terminate. Repayment of the convertible debt contemplated by the
agreement is subject to completion of a contemplated debt financing which is
under negotiation.
Additional information about the convertible debentures listed above is
contained in the Company's Annual Report on Form 10-KSB for the year ended April
30, 2006.
Note and Interest Payable, in default -
On January 24, 1997, HDS entered into a promissory note with a customer for the
purchase of $600,000 of manufacturing equipment from a third party. The note has
been amended several times, the most recent of which was on April 21, 2004, and
now bears interest (payable at maturity) at 8% per annum and was due on December
31, 2005 as discussed further in the Company's Annual Report on Form 10-KSB for
the year ended April 30, 2006.
The balance due on the note at October 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 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 approximates $11,000 per quarter in all
periods presented for this note.
7
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 began 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 are 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 October 31, 2006, approximately $831,000 of the $901,000 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 October 31, 2006 of approximately $598,000 consists
primarily of temporary advances ($240,000) due to an entity owned by a related
party and unpaid rent and real estate taxes ($358,000) on our principal
manufacturing facility due to an entity majority-owned by a related party of the
Company.
Note 8. Stockholders' Deficit
May 25, 2004 Share Exchange - On May 25, 2004, HDS consummated a share exchange
agreement (the "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 on 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 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. 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. 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 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 certain outstanding 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
8
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
repurchase. 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.
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
approximately $227,000 in favor of a bonding company and against the Company and
its former subsidiary National Abatement Corp. who were all named as
Defendants/Judgment Debtors in a matter filed against our former subsidiary
National Abatement Corp., the Company and the bonding company. The original
judgment was for approximately $380,000 (including the approximately $227,000
that was satisfied by the bonding company). In an unrelated matter, in June
2006, a complaint was filed against the Company in the Court of Common Pleas of
Philadelphia County, Pennsylvania seeking recovery of approximately $72,000 of
legal fees, plus interest and other costs, alleged to be owed since 1999.
The Company believes that the above matters, which are related to business
activities prior to its merger in 2004, are covered by the indemnification
provided under the Share Exchange completed on May 25, 2004. The Company is
presently communicating with counsel, the judgment creditor and the indemnifying
party and the Plaintiff in the Pennsylvania matter. However, given the aggregate
amounts and complexity of these matters, the Company believes that it may have
to settle or satisfy such matters. Settlement discussions have commenced. While
the amount of any settlement and the extent of recoveries that could be expected
under indemnification are uncertain, the Company has accrued approximately
$100,000 as its estimate of settlement and legal costs that may not be
recoverable under indemnification.
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 and six months ended October 31, 2006 and 2005, since the effect of
any potentially dilutive securities would be antidilutive.
The loss per common share at October 31, 2005 includes the then 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
October 31, 2006, such 2,400,000 are no longer subject to redemption and are
therefore included, subsequent to May 25, 2006, in the calculation of loss per
share. The loss per share for the three months ended October 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 and six months ended October 31, 2006 and 2005:
Six months ended Three months ended
October 31, October 31,
------------------------------- -------------------------------
2006 2005 2006 2005
------------- ------------- ------------- -------------
Net Loss $ (1,704,000) $ (2,669,000) $ (906,000) $ (1,467,000)
Weighed average common shares
Outstanding, Basic and diluted 112,525,000 110,200,000 112,850,000 110,200,000
Loss per common share, basic and diluted $ (.02) $ (.02) $ (.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.
9
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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. 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 for all unvested share-based payments granted before the effective
date.
The following table illustrates the effect on net loss and loss per share for
the three and six months ended October 31, 2005 as if the Company had applied
the fair value recognition provisions of FASB Statement 123, "Accounting for
Stock-Based Compensation".
Six Three
months ended months ended
October 31, October 31,
2005 2005
--------------- ---------------
Net loss, as reported $ (2,669,000) $ (1,467,000)
Add: Total stock-based employee compensation
expense determined under fair value based
method, net of related tax effects 30,000 15,000
--------------- ---------------
Pro forma net loss $ (2,699,000) $ (1,482,000)
=============== ===============
Net loss as reported $ (0.15) $ (0.08)
=============== ===============
Pro-forma net loss per share $ (0.15) $ (0.08)
=============== ===============
Note 9. Significant Customers
Customers accounting for 10% or more of revenue for the three and six months
ended October 31, 2006 and 2005 are as follows:
Six Months Three Months
----------------- -----------------
October 31, October 31,
2006 2005 2006 2005
---- ---- ---- ----
Customer A 48% 0% 52% 0%
Customer B 15% 6% 14% 5%
Customer C 11% 0% 10% 20%
Customer D 1% 26% 0% 0%
Customer E 2% 23% 1% 0%
Customer F 7% 9% 6% 22%
Customer G 6% 10% 7% 13%
Customer H 0% 8% 0% 21%
---- ---- ---- ----
90% 82% 90% 81%
==== ==== ==== ====
Accounts receivable from these customers aggregated approximately $129,000 at
October 31, 2006.
10
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 its chief executive 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
October 31, 2006, approximately $231,000 was included in accounts payable and
accrued expenses for unpaid compensation and related taxes under such employment
agreement.
Consulting Agreements
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
was payable in cash and $8,200 was payable, at the Company's discretion, in cash
or in common stock of the Company. The common stock payment was 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 has 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 October 31, 2006. This agreement expired at the end of
its term on November 1, 2005. In November 2006, this consultant filed a claim
against the Company to receive its accrued but unpaid compensation.
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 $0.15. 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
and approximately $10,000 each in the quarters ended July 31, 2005 and January
31, 2006.
Also see the Company's Annual Report on Form 10-KSB for the year ended April 30,
2006 for additional information regarding consulting agreements.
Litigation
Except for the claims against former subsidiaries of Nesco, as described in Note
8, the claim described above in Note 10 and 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 October 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 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. See,
however, Note 8.
11
Item. 2 Management's Discussion and Analysis or Plan of Operation
SAFE HARBOR CAUTIONARY STATEMENT
Some of the statements contained in this report as well as statements made from
time to time by our representatives 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. Our Chief
Executive Officer has been working without receiving his contractual
cash compensation since October 2005 and there is no assurance that
he will continue doing so.
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 for the year ended
April 30, 2006 as well as other reports we file with the SEC. 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
12
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, 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 for the year ended April 30, 2006. 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 currently
is dependant on one 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 shares of common stock, which common stock has not been issued. 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 the Share Exchange, 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
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. The repurchase of the 2,400,000 common shares, which were
subject to redemption by the transferee, were 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.
Results of Operations
Six months ended October 31, 2006 compared to the six months ended October 31,
2005
Results of operations for the six months ended October 31, 2006 reflect the
following changes from the prior period:
13
Six months ended
October 31,
-------------------------
2006 2005 Change
----------- ----------- -----------
Revenues $ 895,000 $ 633,000 $ 262,000
Gross profit (loss) (470,000) 106,000 (576,000)
Stock-based compensation charge 13,000 0 13,000
General and administrative expenses 622,000 663,000 (41,000)
Loss from operations (1,105,000) (557,000) 548,000
Other expense (599,000) (2,112,000) (1,513,000)
Net loss $(1,704,000) $(2,669,000) $ (965,000)
Revenues in the six months ended October 31, 2006 consisted of approximately
$461,000 of sales of HDS products and approximately $434,000 of FMI products. No
FMI products were sold in the three months ended October 31, 2005. The decrease
in HDS sales of approximately $172,000 (27%) resulted from sales to one
significant customer in the six months ended October 31, 2005 which did not
recur in the six months ended October 31, 2006. This decrease in HDS revenues
was more than offset by the sales of FMI products.
Gross profit was negatively impacted by operating losses at FMI of approximately
$467,000 primarily as a result of start-up costs as well as fixed costs, such as
occupancy, being spread over a low volume of revenue and high materials usage
and labor expenses that reflect start-up production of FMI's products and not
volume production.
Changes in stock compensation charge result from the adoption, in 2006, of FAS
123R. The decrease in general and administrative expenses reflects reductions in
expenses for payroll and corporate overhead costs which were offset by a
provision for loss on certain pre-merger litigation matters for approximately
$100,000 during the six months ended October 31, 2006.
The decrease in other expense reflects principally the reduction in amortization
of debt discount and financing costs of $1,656,000 in the six months ended
October 31, 2006 due to such costs being fully amortized as of December 31,
2005. This reduction was partially offset by an increase in interest expense of
approximately $53,000 due to higher debt levels and liquidated damages and
related interest of approximately $332,000 associated with the Company's failure
to perform under a registration rights agreement compared to approximately
$242,000 in such penalties in the six months ended October 31, 2005.
Three months ended October 31, 2006 compared to the three months ended October
31, 2005
Results of operations for the three months ended October 31, 2006 reflect the
following changes from the prior period:
Three months ended
October 31,
-------------------------
2006 2005 Change
----------- ----------- -----------
Revenuse $ 469,000 $ 247,000 $ 222,000
Gross profit (loss) (263,000) (34,000) (229,000)
Stock-based compensation charge 7,000 0 7,000
General and administrative expenses 348,000 350,000 (2,000)
Loss from operations (612,000) (384,000) 228,000
Other expense (306,000) (1,083,000) (777,000)
Net loss $ (924,000) $(1,467,000) $ (543,000)
Revenues in the three months ended October 31, 2006 consisted of approximately
$224,000 of sales of HDS products and approximately $245,000 of FMI products. No
FMI products were sold in the three months ended October 31, 2005. The decrease
in HDS sales of approximately $23,000 (9%) resulted from sales to one
14
significant customer in the three months ended October 31, 2005 which did not
recur in the three months ended October 31, 2006. This decrease in HDS revenues
was more than offset by revenues of FMI products.
Gross profit was negatively impacted by operating losses at FMI of approximately
$295,000 primarily as a result of start-up activities as well as fixed costs,
such as occupancy, being spread over a low volume of revenue and materials usage
and labor expenses that reflect start-up production not volume production.
Changes in stock compensation charge result from the adoption, in 2006, of FAS
123R. The decrease in other operating expenses reflects reductions in expenses
for payroll and corporate overhead costs in the current quarter which were
offset by a provision for loss on certain pre-merger litigation matters for
approximately $100,000 during the quarter.
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
October 31, 2006 due to such costs being fully amortized as of December 31,
2005. This reduction was partially offset by an increase in interest expense of
approximately $33,000 due to higher debt levels and liquidated damages and
related interest of approximately $169,000 associated with the Company's failure
to perform under a registration rights agreement compared to approximately
$151,000 in such penalties in the three months ended October 31, 2005.
Trends
The Company's historical revenue run rate is not at a level of profitable
operations. The Company experiences high fixed costs of maintaining a Good
Manufacturing Practices ("GMP") manufacturing facility (including FDA regulated
medical device manufacturing) and trained staff. As such, operations continued
to generate operating losses, and management anticipates it will continue to
generate losses in the absence of increased revenues or significant cost
reductions. Revenue levels are highly dependant on the stage of development of
customer projects. Customers order sporadically or in small production runs
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 costs
would need to be reduced significantly or other synergies would have to be
developed for the business to generate operating income.
One strategic effort to increase revenue and realize synergies is the October
2005 manufacturing agreement with Dicon. In the Dicon Agreement the Company
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 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 of such products during the six months ended
October 31, 2006 have aggregated approximately $434,000, approximately 48% of
consolidated revenues. Although the Company has added significant revenues under
the Dicon Agreement, losses from operations have increased rather than
decreased. This is generally because revenue levels are not yet sufficient to
absorb additional facilities, equipment and personnel that were added to take
advantage of this opportunity. During July 2006, the Company added an additional
$380,000 of equipment to produce the Dicon Agreement products which is not yet
operational. Such equipment can become operational upon the completion of
additional electrical work (and related approvals) which is still being
evaluated, and installation. Such work is subject to the current constraints of
our limited 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
January 31, 2007 and is secured by all of the FMI assets.
15
Liquidity, Capital Resources and Going Concern
The Company's liquidity at October 31, 2006 compared to April 30, 2006 is as
follows:
October 31, April 30,
2006 2006 Change
----------- ----------- -----------
Cash $ 27,000 $ 27,000 $ 0
----------- ----------- -----------
Deficit in working capital $11,736,000 $10,214,000 $ 1,522,000
----------- ----------- -----------
Liabilities in excess of assets $10,963,000 $ 9,602,000 $ 1,361,000
----------- ----------- -----------
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 six months ended October 31,
2006, the following items impacted liquidity negatively:
o losses from operations of approximately $1,105,000
o penalties and liquidated damages accrued of approximately $332,000
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
Net cash used in operating and investing activities in the six months ended
October 31, 2006 was approximately $536,000. These expenditures were largely
funded by net accounts receivable financing of approximately $78,000 and the
issuance of additional subsidiary senior secured notes of approximately
$450,000. The Company continues to experience losses from operations subsequent
to October 31, 2006. 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 $7,692,000. The Company's
subsidiary senior secured notes are due, as amended, on January 31, 2007 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 needs additional time to address its significant liquidity shortage
over a longer term. Over that longer term, the Company is attempting to improve
its liquidity through a combination of measures including renegotiating the term
of, or refinancing existing indebtedness if possible, increasing revenues at its
HDS operation, increasing Company-wide revenues by the manufacture and sale of
the FMI products and raising a significant amount of new capital.
During November 2006, the Company reached agreement with holders representing
more than 50% of the outstanding balance due to its senior secured convertible
debt holders to restructure the convertible notes under the following principal
terms cash payment of 80% of the outstanding principal, repayment of the
remaining outstanding amount in stock using a valuation of $0.02 per share at
such time as the authorized capital of the Company has been increased, no
further accrual of interest and registration rights penalties as of November 1,
2006 and the existing warrant exercise price would be reduced from $0.25 to
$0.025. Under the original loan with the senior secured parties, agreement of
holders of more than 50% of the outstanding amount is necessary to cause certain
amendments to the loan documents . This agreement is subject to closing prior to
January 31, 2007, after which date such agreement would terminate. Repayment of
the convertible debt contemplated by the agreement is subject to completion of a
contemplated debt financing which is under negotiation. There is no assurance
that such financing will be successfully negotiated or closed.
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
1.5% per annum. The installation and operation of such equipment requires the
additional expenditure on equipment and leasehold improvements of more than
$175,000. There are no other material commitments for capital expenditures.
16
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 October 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 October 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 six months ended October 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.
17
PART II- OTHER INFORMATION
Item 1. - Legal Proceedings
On October 27, 2006, a complaint was filed against the Company by Strategic
Corporate Initiatives, Ltd. in the Supreme Court of Nassau County alleging
nonpayment of $116,400 of consulting fees alleged to be due.
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 6. - Exhibits
Exhibits:
10.1 Letter dated as of October 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 October 31, 2006 to January 31, 2007.
10.2 Form of Noteholder Settlement Agreement
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
18
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: December 14, 2006
19
INDEX TO EXHIBITS
No. Description
- ---- -----------
10.1 Letter dated as of October 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 October 31, 2006
to January 31, 2007.
10.2 Form of Noteholder Settlement Agreement
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.
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