SCHEDULE 14c (Rule 14c-101)
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NESCO INDUSTRIES, INC.
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state how it was determined.)
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1) Amount Previously Paid: __________________________________________________
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NESCO INDUSTRIES, INC.
305 Madison Avenue
New York, New York 10165
INFORMATION STATEMENT
To the Holders of the Voting Stock:
The purpose of this Information Statement is to notify you that the
holders of shares representing a majority of the voting stock of Nesco
Industries, Inc. ("Nesco") have given their written consent to resolutions
adopted by the board of directors of Nesco (a) to effect an exchange of our
securities for outstanding securities and debt instruments of Hydrogel Design
Systems, Inc. ("HDSI") pursuant to a share exchange agreement dated April 29,
2004, as a consequence of which, on May 25, 2004, exchanging security holders of
HDSI acquired a majority of our outstanding voting stock, and HDSI became a
subsidiary of Nesco; and (b) to amend the articles of incorporation of Nesco so
as (1) to change the name of the company to "Aquamatrix, Inc." ("Aquamatrix"),
and (2) to increase the authorized number of common shares to 400,000,000. The
board of directors has fixed February 1, 2007 as the record date for determining
the holders of voting stock entitled to notice and receipt of this information
statement. We anticipate that this information statement will be mailed on March
6, 2007 to stockholders of record. On or after March 26, 2007, the amendment to
the articles of incorporation will be filed with the Nevada Secretary of State
and become effective.
The Nevada Revised Statutes permit holders of a majority of the voting
power to take stockholder action by written consent. Accordingly, Nesco will not
hold a meeting of its stockholders to consider or vote upon either the share
exchange agreement or the amendment to Nesco's articles of incorporation.
WE ARE NOT ASKING YOU FOR A PROXY.
YOU ARE REQUESTED NOT TO SEND US A PROXY.
/s/ Matthew Harriton
Matthew Harriton
President and Chief Executive Officer
By Order of the Board of Directors
March 2, 2007
SUMMARY
This summary presents selected information contained in this information
statement relating to the share exchange effected pursuant to the share exchange
agreement and the amendment to our articles of incorporation and may not contain
all of the information that is important to you. To understand the share
exchange and the amendment fully, you should carefully read this entire document
as well as the additional documents to which it refers. We have included page
references to direct you to a more complete description of the topics presented
in this summary.
Share Exchange (see page 4)
The share exchange was effected pursuant to a share exchange agreement
among us, Hydrogel Design Systems, Inc. ("HDSI"), and a majority of our
stockholders and of the stockholders of HDSI. As a consequence of the share
exchange, on May 25, 2004, HDSI became our majority owned subsidiary.
The Company (see page 9)
Nesco Industries, Inc.
305 Madison Avenue, Suite 4510
New York, NY 10165
Telephone: (212) 808-0607
Nesco Industries, Inc. ("Nesco") is a Nevada corporation. Our principal
business is conducted through our wholly-owned subsidiaries, HDSI and, since
January 2006, Foam Manufacturing, Inc. ("FMI"). HDSI 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. Our gel products are marketed by us under the
Aquamatrix(R) brand name, and by other manufacturers that use our products in
the products they sell to others. 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. Nesco acquired the rights to produce the FMI products during October
2005, when we entered into an agreement that grants us the exclusive rights to
manufacture and distribute these products in North America.
Prior to April 29, 2004, we were a "shell company," having ceased business
operations and become inactive in May 2003. Prior to May 2003, we were a
provider of asbestos abatement and indoor air quality testing, monitoring and
remediation services. We provided services through our 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"). Prior to our acquisition of HDSI, our business address
was 12-12 43rd Avenue, Long Island City, NY 11101, and our phone number was
718-937-5333.
HDSI (see page 9)
Prior to our acquisition of a majority of the outstanding securities of
HDSI, HDSI conducted the business of developing, manufacturing and selling high
water content polymer-based radiation ionized gel for medical and cosmetic uses
from the offices currently occupied by us.
Former Holders of HDSI Securities own a Majority of our Voting Securities (see
page 6)
The former holders of approximately 97% of HDSI common stock and 90% of
HDSI preferred stock have accepted our exchange offer, have exchanged their
shares of HDSI common stock and preferred stock for our securities and as a
result have become the owners of approximately 54.1% of our voting securities
outstanding at the time of the exchange. These former HDSI stockholders hold
approximately 50.2% of our voting securities as of the date of this information
statement.
If all of the remaining holders of HDSI common and preferred stock become
holders of our securities and convert such securities into shares of our common
stock, former HDSI stockholders would own approximately 55.3% and 51.5%
respectively, of the shares of our common stock outstanding at the time of the
exchange and as of the date hereof.
Issuance of Preferred Shares in Share Exchange (see page 5)
When we agreed to acquire a majority of the outstanding securities of
HDSI, we did not have enough shares of common stock available for issue under
our articles of incorporation to acquire all the securities of HDSI and assume
all of its share issuance obligations under various debt instruments and
options.
We agreed to issue to the former HDSI stockholders shares of our preferred
stock convertible into shares of our common stock once our articles of
incorporation are amended to provide for the issuance of such additional shares.
We made similar promises to the holders of other securities of HDSI that are
convertible into HDSI common stock.
Accounting Treatment (see page 5)
The accounting for the share exchange is a recapitalization of HDSI, with
HDSI being treated as the acquirer. The acquired assets and assumed liabilities,
if any, of Nesco are carried forward at their historical values.
Material US Federal Income Tax Considerations (see page 27)
There are no material U.S. Federal Income Tax consequences for either HDSI
or Nesco as a consequence of the share exchange. There are no U.S. Federal
Income Tax consequences resulting from the share exchange for holders of Nesco
common stock who have not participated in the share exchange.
Regulatory Approvals (see page 28)
We do not believe that the share exchange was subject to any state or
federal regulatory requirements. Other than the filing of this information
statement and a registration statement with respect to shares of our common
stock, including shares issuable upon conversion of securities issued in the
share exchange, and certain other filings under applicable securities laws and
the filing of the amendment to our articles of incorporation with the Secretary
of State of the State of Nevada, we do not believe that, in connection with the
share exchange and the amendment to our articles of incorporation, any consent,
approval, authorization or permit or filing with any regulatory authority will
be required.
Rights to Dissent (see page 30)
Under applicable Nevada law, holders of shares of Nesco common stock who
did not participate in the share exchange do not have the right to dissent and
exercise appraisal rights.
Interest of our Officers and Directors (see pages 23 and 27)
As a condition to the share exchange, we transferred our wholly owned
subsidiaries, NAC, IAP and NACE to a corporation controlled by Ronald Kuzon, a
former interim officer and consultant to Nesco. In consideration for an
indemnification undertaking, the transferee received 3,000,000 of our common
shares. We also issued an aggregate of 6,500,000 of our common shares to an
advisor, a limited liability company owned by an affiliate of Ronald Kuzon, for
2
services in connection with the share exchange agreement. This advisor, under
related contractual obligations, assigned an aggregate of 5,000,000 of these
common shares to third parties. On May 25, 2004, we entered into a two year
consulting agreement with an affiliate of Ronald Kuzon which provided for the
issuance of 2,000,000 of our common shares and a minimum monthly consulting fee
of $7,500. We also issued, in exchange for outstanding notes and accrued
payroll, convertible 8% debentures in the aggregate principal amounts of
approximately $385,000 to Mr. Matthew Harriton, our current president and chief
executive officer, and approximately $439,000 to Mr. Geoffrey Donaldson, our
former director and chief operating officer, and a like number of warrants.
The officer named below owns securities convertible into shares of our
common stock. Our other officers and directors do not own securities convertible
into shares of our common stock. Because we do not have sufficient authorized
shares of common stock, the securities can not presently be converted into
shares of common stock. Upon filing of the amendment to our articles of
incorporation, this limitation will no longer apply and all of such securities
will become convertible into shares of our common stock.
The following table sets forth the beneficial ownership as of February 1,
2007 of the below named officer, specifying the number of shares of common stock
then held directly (none) and the number of shares of common stock beneficially
owned as of such date. After the amendment becomes effective, the officer may
acquire direct ownership of all shares of common stock beneficially owned:
Shares of Common Stock held Shares of Common Stock
Name and Title in the form of Common Stock Beneficially Owned(1)
-------------- --------------------------- ---------------------
Matthew L. Harriton
President and Chief Executive Officer...... 0 8,910,244
Purpose of Information Statement
We are sending you this information statement to inform you of the share
exchange and the amendment to our articles of incorporation increasing the
number of authorized shares of common stock before the amendment becomes
effective. We are required to do this by the rules of the Securities and
Exchange Commission. We are not requesting a proxy. Please do not send us a
proxy.
- ----------
(1) See Footnotes 1 and 3 to the table under the heading "Voting Securities and
Principal Stockholders" on page 21 for additional information as to the shares
beneficially owned, and how beneficial ownership is determined.
3
SUMMARY SELECTED FINANCIAL INFORMATION
The financial information as presented below and elsewhere in this
information statement reflect the historical results of our predecessor entity,
HDSI, prior to May 25, 2004, the date of the share exchange agreement, and our
consolidated results of operations subsequent to the acquisition date of May 25,
2004.
Years ended April 30, Six Months
2004 2005 2006 Ended October, 2006
---- ---- ---- -------------------
Statement of Operations Data (Unaudited)
Total revenues ............... $ 623,349 $ 738,000 $ 1,001,000 $ 895,000
Total costs and expenses ..... 1,690,032 5,468,000 2,322,000 1,365,000
Other income (expense) ....... (432,358) (3,867,000) (3,078,000) (599,000)
Net loss ..................... (1,499,041) (8,597,000) (4,399,000) (1,704,000)
Net loss per share ........... ($0.34) ($0.55) ($0.25) ($0.09)
Balance Sheet Data:
Total Assets ................. 924,295 994,874 913,000 1,479,000
Working capital (deficit) .... (1,368,544) (6,048,423) (10,214,000) (11,736,000)
Total liabilities ............ 5,485,465 6,426,096 10,515,000 12,442,000
Stockholders' equity (deficit) (4,558,170) (5,431,222) (9,602,000) (10,963,000)
BACKGROUND AND REASONS FOR SHARE EXCHANGE
Nesco Industries, Inc. was incorporated in Nevada in March 1993, and was
inactive for a number of years. In March 1998, Nesco acquired NAC and NACE.
Nesco was a provider of asbestos abatement and indoor air quality testing,
monitoring and remediation services. In the fiscal year ended April 30, 2003, we
consolidated the operations of our various subsidiaries into a single
environmental services operating unit organized under the banner of our
wholly-owned subsidiary NAC. Prior to this consolidation, we also operated
through two other wholly-owned subsidiaries, IAP and NACE.
In the fourth quarter of fiscal 2003, we elected to deactivate the
environmental services operating unit and authorized NAC to cease business
operations in order to conserve financial and other resources until a new
business focus was identified. We ceased business operations in May 2003 and
wrote off goodwill, fixed assets and inventory in fiscal 2003. Our efforts at
that time were directed to winding down this business and considering other
ventures we might pursue.
On April 29, 2004, we entered into a share exchange agreement with HDSI, a
privately held Delaware corporation. The share exchange agreement provided that
HDSI would become a majority-owned subsidiary of Nesco, and upon completion of
the exchange, the holders of HDSI common stock and debt would hold a majority
interest of Nesco.
We initially became aware of HDSI through information provided by KSH
Securities, Inc. KSH Securities, Inc. had previously assisted us in obtaining
financing and knew of the opportunity with HDSI because of prior business
contacts with HDSI management. KSH Securities, Inc. did not participate in any
negotiations with HDSI, and did not receive any fee for introducing HDSI to us.
4
Ronald Kuzon, who was an interim officer and consultant to Nesco prior to
the share exchange, acted as a financial advisor to Nesco in negotiating the
terms of the share exchange with then senior management of HDSI. Mr. Kuzon also
provided due diligence services to Nesco in this engagement. Discussions and
negotiations involving the parties' respective officers and their financial
advisors took place over a period of several months commencing in December 2003.
The definitive share exchange agreement was signed on April 29, 2004 and the
transaction closed on May 25, 2004. The final exchange ratio was based on a
number of factors, including the parties' evaluation of the respective
liquidation preferences of their then outstanding preferred stock, their
respective debt obligations, Nesco's liquidity and ability to access capital
markets and HDSI's business prospects.
The share exchange was completed on May 25, 2004.
Accounting Treatment for Share Exchange
The accounting for the share exchange transaction is a recapitalization of
HDSI, with HDSI treated as the acquirer. The acquired assets and assumed
liabilities, if any, of Nesco are carried forward at their historical values.
HDSI's historical financial statements are carried forward as those of the
combined entity.
The auditors for HDSI have raised substantial doubts about the ability of
HDSI to continue as a going concern because of operating deficits, working
capital deficits and stockholder deficits. HDSI is not a development company.
Issuance of Preferred Shares
We had intended to issue shares of our common stock in exchange for the
equity securities of HDSI in certain ratios as provided for in the share
exchange agreement. However, because we did not have the required number of
authorized shares of common stock to complete the exchange on this basis, we
agreed to issue shares of our newly designated Series B convertible preferred
stock instead of common shares. Upon filing of a certificate of amendment to our
articles of incorporation to increase the number of shares of common stock that
we are authorized to issue, each share of our Series B convertible preferred
stock will be automatically converted into shares of our common stock at a fixed
ratio of 750 shares of common stock for each share of Series B convertible
preferred stock.
Steps to Effect Share Exchange Transaction
As a condition to the share exchange transaction, we transferred our
wholly-owned subsidiaries, NAC, IAP and NACE under the terms of a stock purchase
and assumption agreement to a newly-formed corporation, NAC Calabria Acquisition
Corporation, controlled by Ronald Kuzon, who had been an interim officer and
consultant to us. The transferee assumed all liabilities and obligations of
these subsidiaries and agreed to indemnify us against any claims. In
consideration for the indemnity, the transferee received 3,000,000 shares of our
common stock 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 the twelve month period immediately following
the closing for a price equal to the lesser of (a) all liabilities resulting
from the agreement between NAC and its labor union plus legal fees or (b)
$330,000, then Nesco would repurchase from the transferee 2,400,000 of the
common shares at that amount upon written notice from the transferee requesting
the repurchase. On May 25, 2005, Nesco agreed to extend the put right granted to
the transferee until May 25, 2006, subject to the condition that the right could
not be exercised until after January 1, 2006. The repurchase of the 2,400,000
common shares, which were subject to redemption by the transferee, was included
in Nesco's current liabilities at an aggregate of $330,000, the maximum amount
Nesco would be required to pay in the event of a redemption, until this put
right expired unexcercised on May 26, 2006, at which time the liabilities were
reclassified to common stock and additional paid in capital.
5
In addition to the transfer of our subsidiaries, we were required to
convert our outstanding stockholder debt to equity. On May 11, 2004, prior to
the date of the closing of the share exchange, the holders of this debt in the
aggregate principal amount of $952,501 agreed to exchange the debt for an
aggregate of 20,000 shares of our Series B convertible preferred stock, which is
convertible in the aggregate into 15,000,000 shares of common stock. We were
also required to obtain the consent to cancel an aggregate of 602,500 special
warrants prior to the closing. Certain holders of these special warrants were
granted shares of our common stock in the exchange as part of the common advisor
shares issued. Holders of our Series A convertible preferred stock also agreed
that, upon completion of the share exchange, they would convert their shares to
shares of our common stock and that we would have no further obligations in
respect to these preferred shares, including payment of any prior preferred
share dividends. In addition, we were required to have net cash of approximately
$350,000 at the closing of the transaction as part of the terms of the share
exchange agreement. We provided approximately $208,500 as a bridge loan to HDSI
prior to April 30, 2004. The bridge loan was applied to our net cash obligation,
which was satisfied at the closing of the share exchange.
Concurrent with the exchange, our Series A convertible preferred
stockholders agreed to exchange 512,500 shares of stock for an aggregate of
20,500 shares of our Series B convertible preferred stock, which will be
converted in the aggregate into 15,375,000 shares of common stock (a ratio of
approximately 30 of our common shares for each share of Series A convertible
preferred stock). As of February 1, 2007, 445,500 shares of Series A preferred
stock shares have been exchanged for 17,820 shares of Series B convertible
preferred shares.
Former Holders of HDSI Securities Own a Majority of Our Voting Securities
At the time of the share exchange transaction, HDSI common stockholders
exchanged 3,240,593 shares of HDSI common stock for 38,887 shares of our Series
B convertible preferred stock, which will be converted into 29,165,250 shares of
our common stock (a ratio of approximately nine of our shares for each share of
HDSI common stock). The HDSI preferred stockholders exchanged 295,853 shares of
HDSI preferred stock for 14,201 shares of our Series B convertible preferred
stock, which will be converted into 10,650,750 shares of our common stock (a
ratio of approximately 36 of our shares for each share of HDSI preferred stock).
Approximately 97% of the common and 90% of the preferred stockholders of HDSI
have exchanged their shares as of February 1, 2007, which has resulted in former
HDSI stockholders owning approximately 54.1% of our voting securities
outstanding at the time of the exchange and approximately 50.2% of our voting
securities outstanding as of the date of this information statement. Assuming
that the remaining HDSI stockholders exchange their shares, this will result in
55.3% of our voting securities outstanding at the time of the exchange, and
51.5% of our voting securities outstanding at the date hereof, being owned by
the former HDSI stockholders. Upon completion of this exchange, HDSI common
stockholders will exchange a total of 4,452,806 shares of HDSI common stock for
53,434 shares of our Series B convertible preferred stock, which will be
converted into 40,075,167 shares of our common stock (a ratio of approximately
nine of our shares for each share of HDSI common stock). The HDSI preferred
stockholders will exchange a total of 522,487 shares of HDSI preferred stock for
25,079 shares of our Series B convertible preferred stock, which will be
converted into 18,809,574 shares of our common stock (a ratio of approximately
36 of our shares for each share of HDSI preferred stock). The HDSI stockholders,
upon completion of the exchange of shares, will receive an aggregate of
58,884,741 of our common shares. These shares represented 55.3% of the total
shares outstanding at the time of the share exchange, which aggregated
106,386,847 equivalent common shares on May 25, 2004, and represents 51.5% of
the total shares outstanding as of the date of this information statement, which
aggregate 111,437,475 equivalent common shares.
6
In connection with the share exchange agreement, we also issued an
aggregate of 6,500,000 common shares (with a fair value of $975,000) to an
advisor, a limited liability corporation owned by an affiliate of Ronald Kuzon,
an interim officer and consultant, for services rendered in connection with the
share exchange agreement. This advisor, under related contractual obligations,
assigned an aggregate of 5,000,000 of these common shares to third parties.
Approximately 2,900,000 of these shares were issued to the parties who agreed to
cancel their special warrants, as described above. In addition to the issuance
of the common shares, we also incurred costs related to the exchange
approximating $48,000. Approximately $328,000 of these aggregate costs, the net
amount of cash retained at the time of the acquisition, were charged to equity,
and the balance of $695,000 was recorded as a charge to operations in the
quarter ended July 31, 2004.
Prior to the transaction, we had 7,627,105 common shares outstanding.
After giving effect to the transactions above and after such time that we
increase the number of shares that we are authorized to issue, we will have
approximately 106,387,000 common shares outstanding as of the exchange date.
This amount does not include the additional shares issuable pursuant to the
exchanges described in the following paragraph.
In addition to the exchange of shares, all outstanding options and
warrants of HDSI were exchanged for our options and warrants based on the same
ratios as the share exchange. This resulted in the issuance of options and
warrants to purchase approximately 25,137,000 common shares. These options and
warrants are currently exercisable at prices that range between $.08 and $.39
and expire between one and eight years from their issue date. Compensation
expense approximating $1,794,000 was recorded on May 25, 2004 for the increase
in the fair value of the vested HDSI options and warrants as a result of the
exchange. The HDSI debt holders were also granted, in consideration of an
extension of term debt, a warrant to acquire one share of our common stock for
each dollar of HDSI debt, for an aggregate issuance of warrants to purchase
2,736,000 shares of common stock. The total HDSI term debt of $2,736,000 was
also exchanged for our convertible debt, and the holders may convert this debt
to approximately 28,551,000 shares of our common stock. Approximately $156,000
of the total HDSI debt exchanged was attributed to the fair value of the
warrants and $1,703,000 was attributed to the intrinsic value of the beneficial
conversion feature. These amounts were recorded as equity components. The
remaining balance of $877,000 was recorded as long-term debt. Our convertible
debt bears interest at the rate of 8% per annum and matured on December 31,
2005. This debt is currently in default, and we intend to attempt to negotiate
an extension of the term of, or refinance, this debt. Convertible debt in the
amount of $1,933,000 has a conversion price of $.0833 per share, and the
remaining convertible debt in the amount of $803,000 converted at the time of
the share exchange has a conversion price of $.15 per share.
Prior to the transaction, we had options and warrants to purchase
approximately 4,212,500 shares of common stock outstanding. After giving effect
to the transactions above (including the cancellation of 602,500 warrants) and
the expiration of 1,050,000 options and warrants, we have options and warrants
to purchase approximately 31,483,000 shares of common stock outstanding and debt
convertible into approximately 28,551,000 common shares as a result of the
exchange agreement.
Share Exchange Agreement
The summary of the material terms of the share exchange agreement set
forth above under "Steps to Effect Share Exchange Transaction" and elsewhere in
this information statement is qualified in its entirety by reference to the
share exchange agreement, a copy of which is attached to this information
statement as Appendix A and which we incorporate by reference into this
document. This summary may not contain all of the information about the share
exchange agreement that is important to you. We encourage you to read carefully
the share exchange agreement in its entirety.
7
Summary of Consideration or Contributions in Exchange
The following table summarizes the respective consideration or
contributions by Nesco and HDSI referred to above in the exchange:
Nesco HDSI
----- ----
Approximately $350,000 in cash in HDSI's business and business assets
exchange for
Shares of Series B convertible preferred stock in Shares of HDSI common stock
exchange for
Shares of Series B convertible preferred stock in Shares of HDSI preferred stock
exchange for
Options and warrants to purchase shares of Nesco common Options and warrants to purchase shares of HDSI
stock in exchange for common stock and preferred stock
Shares of Series B convertible preferred stock in
exchange for our own indebtedness
Shares of Series B convertible preferred stock in
exchange for shares of our Series A convertible
preferred stock
Convertible debentures in exchange for HDSI indebtedness
Warrants to acquire common stock for extension of HDSI indebtedness
maturity of
8
Dilution from Share Exchange
The following table sets forth, as of May 25, 2004, the date of the share
exchange effected pursuant to the share exchange agreement, the dilution
in direct ownership of shares of common stock that will occur following
the effectiveness of the amendment to our articles of incorporation,
assuming that all of our securities issued pursuant to the share exchange
agreement are converted into shares of our common stock:
Number of
Shares Percentage of Number of Shares Percentage of
Outstanding Outstanding Outstanding after Shares Outstanding
Prior to Shares Prior Exchange assuming after Exchange
Sources of Share Issuances Exchange to Exchange Amendment assuming Amendment
- ----------------------------------------------------------------------------------------------------------------------------
Common Stock outstanding immediately after
share exchange.............................. 19,127,106 100% 19,127,106 11.61%
Conversion of Series B preferred stock into
common stock by debt holders............... 0 0 15,000,000 9.1%
Conversion of Series A preferred stock into
Series B preferred stock and subsequent
exchange into common stock................. 0 0 15,375,000 9.33%
Exchange of Series B preferred stock by
HDSI holders............................... 0 0 58,884,750 35.73%
Exercise of options and warrants exchanged
by HDSI holders............................ 0 0 27,873,032 16.91%
Conversion of debt held by HDSI holders....
0 0 28,550,747 17.32%
- ----------------------------------------------------------------------------------------------------------------------------
Total number of shares..................... 19,127,106 100% 164,810,635 100%
The 19,127,106 shares of common stock outstanding immediately after the
share exchange represent approximately 11.61% of the total number of shares of
common stock that would be outstanding on a fully diluted basis after giving
effect to the amendment, or a total dilution of approximately 88.39% for the
shares of common stock. The above table does not include 3,610,000 shares of
common stock issuable upon exercise of our options and warrants outstanding
prior to the share exchange.
BUSINESS
HDSI develops, manufactures and markets high water content, electron beam
cross-linked, aqueous polymer hydrogels used for wound care, medical
diagnostics, transdermal drug delivery and cosmetics. HDSI gels are produced
using unique proprietary manufacturing technologies which enable HDSI to
develop, manufacture and market electron beam cross-linked aqueous polymer sheet
hydrogels, which we refer to as "gels". Through discussions with various
customers of our products and through market research, to the best of
management's knowledge and belief, HDSI is one of two known manufacturers in the
world of these gels.
9
HDSI specializes in custom gels capitalizing on proprietary manufacturing
technologies. These capabilities allow HDSI to manufacture gels that meet the
rigid specifications of our customers, a key requirement in gels used for
delivery of active ingredients, the most rapidly growing component of the
hydrogel industry.
On October 3, 2005, Nesco, on behalf of a wholly-owned subsidiary to be
formed, entered into a manufacturing agreement with an entity affiliated with a
director of Nesco (H.H. Brown Shoe Technologies, Inc. doing business as Dicon
Technologies, referred to herein as "Dicon"). The agreement grants Nesco the
exclusive rights to manufacture patented hydrophilic urethane foam products,
polyurethane gels and moisture managed foam footwear inserts and to distribute,
along with Dicon, these products in North America in consideration of a 7-10%
royalty based on sales. The manufacturing agreement also provides for a supply
agreement between Nesco and Dicon. Products manufactured under this agreement
are being sold for use in cosmetic, medical, and household markets including the
foot-care market under the brand name DRYZ, a registered trademark. In December
2005, Foam Manufacturing, Inc. ("FMI") was formed as a wholly-owned subsidiary
of Nesco to control this activity and in February 2006, FMI entered into a lease
for a manufacturing facility. Nesco has been purchasing a significant amount of
its materials requirements under the agreement with Dicon directly from Dicon.
As such, Nesco owed Dicon approximately $240,000 for materials at October 31,
2006. Dicon has allowed Nesco 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.
In acquiring the manufacturing rights under the Dicon agreement we have
acquired rights to produce products that are similar to our HDSI products and
that address many of the same markets, customers and end users as the HDSI
products. Furthermore, there are production similarities between the FMI
manufacturing processes and the HDSI manufacturing processes. We have located
the FMI manufacturing facility within close proximity to the HDSI manufacturing
facility. Therefore, our strategy in acquiring the rights under the Dicon
agreement is to achieve production, management and marketing synergies with our
HDSI business.
Our HDSI gels exhibit significant potential in the following high growth
fields: topical therapeutics in moist wound/burn healing applications; in trans
(systemic) and intradermal (non-systemic) delivery of prescription and
non-prescription medications; cosmetic skin care; and components in medical
diagnostics. FMI manufactures products derived from "Hydrophilic Urethane
Chemistry." The hydrophilic system has two parts: a hydrophilic pre-polymer
phase and a water phase. During the water phase we introduce various water
soluble active ingredients into our products. Current ingredients incorporated
into our proprietary process include: health additives, moisturizers, super
absorbents, soaps, detergents, antibacterials, carbons, electrostatic
dissipative agents, fragrances, and waxes.
We have developed successful strategic relationships in each of these
categories with partners who are meaningful participants in these markets,
including the market leaders in several medical device categories and the
world's leading cosmetic companies.
Hydrogels are gel-like or colloidal substances made of water and solids.
They can be created chemically (through a combination of ultra violet
cross-linking and chemical interface), or by mixing polymer and water then
exposing it to an electron beam creating a "sheet" of water. Currently, and for
the foreseeable future, all of the hydrogel products that we produce are
electron beam cross-linked, water and polymer gels, a category in which our
hydrogels have a significant competitive advantage, in part due to the following
product characteristics: painless adhesion to the human body; stability of form
and composition; purity; reproducibility (manufacturing high quality product on
a consistent basis); compatibility with active ingredients; and high water
content.
10
Hydrophilic Urethane Foam comprises a prepolymer phase with a high
concentration of water to form a plastic membrane that wicks and absorbs up to
160 times its weight. In the water phase, many ingredients can be incorporated
in the foaming process. These ingredients become an integral part of the water
based membrane and can be released over time by heat or pressure. The process
lends itself to many industries such as apparel, sporting goods, athletic,
medical, footwear, and cosmetics.
Many of the competitive products feature physical characteristics which
are less desirable than those of Nesco's gels and foams. These include
aggressive skin bonding, chemical and form instability, lack of uniformity, low
water content, odor and active receptivity issues.
Nesco's products are manufactured using proprietary and non-proprietary
mixing, coating, drying and cross-linking technologies. Together, these
proprietary technologies enable us to produce gels and foams that can satisfy
rigid tolerance specifications with respect to a wide range of physical
characteristics - thickness, water content, adherence, absorption, vapor
transmission, release rates - while maintaining product integrity. These
manufacturing technologies allow us to participate in the development of Food
and Drug Administration ("FDA") regulated medical devices. We are currently
participating in other highly regulated, confidential projects. Management
believes that Nesco has sufficient capacity in its core assets to address the
anticipated manufacturing demand for all current and planned projects.
In addition to our ability to specifically regulate the aforementioned
physical characteristics of the gels and foams, we have the manufacturing
technology to offer broad choices in selection of liners, allowing customers to
create even tighter tolerances in vapor transmission and active ingredient
release rates, while personalizing color and texture, characteristics critical
in the cosmetic category.
While we believe that our products have significant commercial potential,
we recognize that such potential has not yet been achieved and may not occur. We
acknowledge that Nesco has never operated at a profit, incurred a loss of
$4,399,000 in our fiscal year ended April 30, 2006 and at October 31, 2006 had
an accumulated deficit of $25,385,000.
Our auditors have raised substantial doubts about our ability to continue
as a going concern because of operating deficits, working capital deficits and
stockholder deficits. We are not a development stage company.
We manufacture and market electron-beam cross-linked sheet gels,
hydrophilic foam and patches for use as moist wound/burn dressings with and
without active ingredients, components in certain medical devices, transdermal
and intradermal delivery of medication, and topical application of
non-prescription drugs, other skin care treatments and cosmetics. We market our
own brand of moist wound/burn dressings under the Aquamatrix(R) brand name, and
are currently developing additional line extensions of this product. In
addition, the gels and foams are prepared as components for products distributed
by our customers under their brand names. In addition to manufacturing roll
stock, Nesco offers our customers converting services, which creates competitive
advantage in pricing while expediting the production process. Nesco also
specializes in cutting sheet gels and roll stock foam to customers' specified
shapes, a converting process requiring technological expertise and pouching.
For the year ended April 30, 2006, Nesco filled orders from approximately
16 different customers. Of these, approximately 63% of the annual revenue is
attributable to four of these customers, which each had revenues in excess of
10% of our annual revenues individually and with our largest customer accounting
for approximately 23% of annual revenues. While we have a single manufacturing
facility located in the Northeast United States, our customers are located
throughout the world. The products for which our gels are used by our customers
include wound and burn dressings, transdermal drug delivery devices,
warming/cooling apparatus, and medical electrodes. Our non-gel customers utilize
11
our electron accelerator for material modification (the enhancement of materials
through cross-linking).
We have identified several markets in which to market the products by
identifying those fields, such as wound care, which offer reasonable means of
entry, in which we have some form of competitive advantage and those which offer
meaningful growth opportunities. Several of these markets fall under the
regulatory authority of the FDA. Our basic wound care dressings are Class I
exempt devices and therefore are subject only to very basic regulatory
requirements. Some of our other products, including those which incorporate
active ingredients, may fall under more stringent FDA regulatory requirements
that may require prior approvals or testing before the products are sold.
As of December 15, 2006, Nesco and its subsidiaries had 23 employees, one
in administration and 22 in manufacturing and quality control. Additionally,
Nesco has utilized the services of temporary factory workers in the operations
of its FMI subsidiary. Approximately 12 such workers were utilized as of
December 15, 2006, and plans continue to be implemented to hire a full time
workforce for FMI potentially including some of these temporary resources.
We believe we have good relations with our employees and other human
resources, and have never incurred a significant work stoppage due to any strike
or protest by our employees.
During August 2006, Nesco 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 Nesco and its
former subsidiary NAC who were all named as Defendants/Judgment Debtors in a
matter filed against our former subsidiary NAC, Nesco 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 Nesco 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.
Nesco believes that the above matters, which are related to business
activities prior to its merger in 2004, are covered by the indemnification
provided by NAC Calabria, an affiliate of Ronald Kuzon, under the share exchange
agreement completed on May 25, 2004. Nesco 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, Nesco 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, Nesco has accrued approximately $100,000 as its
estimate of settlement and legal costs that may not be recoverable under
indemnification.
On February 15, 2007, we consummated a financing transaction with certain
unaffiliated accredited institutional investors, from which we have received
gross proceeds of $4.150 million. Details of this financing transaction are
disclosed in our Current Report on Form 8-K filed with the Securities and
Exchange Commission on February 22, 2007.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis for Fiscal Years ended April 30, 2006 and
April 30, 2005
Results of Operations
Results of operations for the year ended April 30, 2006 reflect the
following changes from the prior period:
April 30,
2006 2005 Change
---- ---- ------
Sales .......................... $ 1,001,000 $ 738,000 $ 263,000
Gross (loss) ................... (140,000) (190,000) (50,000)
Stock compensation charge ...... 67,000 3,011,000 (2,944,000)
Amortization and other ......... 0 136,000 (136,000)
Other operating expenses ....... 1,114,000 1,393,000 (279,000)
Loss from operations ........... (1,321,000) (4,730,000) 3,409,000
Other expense .................. (3,078,000) (3,867,000) 789,000
Net loss ....................... ($4,399,000) ($8,597,000) $ 4,198,000
Revenues increased by approximately 36% due to the stage of development of
revenue projects in the year ended April 30, 2006 as compared to 2005. Customer
mix was also a factor, as four customers accounted for approximately 63% of the
higher revenues in the fiscal year ended April 30, 2006 as compared to two
customers accounting for approximately 62% of revenues in the fiscal year ended
April 30, 2005. The most significant customer in the year ended April 30, 2005
reduced its purchases in the current fiscal year by approximately 50%, and that
decrease was more than replaced with other customer business. FMI products
represented only approximately $26,000 of consolidated revenues as shipments did
not begin until the last week in April 2006.
The decrease in gross (loss) of approximately $50,000 reflects two
factors: (1) approximately $173,000 of gross margin improvement on sales of HDSI
products due largely to fixed overhead costs being utilized over approximately
$263,000 of higher revenues offset partially by (2) losses associated with the
start up of the production of the FMI products of approximately $123,000.
The reduction in stock compensation charge reflects stock compensation
granted in the prior year that did not recur in the current year. The reduction
in amortization and other of approximately $136,000 reflects the completion in
2005 of amortization associated with certain licensed technology. The reduction
in other operating expenses of approximately $279,000 reflects principally lower
professional costs and consulting fees subsequent to the merger and related
activity in the prior year as well as lower insurance costs and human resources.
The decrease in other expense reflects principally: (a) the charge in the year
ended April 30, 2005 of $713,000 for stock issuance costs, which did not recur
in the current fiscal year and (b) the decrease of an aggregate of approximately
$654,000 of amortization of debt discount and financing costs, which were fully
amortized in the third quarter of the fiscal year ended April 30, 2006, offset
13
by (c) increases in interest expense of approximately $53,000, (d) the permanent
impairment of available-for-sale security and (e) an increase in penalties
associated with Nesco's failure to perform under a registration rights agreement
of approximately $456,000. Such registration rights penalties are continuing at
approximately $46,000 per month plus interest on the unpaid penalties.
Liquidity, Capital Resources and Going Concern
Nesco's liquidity at April 30, 2006, compared to April 30, 2005, is as
follows:
April 30, April 30,
2006 2005 Change
---- ---- ------
Cash .............................. $ 27,000 $ 22,000 $ 5,000
Deficit in working capital ........ $10,214,000 $ 6,049,000 $ 4,165,000
Liabilities in excess of assets ... $ 9,602,000 $ 5,431,000 $ 4,171,000
Debt in default ................... $ 7,133,000 $ 0 $ 7,133,000
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, including approximately $3,013,000 which is secured by the assets
of Nesco and its subsidiaries. These amounts, plus interest and penalties of
approximately $1,547,000 through that date, are now in default. Interest and
penalties continue to accrue at more than $83,000 per month. We do not have the
funds to pay these debts. We are attempting to (a) raise new capital and (b)
negotiate an extension of the term or other restructure of each of the above
debts. In addition, approximately $805,000 face amount ($480,000 face amount at
April 30, 2006) of subsidiary senior secured notes and interest at April 30,
2006 are due on July 31, 2006, and we do not have the funds to repay this loan.
Furthermore, Nesco spent $50,000 of cash and incurred an additional $330,000 of
debt in June 2006 in connection with the purchase of certain "second line"
equipment under the Dicon manufacturing agreement. Debt service payments of
approximately $11,000 per month on such debt begin in September 2006 as
discussed in "Commitments for Capital Expenditures" below.
In addition, Nesco has obligations under long-term operating leases as
described in the notes to consolidated financial statements included later in
this information statement. Arrearages of approximately $375,000 exist for the
rent in the HDSI manufacturing facility and Nesco's headquarters office, which
are leased from related parties. These arrearages extend for more than one year
and are continuing. Further, Nesco ceased paying cash compensation to its chief
executive officer during October 2005 and is indebted to him for approximately
$106,000 of unpaid payroll at April 30, 2006. Such non-payment has continued
subsequent to April 30, 2006.
Net cash used in operating and investing activities in the years ended
April 30, 2006 and 2005 was approximately $762,000 and $1,718,000, respectively.
These expenditures were largely funded in the year ended April 30, 2006 by
advances of approximately $165,000 from a related party, accounts receivable
financing of approximately $122,000 and the issuance of subsidiary senior
secured notes of approximately $480,000. In the year ended April 30, 2005, these
expenditures were largely funded by the issuance of $2,295,000 of 8% senior
secured convertible debentures due in December 2005, net of expenses and pay
down of other debts. Nesco continues to experience losses from operations
subsequent to April 30, 2006.
All of these factors above, among others, indicate that Nesco may be
unable to continue operations as a going concern.
14
Nesco 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 and others. In the year ended April 30,
2006, the following items impacted liquidity negatively:
o Operations - Losses from operations of approximately $1,321,000,
approximately 10% of which represents start-up losses at FMI
o Finance - Interest and penalties on debt obligations of
approximately $1,031,000, which interest and penalties continue to
accrue at more than $90,000 per month
o Amortization of debt discount - Normal amortization of debt discount
of $1,731,000 increases the outstanding balance reported as debt by
a systematic charge to earnings
o Capital expenditures - Purchases of equipment and deposits on a new
lease aggregate approximately $413,000 for the FMI subsidiary
These negative impacts to liquidity, approximately $4,496,000, were
partially offset by the proceeds from issuance of subsidiary senior secured
notes, accounts receivable financing and advances from affiliates aggregating
approximately $767,000. Subsequent to April 30, 2006, an additional $325,000 was
raised through the issuance of additional senior secured subsidiary notes. Such
notes were due, as amended, on July 31, 2006 (earlier if a financing of $500,000
or more is completed) and are secured by all of the assets of FMI. These amounts
are now in default and we intend to attempt to negotiate an extension of the
term of, or refinance, this debt.
We intend to attempt to improve our liquidity through a combination of
measures including: (a) renegotiating the term or other restructuring of
existing indebtedness if possible, (b) increasing revenues at our Hydrogel
operation, (c) increasing company-wide revenues through operations of the Dicon
agreement, (d) raising a significant amount of capital and (e) other measures.
Commitments for capital expenditures
In June 2006, Nesco purchased certain "second line" equipment 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 implies the additional expenditure
on equipment and leasehold improvements of more than $175,000. There are no
other material commitments for capital expenditures.
Off-Balance Sheet Arrangements
At April 30, 2006, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which would have been
established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. In addition, Nesco does not
engage in trading activities involving non-exchange traded contracts. As such,
Nesco is not exposed to any financing, liquidity, market, or credit risk that
could arise if Nesco had engaged in such activities.
15
Management's Discussion and Analysis for Six Months ended October 31, 2006 and
October 31, 2005
Results of Operations - Six Months ended October 31, 2006 compared to 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:
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 HDSI products and approximately $434,000 of
FMI products. No FMI products were sold in the three months ended October 31,
2005. The decrease in HDSI 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 HDSI
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 Nesco'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.
16
Results of Operations - Three Months ended October 31, 2006 compared to 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
---- ---- ------
Revenues ....................... $ 504,000 $ 247,000 $ 257,000
Gross profit (loss) ............ (244,000) (34,000) 210,000
Stock-based compensation charge
7,000 0 7,000
General and administrative ..... (2,000)
expenses .................... 348,000 350,000
Loss from operations ........... (599,000) (384,000) 215,000
Other expense .................. (307,000) (1,083,000) (776,000)
Net loss ....................... ($ 906,000) ($1,467,000) ($ 561,000)
Revenues in the three months ended October 31, 2006 consisted of
approximately $224,000 of sales of HDSI products and approximately $245,000 of
FMI products. No FMI products were sold in the three months ended October 31,
2005. The decrease in HDSI sales of approximately $23,000 (9%) resulted from
sales to one 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
HDSI 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 Nesco'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.
17
Liquidity, Capital Resources and Going Concern
Nesco'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
----------- ----------- -----------
Nesco currently does not have the liquidity or financing available to it
to fund our 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. Nesco 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. Our subsidiary
senior secured notes are due, as amended, on January 31, 2007 and Nesco does not
have the means to pay that debt. All of these factors, among others, indicate
that we may be unable to continue operations as a going concern.
Nesco needs additional time to address our significant liquidity shortage
over a longer term. Over that longer term, Nesco is attempting to improve our
liquidity through a combination of measures including renegotiating the term of,
or refinancing existing indebtedness if possible, increasing revenues at our
HDSI 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, Nesco 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 our authorized capital 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.
18
Commitments for capital expenditures
In June 2006, we 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 implies the additional expenditure
on equipment and leasehold improvements of more than $175,000. There are no
other material commitments for capital expenditures.
Trends
Our historical revenue run rate is not at a level of profitable
operations. Despite increases in revenues in the fiscal year ended April 30,
2006, 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. While losses from operations decreased
significantly in the fiscal year ended April 30, 2006, 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 HDSI products. Further, these
new products address many of the same markets, customers and end users as the
HDSI products, namely cosmetic, medical, and household markets. Furthermore,
there are production similarities between the manufacturing processes for these
new products and the HDSI manufacturing processes. We have opened a
manufacturing facility for production of these new products within close
proximity to our existing HDSI 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 HDSI
business. We 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 we have 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, we 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 we can generate our 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.
Critical Accounting Policies
Our critical and significant accounting policies, including the
assumptions and judgments underlying them, are disclosed in the notes to the
consolidated financial statements included with this information statement.
19
These policies have been consistently applied in all material respects and
address such matters as revenue recognition and depreciation methods. The
preparation of the consolidated financial statements in conformity with
generally accepted accounting principles in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities as of
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. An accounting policy that we consider to be material is
the following.
Going concern and liquidity. At October 31, 2006, Nesco 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 Nesco's
ability to continue as a going concern. Nesco'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 our continued
operation as a going concern.
The interim condensed consolidated financial statements accompanying this
information statement have been prepared in conformity with accounting
principles generally accepted in the United States of America, which contemplate
Nesco's continuation 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 Nesco be unable to
continue in existence.
New Accounting Pronouncements
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 Nesco is May 1, 2006. Nesco 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 based on the
requirements of SFAS No. 123 for all unvested awards granted prior to the
effective date of SFAS No. 123R.
The adoption of this statement has had no effect on net loss and loss per
share due to the adoption of the "modified prospective" method for existing
options and the fact that no new options have been granted.
20
VOTING SECURITIES AND PRINCIPAL STOCKHOLDERS
We determined the stockholders of record for purposes of the information
statement as of the close of business on February 1, 2007, which we refer to as
the record date. On the record date, our authorized voting stock consisted of
25,000,000 shares of common stock, 850,000 shares of Series A convertible
preferred stock and 150,000 shares of Series B convertible preferred stock. Each
share of common stock is entitled to one vote, each share of Series A
convertible preferred stock is entitled to 30 votes and each share of Series B
convertible preferred stock is entitled to 750 votes. On the record date, there
were 21,636,225 shares of common stock, 67,000 shares of Series A convertible
preferred stock and 117,055 shares of Series B convertible preferred stock
outstanding and entitled to vote. Upon conversion, there shares would aggregate
111,437,475 common shares.
We are in the process of increasing our authorized common number of shares
to 400,000,000 shares at which time Series A and Series B convertible preferred
stock will be exchanged for common shares. Upon conversion, these shares would
aggregate 89,801,250 common shares.
The following table sets forth the beneficial ownership as of February 1,
2007 with respect to the beneficial ownership of Nesco's common stock by
officers and directors, individually and as a group, and all holders of more
than 5% of the common stock. For this purpose, each outstanding share of Series
A convertible preferred stock has been treated as having been converted into 30
common shares and each outstanding share of Series B Stock has been treated as
having been converted into 750 common shares. Unless otherwise indicated, all
shares are beneficially owned and sole investment and voting power is held by
the beneficial owners indicated.
Name and Address of Amount and Nature of Percent
Beneficial Owner Beneficial Ownership (1) of Class
- ----------------------------------------------------------------------------------------------
Santo Petrocelli, Sr. (2)(7) ...................... 19,741,667 17.52%
Cornell Capital Partners L.P. .....................
101 Hudson Street
Jersey City, New Jersey 07302 (4) ................. 12,074,739 9.99%
Richard Harriton (5)(7) ........................... 27,840,007 20.03%
Matthew Harriton (3)(7) ........................... 8,910,244 7.54%
Gene E. Burelson (7) .............................. -0- *
Wayne M. Celia (7) ................................ -0- *
Joel S. Kanter (7) ................................ -0- *
Arlen Reynolds (7) ................................ -0- *
KSH Strategic Investments
575 Jericho Turnpike
Jericho, NY 11753 (6) ............................ 10,316,500 8.76%
Directors and Officers
as a Group (5 persons) ............................ 8,910,244 7.54%
* Less than 1% unless otherwise indicated.
(1) As used herein, the term beneficial ownership with respect to a
security is defined by Rule 13d-3 under the Securities Exchange Act
of 1934 as consisting of sole or shared voting power (including the
power to vote or direct the vote) and/or sole or shared investment
power (including the power to dispose or direct the disposition of)
21
with respect to the security through any contract, arrangement,
understanding, relationship or otherwise, including a right to
acquire such power(s) during the next 60 days. Unless otherwise
noted, beneficial ownership consists of sole ownership, voting and
investment rights. Additionally, the number of shares shown assumes
the conversion or exercise of all Series A convertible preferred
stock, Series B convertible preferred stock, convertible debentures,
warrants and vested options.
(2) Mr. Petrocelli was the chairman and a director of Nesco until June
22, 2004. The above number of shares beneficially owned includes
2,900,000 shares owned by Petrocelli Industries, Inc. and 566,667
shares owned by SMFS Corp. Mr. Petrocelli is the president and chief
executive officer of Petrocelli Industries, Inc., and beneficially
owns 25% of its outstanding capital stock. The other 75% is owned by
members of Mr. Petrocelli's family. Mr. Petrocelli is the president
of SMFS Corp. In addition, the number of shares beneficially owned
includes 1,000,000 shares issuable upon the exercise of a warrant
issued in March 2002 to Mr. Petrocelli and 275,000 shares issuable
upon the exercise of a warrant issued in December 2003 to Petrocelli
Industries, Inc.
(3) Mr. Matthew Harriton is our president, chief executive officer,
chief financial officer and a director. Mr. Harriton is also chief
executive officer and a director and the holder of approximately
32.1% of the outstanding common and Class B shares of Embryo
Development Corp., a public company traded under the symbol "EMBR,"
which holds a 4.44% beneficial interest in us. The above number of
shares beneficially owned includes 2,430,647 shares issuable upon
the conversion of debt, 364,597 shares issuable upon exercise of a
warrant granted for the extension of debt, and 4,000,000 of a total
of 5,000,000 shares issuable upon exercise of a warrant granted as
part of Mr. Harriton's employment agreement in May 2004, 1,000,000
of which are not exercisable until the third anniversary of his
employment agreement.
(4) The above number of shares beneficially owned by Cornell Capital
includes 4,666,669 shares issuable upon the conversion of a
debenture, and 4,666,669 shares issuable upon the exercise of
warrants granted in conjunction with a convertible debenture. Marc
Angelo and Troy Willow, the president and senior vice president,
Capital Markets, respectively, of Cornell Capital Partners L.P. hold
voting and investment control over the shares held by Cornell.
(5) The above number of shares beneficially owned by Mr. Richard
Harriton includes 15,696,000 shares issuable upon the conversion of
debentures, and 11,874,007 shares issuable upon the exercise of
warrants granted in conjunction with convertible debentures and for
the extensions of debenture debt of HDSI. Both the convertible
debenture and the related warrants have been converted to our debt
and warrants. Mr. Richard Harriton is a related party of Mr. Matthew
Harriton, a director and officer (See (3) above).
(6) The above number of shares beneficially owned by KSH Strategic
Investment Fund includes 3,900,000 shares issuable upon the
conversion of a debenture, 2,417,500 shares issuable upon the
exercise of warrants granted in conjunction with a convertible
debenture and for the extensions of such debenture debt of HDSI.
Both the convertible debenture and the related warrants have been
converted to our debt and warrants. Cary Sucoff and Harvey Kohn,
each a manager of KSH Strategic Investment Fund, hold voting and
investment control over the shares held by KSH. Strategic Investment
Fund.
(7) The address for these entities and individuals is c/o Nesco
Industries, Inc., 305 Madison Avenue, Suite 4510, New York, New York
10165
22
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Relationships and Related Transactions of Nesco Unrelated to the HDSI Share
Exchange Agreement:
During the six months ended October 31, 2006, Nesco 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 (Gene Burleson, $50,000, Arlen Reynolds, $20,000)
and other related parties and affiliates (Kanter Family Foundation, $25,000,
Richard Harriton, $70,000), as well third parties (Chicago Investments, Inc.,
$390,000 and CIBC, solely as Trustee for T-555, $250,000). $100,000 of the
amounts borrowed from the initial investor in the senior secured notes may be
converted into new instruments upon the completion of a proposed financing.
Beginning in November 2005, we began raising short-term financing through
financing our accounts receivable. Under this program, specific accounts
receivable are sold at a discount and we retain 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. Nesco records this as a financing transaction in which the receivables
sold are carried on the consolidated balance sheet and the amount to be repaid
is reflected as a short-term debt. At October 31, 2006, approximately $183,000
of this liability was payable to Richard Harriton or an affiliate of Richard
Harriton.
On May 25, 2004, Nesco entered into a two-year consulting agreement with
JMK Associates, an affiliate of Ronald Kuzon who was interim officer and
consultant of Nesco, 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 based on the market price of
$0.15 on the date of the consulting agreement) was charged to operations in the
quarter ended July 31, 2004. As of October 31, 2006, Nesco owed Mr. Kuzon
approximately $34,000 in consulting fees associated with this agreement, net of
expenses advanced on his behalf.
On May 25, 2004, Nesco entered into a one-year advisory services agreement
with Marlin Financial Group, Inc. 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 ($102,250 based on the market price of $0.15 on the date of the
agreement) was charged to operations in the quarter ended July 31, 2004. On
December 17, 2004, Nesco terminated the agreement, which was cancelable by
either party after six months. On January 5, 2005, Nesco issued an aggregate of
908.89 shares of Series B convertible preferred shares (convertible into 681,667
common shares) as per the agreement.
On July 1, 2004, Nesco entered into an investment banking agreement with
Sloan Securities Corp. for the sale of up to $3,000,000 principal amount of 8%
senior secured convertible notes due December 1, 2005, with interest payable on
December 1 and June 1 semi-annually, either in cash or common stock, and
convertible into common stock at $0.15 per share. The notes are secured by the
assets of Nesco. Each note was issued with a five-year warrant to purchase
shares of Nesco's common stock at $0.25 per share or warrants to purchase
666,667 shares for each $100,000 of principal amount of notes purchased. As a
result of the agreement, which terminated on September 30, 2004, Nesco received
$2,295,000 in gross proceeds in connection with this agreement convertible into
15,300,000 common shares and issued warrants to purchase 15,300,000 shares.
Under the terms of the private placement Nesco agreed to undertake to register
23
the common stock issuable upon the conversion of the notes and the exercise of
the warrants. The balance due on the notes at October 31, 2006 is approximately
$3,345,000 consisting of approximately $2,295,000 in principal, approximately
$264,000 of accrued interest and approximately $786,000 of accrued registration
rights penalties and interest. Interest expense for the years ended April 30,
2006 and 2005 was approximately $183,000 and $136,000. On December 1, 2004,
Nesco issued 390,305 shares of common stock as payment for the interest due in
the aggregate of approximately $59,000. Financing fees in connection with this
agreement approximated $286,000 and were amortized over the term of the
convertible notes. At October 31, 2006, none of this debt had been converted.
In connection with this agreement, Nesco issued the broker warrants to
acquire 5,052,600 shares of Nesco common stock at an exercise price of $0.15 per
share. The fair value of the warrants ($405,000) was charged to operations over
the life of the underlying debt.
Additionally, under the terms of a related registration rights agreement,
Nesco was required to file a registration statement to effectively register the
common stock issuable upon the conversion of the notes and exercise of the
warrants no later than 60 days after the termination of the offering. Because
Nesco did not file the required registration statement until January 27, 2005,
liquidated damages in the amount of 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 $91,800 in Nesco
common stock. The fair value of the shares due ($91,800) has been charged to
operations and this expense is included in current liabilities as these shares
have not been issued at April 30, 2006. Nesco was also required to have such
registration statement declared effective by July 27, 2005. In November 2005,
Nesco withdrew the registration statement. Penalties of 2% per month accrue for
the failure to have the registration statement declared effective. Interest on
the unpaid penalties accrues at 18% per annum. Accrued penalties and related
interest on penalties were approximately $786,000 at October 31, 2006 and
continue to accrue at approximately $47,000 per month plus interest.
On August 23, 2004, Nesco entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, LP, an investment firm. Under the terms
of the agreement, the investment firm has committed to purchase up to
$10,000,000 of common stock at a purchase price equal to 98% of the market price
at the time of purchase. The investment firm is entitled to a 5% commission per
transaction. The equity line could be drawn down upon (a) an increase in the
authorized shares of the Company and (b) a registration statement covering the
shares being declared effective by the Securities and Exchange Commission.
Amending the articles of incorporation requires vote of, or notification to,
stockholders. On November 4, 2005, Nesco withdrew the registration statement
thereby effectively terminating the financing. No proceeds were or will be
raised under this financing.
As consideration for entering into the Standby Equity Distribution
Agreement, we granted Cornell Capital Partners, LP 3,266.66 shares of Series B
convertible preferred stock (convertible into 2,450,000 common shares) and paid
a $70,000 cash consulting fee. In addition, we granted the placement agent 66.66
shares of Series B convertible preferred shares (convertible into 50,000 common
shares). The fair value of the shares ($625,000) as well as $17,500 in fees and
the $70,000 cash consulting fee associated with this agreement were recorded on
the balance sheet as stock issuance costs in the quarter ended October 31, 2004.
Such costs were charged to operations in the fiscal year ended April 30, 2005.
On November 1, 2004, we entered into a one-year advisory services
agreement with Strategic Corporate Initiative, Ltd. which provides for
compensation of $10,000 per month, of which $1,800 will be payable in cash and
$8,200 will be payable, at Nesco's discretion, in cash or in common stock. The
common stock payment will be based each month on the closing bid price of common
stock on the first day of the month for which payment is due. The consultant
will 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
24
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 Nesco to receive its accrued but unpaid
compensation in the alleged amount of $116,400.
On November 15, 2004, Nesco entered into a one-year consulting agreement
with Waterville Investment Research, Inc. 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 ($46,920 based on the market price of $0.17 on the date of
the agreement) has been charged to operations and this expense is included in
current liabilities as these shares have not been issued at April 30, 2005. In
December 2005, we issued 368 shares of Series B convertible preferred stock
(which are convertible into 276,000 shares of common stock) in order to settle
this obligation in stock.
On December 14, 2004, Nesco entered into two four-month consulting
agreements with Barry Constantine and Jordan Warshafsky for advisory services
related to financial matters and marketing. Each agreement provides for the
payment of a monthly fee of $7,800 and the issuance of a five-year warrant to
purchase 40,000 shares of the common stock exercisable at the closing price on
the date of the agreement ($0.15). The warrants vest at the rate of 10,000
shares per month. The fair value of the warrants ($12,000) were charged to
operations in the fiscal year ended April 30, 2005. These agreements were not
paid according to their terms and in February 2006, we reached a settlement with
Mr. Constantine and Mr. Warshafsky calling for 6 monthly payments of $1,593.75
and $943.75, respectively followed by six monthly payments of $4,781.25 and
$2,831.25, respectively.
On December 20, 2004, we entered into a one-year advisory services
agreement with Ira Siegel which provides for compensation in the form of a five
year warrant to purchase 204,000 shares of common stock at an exercise price of
$0.15. The warrants vested at the rate of 1/3 immediately, 1/3 on the six month
anniversary of the agreement and 1/3 one year from the agreement date. 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.
During November 2006, Nesco 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 Nesco 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 our Annual Report on Form
10-KSB for the year ended April 30, 2006.
Relationships and Related Transactions of Nesco Related to the Operations of
HDSI Prior to and as a Result of the Share Exchange Agreement
Nesco had an aggregate balance due to an affiliate, Embryo Development
Corp., in connection with an $850,000 8% revolving line of credit, which expired
in September 2002. The balance due on this obligation was approximately $15,000
at April 30, 2004. Subsequent to April 30, 2004, the balance with accrued
interest has been paid in full. Embryo Development Corp. held approximately
11.4% of the common stock of HDSI prior to the share exchange and currently
holds approximately 4.44% of the common stock of Nesco as a result of the
25
exchange. HDSI was a majority-owned subsidiary of Embryo Development Corp. Since
the inception of HDSI, Embryo Development Corp.'s equity interest has decreased
as financings have occurred. Matthew Harriton, our president, chief executive
officer, chief financial officer and director, is also chief executive officer
and a director and the holder of approximately 32.1% of the outstanding common
and Class B shares of Embryo Development Corp.
On January 25, 2002, the manufacturing facility of HDSI was purchased by
an entity owned by a related party, Mr. Richard Harriton, the father of Mr.
Matthew Harriton, the then chief executive officer and president of HDSI and
currently the chief executive officer and president of Nesco. In addition, Mr.
R. Harriton has a beneficial ownership in Nesco of approximately 20.29% upon
conversion of all outstanding warrants and debt issued to him and holds debt in
the amount of $1,308,000 convertible to 15,696,000 shares of common stock as a
result of the share exchange. On January 25, 2002, HDSI entered into a lease
with 2150 Cabot, LLC, an entity owned by Mr. R. Harriton, which provides for
minimum monthly rental payments of $11,687 and expires in 2012. The rent
increases by 5% every two years for the duration of the lease. On September 30,
2002, in consideration for extension of certain debt due, the rent increase of
5% effective February 1, 2004 was increased by an additional 10%. The rent
increases subsequent to that date, every two years, remain at 5% of the prior
period amount inclusive of the 10% additional one-time increase. HDSI also
entered into a month to month lease for office space with another entity, Park
Avenue Consulting, owned by Mr. R. Harriton in December 1, 2001 which terminated
in April 2004. Unpaid rents of approximately $312,000, $77,000 and $229,000 were
due to Mr. R. Harriton on these leases as of April 30, 2006, 2005 and 2004,
respectively. In addition, Mr. Harriton made temporary advances to Nesco during
2006 and 2005, of which approximately $243,000 and $78,000, respectively, was
due to Mr. Harriton at April 30, 2006 and 2005 and approximately $256,000 was
due at October 31, 2006.
As of April 30, 2004, Mr. Richard Harriton had loaned HDSI an aggregate of
$1,308,000. HDSI 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, Mr. Harriton agreed, upon consummation of 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 nine Nesco common shares for each
common share of HDSI stock and 36 Nesco common shares for each preferred share
of HDSI stock). On May 25, 2004 the exchange was completed. This debt is
convertible at approximately $0.08 per share into an aggregate of approximately
15,696,000 shares of Nesco. Mr. Harriton, was also granted, in consideration for
an extension and exchange of the debt, 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 HDSI debt for an aggregate of the issuance of 1,308,000 warrants. The
balance due on the note at April 30, 2006 was approximately $1,652,000,
consisting of approximately $1,308,000 in principal and approximately $344,000
of accrued interest. Interest expense was approximately $105,000 for each of the
years ended April 30, 2006 and April 30, 2005. In addition, Mr. Harriton
exchanged an aggregate of 331,500 options and warrants of HDSI for an aggregate
of 10,566,000 warrants of Nesco based on the same ratios in the share exchange.
These options and warrants are currently exercisable at prices that range
between $0.08 and $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 HDSI options/warrants as a result of the
exchange.
At April 30, 2004 we had notes payable, including interest, of
approximately $370,000 due to Mr. Matthew Harriton, the president and chief
executive officer of HDSI. The notes were at an interest rate of 10% per annum
and collateralized by the accounts receivable of HDSI. On May 1, 1999, 200,000
options, which were previously granted to Mr. M. Harriton under the terms of an
employment agreement, were exercised at a price of $0.40 and 200,000 shares of
common stock were issued. We received a promissory note dated May 1, 1999 from
Mr. M. Harriton in the amount of $80,000 for payment of the shares. The note
matured on May 1, 2004, with interest at 8% and was secured by the related
securities. On May 25, 2004, this note and related interest in the aggregate
amount of $112,000 was cancelled and applied as a reduction of the notes due to
the officer. At April 30, 2004, HDSI also owed Mr. M. Harriton approximately
$113,000 in accrued payroll. On May 25, 2004, the remaining aggregate balance of
26
approximately $365,000 due to Mr. M. Harriton on that date was exchanged for
convertible 8% debentures of Nesco which mature in December 2005. This debt is
convertible at approximately $0.15 per share into an aggregate of approximately
2,431,000 shares of Nesco. Mr. Harriton, was also granted, in consideration for
an extension and exchange of the debt, 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 HDSI debt for an aggregate of the issuance of approximately 365,000
warrants. The balance due on the note at October 31, 2006 is approximately
$436,000 consisting of approximately $365,000 in principal, approximately
$71,000 of accrued interest. Interest expense was approximately $27,000 for each
of the years ended April 30, 2006 and April 30, 2005.
At April 30, 2004, HDSI owed Mr. Geoffrey Donaldson, the chief operating
officer of HDSI until December 19, 2005, approximately $439,000 in accrued
payroll. On May 25, 2004, this obligation due to Mr. G. Donaldson was exchanged
for a convertible 8% debenture of Nesco which matures in December 2005. This
debt is convertible at approximately $0.15 per share into an aggregate of
approximately 2,924,000 shares of Nesco. Mr. Donaldson, was also granted, in
consideration for an extension and exchange of the debt, 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 HDSI debt, for an aggregate of the issuance of warrants
to purchase approximately 439,000 shares of common stock. The balance due on the
note at October 31, 2006 is approximately $524,000 consisting of approximately
$439,000 in principal and approximately $85,000 of accrued interest. Interest
expense was approximately $34,000 for the each of years ended April 30, 2006 and
2005. In addition, Mr. Donaldson exchanged options to purchase an aggregate of
133,334 shares of HDSI for warrants to purchase an aggregate of 1,200,000 shares
of common stock of Nesco based on the same ratios in the share exchange. These
options are currently exercisable at $0.39 and expire in January 2006.
Compensation expense approximating $23,000 was recorded on May 25, 2004 for the
increase in the fair value of these vested HDSI options and warrants as a result
of the exchange.
Interests of Certain Persons in the Share Exchange
Information as to the participation in the share exchange by the holders
of more than five percent (5%) of our outstanding voting interests, our
officers and directors and other affiliates is set forth above in this
information statement under the heading "Certain Relationships and Related
Transactions-Relationships and Related Transactions of Nesco Related to the
Operations of HDSI prior to and as a Result of the Share Exchange Agreement."
Material U.S. Federal Income Tax Consequences
Beckman, Lieberman & Barandes, LLP, as counsel to Nesco, has rendered an
opinion to Nesco to the effect that, with respect to Nesco and the Nesco
stockholders who did not participate in the share exchange, the share exchange
will be a nontaxable transaction for U.S. federal income tax purposes. As a
consequence, neither Nesco nor such Nesco stockholders will recognize any gain
or loss in the share exchange.
EACH NESCO STOCKHOLDER SHOULD CONSULT HIS OR HER TAX ADVISOR AS TO THE SPECIFIC
TAX CONSEQUENCES OF THE SHARE EXCHANGE TO HIM OR HER, INCLUDING THE APPLICATION
AND EFFECT OF FEDERAL, STATE, LOCAL AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS
OF CHANGES IN FEDERAL LAW OR OTHER TAX LAWS.
27
Regulatory Approvals
Nesco does not believe that the share exchange was subject to any state or
federal regulatory requirements.
Other than the filing of this information statement and a registration
statement with respect to shares of our common stock, including shares issuable
upon conversion of our securities issued in the share exchange, and certain
other filings under applicable securities laws and the filing of the amendment
to our articles of incorporation with the Secretary of State of the State of
Nevada, we do not believe that, in connection with the and the amendment to our
articles of incorporation any consent, approval, authorization or permit of, or
filing with or notification to, any regulatory authority will be required.
AMENDMENT OF THE ARTICLES OF INCORPORATION TO
CHANGE THE NAME OF THE CORPORATION AND
INCREASE SHARES OF AUTHORIZED COMMON STOCK
Our Board of Directors has unanimously adopted resolutions to (a) change
the name of the corporation from "Nesco Industries, Inc." to "Aquamatrix, Inc."
and (b) increase the authorized number of common shares to 400,000,000. The
holders of shares representing 91.40 of our outstanding voting power have given
their written consent to the resolution. As of the record date, of the (1) of
the 21,636,225 shares of common stock outstanding, 15,898,809 shares, or 74% of
the shares outstanding have provided written consent; and (2) of the 117,055
shares of Series B convertible preferred stock outstanding, 112,445 shares of
Series B convertible preferred stock (which are convertible into 84,333,750
shares of common stock) or 96% have provided written consent to this action. In
aggregate, as converted, 100,232,559 of 111,437,475 total outstanding common
shares 90%) have consented. Under the Nevada Revised Statutes, the consent of
the holders of a majority of the voting power is effective as stockholders'
approval. We will file the Amendment with the Secretary of State of Nevada on or
after March 26, 2007, and it will become effective on the date of such filing
(the "Effective Date").
Reasons for Approving the Name Change
The name change has been approved because the new name better represents
our business. We develop, manufacture and market high water content, electron
beam cross-linked, aqueous polymer hydrogels used for wound care, medical
diagnostics, transdermal drug delivery and cosmetics. Our gels are produced
using proprietary manufacturing technologies which enable us to produce gels
that can satisfy rigid tolerance specifications with respect to a wide range of
physical characteristics while maintaining product integrity. Our gels are also
stable in form and composition, adhere painlessly to the human body and are
compatible with active ingredients.
Certificates for the corporation's common stock that recite the name
"Nesco Industries, Inc." will continue to represent shares in the corporation
after the Effective Date. If, however, a stockholder wishes to acquire a
certificate reciting the name "Aquamatrix" after the Effective Date, he may do
so by surrendering his certificate to our transfer agent with a request for a
replacement certificate and the appropriate stock transfer fee. Our transfer
agent is:
Interwest Transfer Co., Inc.
1981 East 4800 South, Suite 100
Salt Lake City, UT 84117
Attn: Stacie Banks
Phone: 801-272-9294
28
Reasons for Approving the Increase in Authorized Common Stock
The primary purposes of the increase are (a) to enable us to satisfy the
conversion obligations set forth in our outstanding convertible securities,
including preferred stock, convertible debentures, options and warrants, (b) to
enable us to satisfy provisions of the share exchange agreement by and among
Nesco, HDSI, certain stockholders of Nesco and certain stockholders of HDSI ,
(c) have authorized common stock available to issue in accordance with an August
23, 2004 standby equity distribution agreement with Cornell Capital Partners
L.P., (d) have authorized common stock available for securities issuances to
fund our business plan and operations and (e) to have authorized common stock
available for such other purposes as may be properly taken by us.
Information as to the number of shares of our common stock issuable upon
conversion, exchange or exercise of the securities issued pursuant to the share
exchange agreement is set forth under the caption "Dilution from Share Exchange"
on page 9 of this information statement.
Under the terms of the exchange agreement, we were required to issue
58,884,786 shares of our common stock to the former HDSI stockholders. We had
25,000,000 shares authorized. In order to facilitate the closing of the
Agreement in the absence of sufficient shares of our common stock, we issued a
newly created Series B convertible preferred stock, which is convertible in to
shares of our common stock at a fixed ratio of 750 shares of common stock for
each share of Series B convertible preferred stock upon filing of the amendment
authorizing additional common stock described in this information statement.
If all shares of HDSI common and preferred stock are exchanged for Nesco
voting securities, the equivalent of a total of 58,884,786 shares of Nesco
common stock will be issued in the exchange. If all the HDSI common and
preferred stock is exchanged for Nesco common stock the holders would own
approximately 55.3 % of Nesco's common stock outstanding at the time of the
exchange and 52.8% of the common stock outstanding on the date hereof.
In addition to the Nesco common stock exchange shares, Nesco also issued
the following:
o 6,500,000 shares of common stock to various advisors for services
rendered in connection share exchange agreement;
o 3,000,000 shares of common stock issued in connection with the sale
of the Nesco subsidiaries; and
o 20,000 shares of preferred stock, which will be converted to
15,000,000 shares of common stock for the conversion of Nesco
outstanding debt of $953,000.
The amendment to the articles of incorporation will permit us to issue:
- 2,010,000 shares of common stock upon conversion of 67,000 shares of
Series A convertible preferred stock (30-to-1 conversion ratio).
- 87,791,250 shares of common stock upon conversion of 117,055
shares of Series B convertible preferred stock (750-to-1 conversion
ratio).
- 56,436,304 shares of common stock upon exercise of outstanding
options and warrants to purchase shares of common stock (exercise
prices between $.08 and $.39 per share and varying exercise periods
through April 30, 2012).
- 43,850,747 shares of common stock upon conversion of $5,031,212
principal amount of convertible debentures (conversion price of
either $.0833 or $.15 per share).
29
The amendment of our articles of incorporation to increase the authorized
common stock is not being done for the purpose of impeding any takeover attempt,
and we are is not aware of any person who is acquiring or plans to acquire
control of our company. Nevertheless, the power of our board of directors to
provide for the issuance of shares of common stock without stockholder approval
has potential utility as a device to discourage or impede a takeover. In the
event that a non-negotiated takeover were attempted, the private placement of
stock into "friendly" hands, for example, could make us unattractive to the
party seeking control. This would have a detrimental effect on the interests of
any stockholder who wanted to tender his or her shares to the party seeking
control or who would favor a change of control.
VOTE OBTAINED - NEVADA LAW
Nevada Revised Statutes ("NRS") 78.390 provides that every amendment to
our articles of incorporation shall first be adopted by the resolution of the
Board of Directors and then be subject to the approval of stockholders entitled
to vote on any such amendment. Under NRS 78.390 and our bylaws, an affirmative
vote by stockholders holding shares entitling them to exercise at least a
majority of the voting power is sufficient to amend our articles of
incorporation. NRS 78.320 provides that, unless otherwise provided in our
articles of incorporation or the bylaws, any action required or permitted to be
taken at a meeting of the stockholders may be taken without a meeting if, before
or after the action, a written consent thereto is signed by stockholders holding
at least a majority of the voting power. In order to eliminate the costs and
management time involved in holding a special meeting and in order to effect the
amendments described herein as early as possible in order to accomplish the
purposes as hereafter described, our board of directors voted to utilize, and
did in fact obtain, the written consent of the holders of a majority in interest
of our voting power. NRS 78.320 provides that in no instance where action is
authorized by written consent need a meeting of stockholders be called or notice
given.
No Dissenters Rights
Under Nevada law, stockholders are not entitled to dissenters' rights with
respect to any of the transactions in this information statement.
DESCRIPTION OF SECURITIES
Our authorized capital consists of 25,000,000 shares of common stock
$0.001 par value, of which 21,636,225 shares were outstanding as of February 1,
2007. In addition, we are authorized to issue 850,000 shares of our Series A
convertible preferred stock and 150,000 shares of our Series B convertible
preferred stock, respectively. As of February 1, 2007, there were 67,000 shares
of our Series A convertible preferred stock outstanding and 117,055 shares of
our Series B convertible preferred stock outstanding.
Set forth below is a summary description of certain provisions relating to
our capital stock contained in and qualified in its entirety by our articles of
incorporation and by-laws and under the NRS.
Common Stock
Holders of common stock are entitled to one vote for each share of common
stock owned of record on all matters to be voted on by stockholders. Our
articles of incorporation do not contain any special voting provisions, and no
corporate action requires a greater than majority vote of stockholders.
Cumulative voting is not permitted in the election of directors.
The holders of common stock are entitled to receive such dividends, if
any, as may be declared from time to time by our board of directors, in its
discretion, from funds legally available therefor.
30
The common stock has no preemptive or other subscription rights, and there
are no conversion rights or redemption provisions. All outstanding shares of
common stock are validly issued, fully paid, and non-assessable.
Series A Preferred Stock
Our board of directors has designated and authorized the issuance of
850,000 shares of Series A convertible preferred stock of which 67,000 shares
are outstanding.
Conversion
Each share of Series A convertible preferred stock will be automatically
converted into 30 shares of our common stock upon the filing of an amendment to
our articles of incorporation to increase the number of shares of common stock
we are authorized to issue.
Voting Rights
At a meeting of our stockholders, each share of common stock has one vote
per share and each share of our Series A convertible preferred stock has 30
votes per share. Each share of Series A convertible preferred stock, when voting
as a class, is entitled to one vote per share.
Liquidation
Until exchange for common shares as contemplated by the exchange
agreement, upon any liquidation or dissolution, holders of Series A convertible
preferred stock will be entitled to receive $2.00 per share plus an amount equal
to all dividends accrued but unpaid.
Series B Convertible Preferred Stock
Our board of directors has designated and authorized the issuance of
150,000 shares of Series B convertible preferred stock of which 117,055 shares
are outstanding.
Conversion
Each share of Series B convertible preferred stock will be automatically
converted into 750 shares of our common stock upon the filing of an amendment to
our articles of incorporation to increase the number of shares of common stock
we are authorized to issue sufficient to convert the then outstanding shares of
Series B convertible preferred stock.
Voting Rights
At a meeting of our stockholders, each share of common stock has one vote
per share and each share of our Series B convertible preferred stock has 750
votes per share. Each share of Series B convertible preferred stock, when voting
as a class, will be entitled to one vote per share.
Rank
Shares of Series B convertible preferred stock ranks junior to shares of
Series A convertible preferred stock.
31
MANAGEMENT
Directors and Executive Officers
Our directors and executive officers are as follows:
Name Age Position with the Company
---- --- -------------------------
Matthew Harriton 42 President, Principal Executive and
Principal Financial Officer and Director
Arlen Reynolds 64 Chairman of the Board and Director
Gene E. Burelson 65 Director
Wayne M. Celia 51 Director
Joel S. Kanter 49 Director
Matthew L. Harriton became our chairman of the board of directors, chief
executive officer and president in May 2004 and chief financial officer in
January 2006. He served as chairman until June 2005, at which time Arlen
Reynolds assumed the role. He has served as chief executive officer of HDSI
since October 1996, and also serves as chief executive officer, chief financial
officer and director of Embryo Development Corporation, a company formerly
involved in the medical device development industry, since January 1996. Prior
to joining Embryo Development Corporation, Mr. Harriton's professional
experience included positions at CIBC Wood Gundy Securities Corporation, Coopers
& Lybrand, and The First Boston Corporation. He is a graduate of Lehigh
University and received his M.B.A. from Duke University's Fuqua School of
Business.
Arlen Reynolds became a director in December 2004 and assumed the role of
chairman of the board from Mr. Harriton in June 2005. He is currently and has
been since 1997, a private investor and strategic advisor to healthcare
companies. From 1995 to 1997, Mr. Reynolds was President of TeamCare, Inc., an
institutional pharmacy company. From 1972 to 1995, he served as chief executive
officer of, among others, Brookwood Medical Center in Birmingham, Alabama and
Park Plaza Hospital in Houston, Texas. Mr. Reynolds serves on the boards of
several private companies and not-for-profit charitable organizations.
Gene E. Burelson became a director in December 2004. From June 2002 to the
present he has been a private investor in healthcare companies. From January
2000 to June 2002, he served as chairman of the board of directors of Mariner
Post-Acute Network Inc., an operator of long term health care facilities. From
October 1989 to November 1997 he served as chairman of the board of GranCare
Inc., and from December 1990 to February 1997, its president and chief executive
officer. Mr. Burelson is involved with several private health care companies as
an investor and member of the board of directors.
Wayne M. Celia became a director in December 2004. He has been president
of Dicon Technologies, a wholly-owned subsidiary of Berkshire Hathaway, Inc.
since 1997. From 1975 until 1997, Mr. Celia founded Dicon Inc., WP Industries,
TekPak Inc. and Dicon Systems Inc. Dicon has been acquired by Berkshire
Hathaway.
Joel S. Kanter became a director in December 2004. Since July 1986, he has
served as president of Windy City Inc., a privately held investment firm. Mr.
Kanter serves on the board of directors of several public companies including
Echo Healthcare Acquisition Corp., Encore Medical Corporation, Prospect Medical
Group, Inc., Magna-Lab Inc. and I-Flow Corporation, as well as a number of
private concerns.
Geoffrey Donaldson, who became a director in December 2004, resigned on
December 19, 2005. Since January 2000, and through December 19, 2005, Mr.
Donaldson had been chief operating officer of the Company.
32
Richard Selinfreund, who became a director in October 2004, resigned on
December 12, 2005.
Karen Nazzareno, who served as our controller since 1996 and our chief
financial officer since 2004, resigned in January 2006.
All directors currently serve for one-year terms and until their
successors have been elected and qualified. Unless expressly agreed otherwise,
officers are elected annually and serve at the discretion of the board of
directors.
We have an audit committee that was established by our board of directors
for the purpose of overseeing our accounting and financial reporting processes
and audits of our consolidated financial statements by our independent auditors.
The audit committee is made up of Mr. Kanter (chairman), Mr. Reynolds and Mr.
Burelson. We believe that each of the members of the audit committee meets the
independence requirements of the Securities and Exchange Commission. Each of the
members of the audit committee is financially literate and has accounting and
finance experience and Mr. Joel S. Kanter is deemed an audit committee financial
expert within the meaning of Securities and Exchange Commission regulations as
defined in Item 401 of Regulation S-B.
Summary Compensation
The following table sets forth, for Nesco's last three fiscal years, all
compensation awarded to, earned by or paid to all persons serving as Nesco's
chief executive officer or interim chief executive officer in fiscal 2005 and
the most highly compensated executive officers of Nesco other than the chief
executive officer or interim chief executive officer whose salary and bonus
payments exceeded $100,000 in fiscal 2005.
Long Term
Annual Compensation Compensation
------------------- ------------
Year
Ended Other Options/
Name & Principal Position April 30, Salary ($) Bonus ($) Compensation ($) SAR (#)
- ------------------------- --------- ---------- --------- ---------------- -------
Matthew Harriton (Chief Executive 2006 $203,000 - $ 0 -
and Chief Financial Officer)
2005 $143,700 - $ 0 5,000,000
2004 $ 75,000 - $ 0 -
(1) Approximately $106,250 and $75,000 of salary for the years ended April 30,
2006 and April 30, 2004 were accrued but not paid. The $75,000 outstanding
at April 30, 2004 was converted to debt as part of the terms of the share
exchange agreement.
Except as set forth above, no other options or warrants have been issued
to our officers and directors named in the above summary compensation table
during the last three fiscal years.
Options/SAR Grants in Last Fiscal Year
During fiscal 2006 no option grants were made to the named executive
officers.
33
Aggregated Option/SAR Exercises in Fiscal 2006 and Fiscal 2006 Year-End
Option/SAR Value
Information relating to the number and value of options exercised during
the year and held at year end by such named executive officers is set forth in
the following table:
Value of Unexercised
Number of Unexercised In-the Money
Shares Options/SARs at F/Y Options/SARs at F/Y
Acquired on Value End (#) Exercisable/ End ($)Exercisable/
Exercise (#) Realized($) Unexercisable Unexercisable
------------------------------------------------------------------------------------
Matthew Harriton 0 $0 4,000,000/1,000,000 $-0-/$-0-
(1) Shares of common stock. Mr. Harriton was granted options to purchase
5,000,000 shares of common stock in connection with his employment
agreement on May 19, 2004, of which 2,000,000 are immediately exercisable
and 1,000,000 are exercisable on each of the first, second and third
anniversaries of the agreement.
(2) Based on the closing price (estimated to be $0.03) of shares quoted on
April 28, 2006.
Long-Term Incentive Plans
Not Applicable.
Compensation of Directors
During the fiscal years ended April 30, 2006 and 2005, no director
received any compensation for services provided in such capacity. Directors are
reimbursed for reasonable expenses incurred by them in connection with their
activities on behalf of Nesco.
Employment Contracts and Termination of Employment and Change in Control
Arrangements
On May 19, 2004 we entered into an employment agreement with Mr. Matthew
Harriton for a term of three years with an automatic one year extension. The
agreement provides for an annual base salary of $120,000 with annual increases
of 10%. The agreement also provides for an annual performance bonus based on an
annual operating profit in excess of $500,000. The agreement provides for
certain payments in the event of death, disability or change in control. In
addition, Mr. Harriton was granted a nonqualified option, effective the date of
the closing of the share exchange agreement, to purchase 5,000,000 shares of
common stock for a period of 5 years. The option is immediately exercisable for
the purchase of 2,000,000 shares and exercisable as to an additional 1,000,000
shares commencing on each of the first, second, and third anniversaries of the
closing date, respectively, provided that he remains an employee. The options
are exercisable at the "Applicable Trading Price" based on a formula contained
in the share exchange agreement which resulted in an option price, based on the
average bid closing price for 30 consecutive trading days prior to the closing,
of $0.15.
On November 22, 2004, this employment agreement was amended and restated.
The amended and restated agreement provides for annual compensation of $200,000
effective January 1, 2005, with a 10% increase each year on December 31 during
the term of the agreement. The annual performance bonus was eliminated and
bonuses now are to be paid at the discretion of the board of directors. The
agreement was also extended to December 31, 2009. All other terms remained the
same as in the original agreement.
34
Mr. Harriton has not collected cash compensation required under this
agreement since October 2005, and is owed approximately $231,000 at October 31,
2006.
Report on Repricing of Options/SARS
None.
By Order of the Board of Directors, at
New York, New York on March 2, 2007
By: /s/ Matthew Harriton
----------------------------------
Matthew Harriton, President
35
FINANCIAL STATEMENTS
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM......................F-1
FINANCIAL STATEMENTS FOR YEAR ENDED APRIL 30, 2006
CONSOLIDATED BALANCE SHEET........................................F-2
CONSOLIDATED STATEMENTS OF OPERATIONS.............................F-3
CONSOLIDATED STATEMENTS OF CASH FLOWS......................F-4 to F-5
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'
DEFICIT.......................................................F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ...............F-7 to F-25
UNAUDITED FINANCIAL STATEMENTS FOR SIX MONTHS ENDED OCTOBER 31, 2006
CONDENSED CONSOLIDATED BALANCE SHEET.............................F-26
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS..................F-27
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS..................F-28
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS'
DEFICIT......................................................F-29
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ....F-30 to F-39
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Nesco Industries, Inc.
We have audited the accompanying consolidated balance sheet of Nesco
Industries, Inc. and Subsidiaries (collectively the "Company") as of April 30,
2006, and the related consolidated statements of operations, cash flows and
changes in stockholders' deficit for each of the years in the two-year period
ended April 30, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Nesco
Industries, Inc. and Subsidiaries as of April 30, 2006, and the results of its
operations and its cash flows for each of the years in the two-year period ended
April 30, 2006, in conformity with accounting principles generally accepted in
the United States of America.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
2, the Company has incurred cumulative losses of approximately $23,681,000 since
inception and utilized cash of approximately $2,144,000 for operating activities
during the two-years ended April 30, 2006. The Company has a working capital
deficit of approximately $10,214,000 (including approximately $7,133,000 of debt
which is in default), and a stockholders' deficit of approximately $9,602,000 as
of April 30, 2006. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans regarding those
matters are also described in Note 2. These consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
/s/ Rothstein, Kass & Company, P.C.
-----------------------------------
Roseland, New Jersey
June 23, 2006
F-1
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
- -----------------------------------------------------------------------------------------------------------------
April 30,
2006
ASSETS
Current assets
Cash $ 27,000
Accounts receivable 85,000
Inventories 100,000
Prepaid expenses and other current assets 19,000
------------------
Total current assets 231,000
Property and equipment, net of accumulated depreciation
and amortization of approximately $1,833,000 633,000
Other assets - deposits and other 49,000
------------------
$ 913,000
==================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Secured accounts receivable and purchase order financing,
including $92,000 payable to a related party $ 122,000
Subsidiary senior secured notes payable and interest, including
$168,000 payable to related parties 489,000
Note and interest payable, in default 709,000
Convertible debentures, including interest and penalties, in default
($3,013,000 is secured by the assets of the Company and another
$2,579,000 is payable to related parties and current or former officers) 6,424,000
Customer deposits 846,000
Accounts payable and accrued expenses 829,000
Stock to be issued 190,000
Common stock subject to redemption 330,000
Due to related party and affiliates 506,000
------------------
Total current liabilities 10,445,000
------------------
Long-term liability - deferred sublease income 70,000
------------------
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,
17,736,225 issued and outstanding 18,000
Additional paid-in-capital 14,061,000
Accumulated deficit (23,681,000)
------------------
Total stockholders' deficit (9,602,000)
------------------
$ 913,000
==================
See accompanying notes to the consolidated financial statements.
F-2
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- -----------------------------------------------------------------------------------------------------------------------
Years ended April 30,
---------------------
2006 2005
Revenues $ 1,001,000 $ 738,000
Cost of revenues 1,141,000 928,000
--------------------------------------------
Gross profit (loss) (140,000) (190,000)
--------------------------------------------
Operating expenses
General and administrative 1,114,000 1,393,000
Stock compensation charge 67,000 3,011,000
Amortization and other expenses -- 136,000
--------------------------------------------
1,181,000 4,540,000
--------------------------------------------
Loss from operations (1,321,000) (4,730,000)
--------------------------------------------
Other income (expenses)
Sublease income 47,000 47,000
Amortization of debt discount (1,731,000) (2,281,000)
Stock issuance costs expensed -- (713,000)
Interest and other expense (351,000) (265,000)
Interest expense, related parties (132,000) (165,000)
Amortization of financing costs (294,000) (398,000)
Penalties under registration rights agreement (548,000) (92,000)
Permanent impairment of available-for-sale securities (69,000) -
--------------------------------------------
(3,078,000) (3,867,000)
--------------------------------------------
Net loss $ (4,399,000) $ (8,597,000)
============================================
Weighted average common shares
Basic and diluted 17,812,000 15,743,000
--------------------------------------------
Net loss per common share
Basic and diluted $ (0.25) $ (0.55)
============================================
See accompanying notes to the consolidated financial statements.
F-3
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Year Ended April 30,
2006 2005
----------- -----------
Cash flows from operating activities
Net loss $(4,399,000) $(8,597,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Stock and warrants issued for services 67,000 1,217,000
Revaluation of warrants issued for services -- 1,794,000
Stock issuance costs expensed -- 713,000
Depreciation and amortization 161,000 251,000
Amortization of debt discount 1,731,000 2,281,000
Amortization of financing costs 294,000 398,000
Permanent impairment of available-for-sale securities 69,000 --
Changes in operating assets and liabilities:
Accounts receivable 39,000 (50,000)
Inventories (35,000) 23,000
Prepaid expenses and other current assets 32,000 1,000
Accrued penalties and interest (included in Convertible debentures) 548,000 92,000
Customer deposits 7,000 (8,000)
Accounts payable, accrued expenses and other 521,000 (55,000)
Interest payable 459,000 343,000
Due to affiliates 192,000 (151,000)
Deferred sublease income (35,000) (47,000)
---------------------------
Net cash used in operating activities (349,000) (1,795,000)
---------------------------
Cash flows from investing activities
Net cash acquired from merger -- 86,000
Purchase of equipment and deposit on lease (413,000) (9,000)
---------------------------
Net cash provided (used) by investing activities (413,000) 77,000
---------------------------
Cash flows from financing activities
Proceeds from issuance of subsidiary senior secured notes 480,000 --
Proceeds from accounts receivable financing 336,000 --
Payments of accounts receivable financing (214,000) --
Proceeds from issuance of senior secured convertible debentures -- 2,295,000
Payments for financing costs -- (286,000)
Payments on notes payable -- (238,000)
Payments of stock issuance costs -- (88,000)
Payments on loan from officer -- (7,000)
Payments from affiliate 165,000 63,000
---------------------------
Net cash provided by financing activities 767,000 1,739,000
---------------------------
Net increase in cash 5,000 21,000
Cash
Beginning of year 22,000 1,000
---------------------------
End of year $ 27,000 $ 22,000
===========================
Supplemental disclosure of cash flow information,
Cash paid during the year for interest $ 1,000 $ 89,000
===========================
See accompanying notes to the consolidated financial statements.
F-4
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
- --------------------------------------------------------------------------------
Years Ended April 30,
2006 2005
--------------------------
Supplemental disclosure of non-cash investing and financing,
activities:
Stock issued for interest payment on convertible debentures $ 93,000 $ 59,000
==========================
Stock issued in connection with Equity Distribution Agreement $ -- $ 625,000
==========================
Fair value of warrants issued to brokers $ -- $ 405,000
==========================
Debt discount related to convertible debentures $ -- $ 3,971,000
==========================
Reclassification of note receivable (and interest), officer,
accrued expenses, officer, and due to officer to convertible
debentures and interest payable, officer $ -- $ 922,000
==========================
Reclassification of accounts payable to due to affiliate $ -- $ 5,000
==========================
Reclassification of treasury stock to additional paid in capital $ -- $ 43,000
==========================
Reclassification of additional paid in capital to series A
convertible preferred stock $ -- $ --*
==========================
Reclassification of additional paid in capital to series B
convertible preferred stock $ -- $ --*
==========================
Conversion of series A convertible preferred stock to series B
convertible preferred stock $ -- $ 1,000
==========================
Balance sheet of Nesco Industries, Inc. at the date of the
Share Exchange (See Note 1):
Property and equipment $ -- $ 5,000
--------------------------
Accounts payable and accrued expenses 177,000
Deferred sublease income 164,000
Stockholders' equity -- 7,000
--------------------------
Total liabilities and stockholders' equity -- 348,000
--------------------------
Elimination of intercompany bridge loan -- (209,000)
--------------------------
Cash acquired from merger -- 134,000
Expenditure of legal fees in connection with merger -- (48,000)
--------------------------
Net cash acquired from merger $ -- $ 86,000
--------------------------
* Amounts round to less than $1,000 in the fiscal year ended April 30, 2005.
See accompanying notes to consolidated financial statements.
F-5
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
- --------------------------------------------------------------------------------
Years Ended April 30, 2006 and 2005
- --------------------------------------------------------------------------------
Nesco HDS
Series A Series B Series B
Convertible Convertible Convertible
Preferred Stock Preferred Stock Preferred Stock Common Stock
------------------- ---------------- ------------------ -----------------------
Shares Amount Shares Amount Shares Amount Shares Amount
----------- ------ ------- ------ ---------- ------ ---------- ----------
Balances, May 1, 2004 - $ - - $ - 522,487 $ - 4,702,806 $ -
Reverse acquisition 512,500 - 94,625 - (522,487) - 2,924,299 7,000
Revaluation of warrants
Conversion of series A
to series B convertible (445,500) - 17,820 -
preferred stock
Conversion of officer note
receivable to convertible
debentures
Issuance of common stock
for services 8,500,000 9,000
Issuance of common stock
in connection with sale
of subsidiaries 600,000 1,000
Issuance of common stock
for interest expense 390,305 -
Issuance of series B
convertible preferred
stock for services 4,242 -
Debt discount on
convertible securities
Issuance of warrants
for services
Net loss
--------------------------------------------------------------------------------------------
Balances, April 30, 2005 67,000 - 116,687 - - - 17,117,410 17,000
Issuuance of common stock
for interest 618,815 1,000
Issuance of convertible
preferred stock for services 368
Stock compensation charge
Permanent impairment in
available-for-sale security
Net loss
--------------------------------------------------------------------------------------------
Balances, April 30, 2006 67,000 $ - 117,055 $ - - $ - 17,736,225 $ 18,000
============================================================================================
Accumulated
Other Treasury
Additional Compre- Officer Stock
Paid-in hensive Note ---------------------- Accumulated
Capital Loss Receivable Shares Amount Deficit Total
------------ --------- ----------- --------- --------- ------------- ------------
Balances, May 1, 2004 $ 6,318,000 $ (69,000) $ (80,000) 250,000 $ (42,000) $ (10,685,000) $ (4,558,000)
Reverse acquisition 1,346,000 (250,000) 42,000 1,395,000
Revaluation of warrants 1,794,000 1,794,000
Conversion of series A
to series B convertible - -
preferred stock
Conversion of officer note
receivable to convertible
debentures 80,000 80,000
Issuance of common stock
for services 986,000 995,000
Issuance of common stock
in connection with sale
of subsidiaries (1,000) -
Issuance of common stock
for interest expense 58,000 58,000
Issuance of series B
convertible preferred
stock for services 727,000 727,000
Debt discount on
convertible securities 2,204,000 2,204,000
Issuance of warrants
for services 470,000 470,000
Net loss (8,597,000) (8,597,000)
-------------------------------------------------------------------------------------------------
Balances, April 30, 2005 13,902,000 (69,000) - - - (19,282,000) (5,432,000)
Issuuance of common stock
for interest 92,000 93,000
Issuance of convertible
preferred stock for services 47,000 47,000
Stock compensation charge 20,000 20,000
Permanent impairment in -
available-for-sale security 69,000 69,000
Net loss (4,399,000) (4,399,000)
-------------------------------------------------------------------------------------------------
Balances, April 30, 2006 $ 14,061,000 $ - $ - - $ - $ (23,681,000) $ (9,602,000)
=================================================================================================
See accompanying notes to the consolidated financial statements.
F-6
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Nature of Operations
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. ("HDSI") and, since January 2006, Foam Manufacturing, Inc.
("FMI"). HDSI 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.
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. See Note 11.
The accompanying consolidated financial statements of the Company reflect the
historical results of the predecessor entity, HDS, prior to May 25, 2004 and the
consolidated results of operations of the Company subsequent to the acquisition
date of May 25, 2004. The common stock and per share information in the
condensed consolidated financial statements and related notes have been
retroactively adjusted to give effect to the reverse acquisition on May 25,
2004. See also Note 11. The following unaudited supplemental pro forma condensed
financial information is presented to illustrate the effects of the acquisition
of HDS on the historical operating results for the year ended April 30, 2005 as
if the acquisition had occurred at the beginning of the period:
Year ended
April 30, 2005
--------------
Revenues $ 738,000
Net loss $ (8,641,000)
Net loss per share $ (0.52)
The above information is presented for illustrative purposes only and is not
necessarily indicative of the condensed consolidated results of operations that
actually would have been realized had HDS and Nesco been a combined company
during the specified periods.
All amounts in the consolidated financial tatements have been rounded to the
nearest $1,000.
F-7
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Going concern and liquidity
The accompanying 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
Company has incurred cumulative losses of approximately $23,681,000 since
inception and utilized cash of approximately $2,144,000 for operating activities
during the two years ended April 30, 2006. The Company has a working capital
deficit of approximately $10,214,000, stockholders' deficit of approximately
$9,602,000 as of April 30, 2006 and approximately $7,133,000 of debt is
currently in default. These factors, among others, raise substantial doubt about
the Company's ability to continue as a going concern. Management's plan to deal
with this uncertainty is to raise capital, attempt to convert some of its debt
into equity and to improve operations through building of its customer base and
through the new manufacturing agreement with Dicon Technologies ("Dicon") (See
Note 4) and other measures. There can be no assurance that management's plans to
raise capital, convert debt to equity or improve operations will be successful.
If management's efforts are not successful, the Company may be unable to
continue as a going concern. The 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 as a going concern.
3. Summary of significant accounting policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions are eliminated in consolidation.
Revenue Recognition
Revenues are generally recognized as product is shipped to a customer. In cases
where a customer requests a development project for a gel or a gel to be used as
a component of a new product, the Company will recognize revenue at the time the
project is completed.
Accounts Receivable
Accounts receivable are presented net of any allowance for doubtful accounts.
The Company periodically evaluates its accounts receivable and establishes an
allowance for doubtful accounts based on history, collections and current
conditions.
Inventories
Inventories, consisting principally of raw materials, are stated at cost on the
first-in, first-out basis, which does not exceed market value. Excess or
obsolete inventories are reduced to net realizable value.
Property and Equipment
Property and equipment is recorded at cost less accumulated depreciation and
amortization. Depreciation and amortization is computed using the straight-line
method over the estimated useful lives of the related assets. Amortization of
leasehold improvements is computed using the straight-line method over the
estimated lives of the related assets or the remaining term of the lease, which
ever is shorter.
F-8
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company provides for depreciation and amortization over the following
estimated useful lives:
Machinery and equipment 10 years
Office equipment and fixtures 3 - 7 years
Leasehold improvements Lease term
Purchased Technology 7 years
Loss Per Share
The Company complies with Statement of Financial Accounting Standard ("SFAS")
No. 128 "Earnings per Share", which requires basic loss per common share to be
computed by dividing net loss by the weighted average number of common shares
outstanding during the period. Diluted loss per common share incorporates the
dilutive effect of common stock equivalents on an average basis during the
period. The calculation of diluted net loss per share excludes potential common
shares if the effect is anti-dilutive. Therefore, basic and diluted loss per
share were the same for the years ended April 30, 2006 and 2005.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Income Taxes
The Company complies with SFAS No. 109, "Accounting for Income Taxes," which
requires an asset and liability approach to financial accounting and reporting
for income taxes. Deferred income tax assets and liabilities are computed for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future,
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce the deferred income tax assets to the
amount expected to be realized.
Fair Value of Financial Instruments
The fair value of the Company's assets and liabilities, which qualify as
financial instruments under SFAS No. 107, "Disclosures About Fair Value of
Financial Instruments," approximate the carrying amounts presented in the
balance sheets.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk are cash and accounts receivable arising from its normal business
activities. The Company routinely assesses the financial strength of its
customers and third party payors and, believes that its accounts receivable
credit risk exposure is limited. The Company places its cash with high credit
quality financial institutions. The amount on deposit in any one institution
that exceeds federally insured limits is subject to credit risk.
F-9
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impairment of Long-Lived Assets
Certain long-lived assets of the Company are reviewed at least annually to
determine whether there are indications that their carrying value has become
impaired, pursuant to guidance established in SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". Management considers assets to be
impaired if the carrying value exceeds the future projected cash flows from
related operations (undiscounted and without interest charges). If an impairment
is deemed to exist, the assets will be written down to fair value. Management
also reevaluates the periods of amortization to determine whether events and
circumstances warrant revised estimates of useful lives.
Stock-Based Compensation
The Company complies with the disclosure requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation", as amended by SFAS No. 148.
The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plans and, accordingly, no
compensation cost has been recognized because stock options granted under the
plans were at exercise prices which were equal to or above the market value of
the underlying stock at date of grant. Had compensation for the Company's stock
options been determined as provided by SFAS No. 123 using the Black-Scholes
option pricing model, the Company's consolidated net loss would have been
adjusted to the pro forma amounts indicated below:
2006 2005
---- ----
Net loss, as reported $ (4,399,000) $ (8,597,000)
Stock-based compensation determined under
fair valued based method, net of related tax effect (60,000) (242,000)
------------ ------------
Net loss, pro forma $ (4,459,000) $ (8,839,000)
============ ============
Loss per common share, basic and diluted
As reported $ (0.24) $ (0.55)
Pro forma $ (0.24) $ (0.56)
The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in fiscal year ended April 30, 2005: no dividend
yield, expected volatility of 59%, risk-free interest rate of 1.38% and
three-year expected lives.
Comprehensive Income
The Company complies with the provisions of SFAS No. 130, "Reporting
Comprehensive Income". SFAS 130 governs the financial statement presentation of
changes in stockholder's equity resulting from non-owner sources. Accumulated
other comprehensive income as reported in the accompanying balance sheets
represents unrealized losses on available-for-sale securities. During the year
ended April 30, 2006, the Company determined that the impairment of its
investment in an available-for-sale security was permanent. Accordingly, this
impairment has been charged to operations for the year ended April 30, 2006 with
an offsetting reduction of the accumulated other comprehensive loss to zero.
New Accounting Pronouncements
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
F-10
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 based on the
requirements of SFAS No. 123 for all unvested awards granted prior to the
effective date of SFAS No. 123R.
The adoption of this statement has had no effect on net loss and loss per share
due to the adoption of the "modified prospective" method for existing options
and the fact that no new options have been granted.
4. Manufacturing Agreement and Related Activities
On October 3, 2005, the Company, on behalf of a wholly-owned subsidiary to be
formed, entered into a manufacturing agreement (the "Agreement") with an entity
affiliated with a Director of the Company (H.H. Brown Shoe Technologies, Inc.
doing business as Dicon). The Agreement grants the Company the exclusive rights
to manufacture patented hydrophilic urethane foam products, polyurethane gels
and moisture managed foam footwear inserts and to distribute, along with Dicon,
these products in North America in consideration of a 7-10% royalty based on
sales. The Agreement also provides for a supply agreement between the Company
and Dicon. Products to be manufactured under this Agreement will be sold for use
in cosmetic, medical, and household markets including the foot-care market under
the brand name DRYZ, a registered trademark. In December 2005, FMI
Manufacturing, Inc. ("FMI") was formed as a wholly-owned subsidiary of the
Company to control this activity and in February 2006, FMI entered into a lease
for a manufacturing facility (Note 13). In April 2006, under the Agreement, the
Company purchased certain "first line" equipment from Dicon for a purchase price
of $270,000. In June 2006, the Company purchased $380,000 of "second line"
equipment, paying Dicon $50,000 and entering into a secured three-year note
payable to Dicon for the remaining $330,000. FMI's activities have been funded
by subsidiary senior secured notes that mature on July 31, 2006 and the
equipment note with Dicon, which are discussed in Notes 6 and 7.
5. Property and equipment and purchased technology
Property and equipment
Property and equipment, at cost, consist of the following at April 30, 2006:
Machinery and equipment $ 1,933,000
Office equipment and fixtures 97,000
Leasehold improvements, 436,000
-----------
2,466,000
Less: accumulated depreciation and amortization (1,833,000)
-----------
$ 633,000
===========
Capital expenditures associated with the FMI business were approximately
$385,000 during the fiscal year ended April 30, 2006. Subsequent to April 30,
2006, the Company exercised its option to purchase an additional approximately
$380,000 of equipment for the FMI business, before delivery and installation
costs, as discussed in Note 4. Depreciation expense for the years ended April
30, 2006 and 2005 amounted to approximately $161,000 and $166,000, respectively.
F-11
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Purchased Technology
In 1997 the Company purchased technology for net consideration, as amended,
approximating $797,000. For the year ended April 30, 2005 amortization expense
related to the purchased technology amounted to approximately $85,000 and it was
fully amortized at April 30, 2005.
6. Short-term financing
Subsidiary Senior Secured Notes
Between December 20, 2005 and April 30, 2006, the Company raised approximately
$480,000 by issuing 11% per annum subsidiary senior secured notes of FMI
pursuant to a note purchase agreement as amended and restated on February 1,
2006. Such subsidiary senior secured notes are secured by all the assets of FMI
and, as amended in May 2006, are due on the earlier of July 31, 2006 or the
completion of a financing of at least $500,000. The notes were issued to
directors and other related parties, an affiliate as well a third party.
$100,000 of the amounts borrowed from the initial investor in the subsidiary
senior secured notes may be converted into new instruments upon the completion
of a proposed financing. Subsequent to April 30, 2006, additional subsidiary
senior secured notes were issued thereby raising the principal amount
outstanding to $805,000 at June 23, 2006.
Secured Accounts Receivable and Purchase Order Financing
Beginning in November 2005, the Company began raising short-term financing
through financing its accounts receivable. 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 consolidated
balance sheet and the amount to be repaid is reflected as a short-term debt. At
April 30, 2006, approximately $92,000 of this liability was payable to a related
party. All accounts receivable sold at April 30, 2006, were subsequently
repurchased by the Company.
7. Notes and convertible debentures payable and in default
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 April 30, 2006 is approximately $709,000 consisting of approximately $555,000
in principal and $154,000 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 expenses for the years ended April 30, 2006 and 2005
approximated $45,000 and $76,000, respectively.
F-12
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Convertible Debentures, Including Interest and Penalties Payable, in Default
The Company has the following convertible debentures outstanding at April 30,
2006:
Face Registration Accrued
Due to Due date amount penalties interest Total
------ -------- ------ --------- -------- -----
Senior secured parties December 1, 2005 $2,295,000 $548,000 $170,000 $3,013,000
Officers and related parties December 31, 2005 2,111,000 - 468,000 2,579,000
Other third parties December 31, 2005 625,000 - 207,000 832,000
---------- -------- -------- ----------
Subtotal $5,031,000 $548,000 $845,000 $6,424,000
========== ======== ======== ==========
The original debt discount, and amortization of debt discount for the years
ended April 30, 2006 and 2005 and annual interest expense on these instruments
follows:
Amortization
Year ended April 30
-------------------
Original Debt Annual
Due to Discount 2006 2005 Interest
------ -------- ---- ---- --------
Senior secured parties $2,112,000 $ 952,000 $1,202,000 $184,000
Officers and related parties 1,287,000 540,000 747,000 169,000
Other third parties 571,000 239,000 332,000 50,000
---------- ---------- ---------- --------
Total $3,970,000 $1,731,000 $2,281,000 $403,000
========== ========== ========== ========
The debt discount has been fully amortized at April 30, 2006.
The conversion features and related warrant exercise prices are as follows:
Total shares Total shares
issuable on issuable under
Description Conversion price Warrant 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 the quarter ended July 31, 2004.
F-13
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 offering. 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 April 30, 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 of approximately $548,000 have been charged to operations for the year
ended April 30, 2006.
Financing fees in connection with this agreement approximated $285,000. In
addition, the Company issued the 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, $294,000 and $398,000 in the years
ended April 30, 2006 and 2005, respectively.
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
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
F-14
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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.
F-15
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Other Long Term Debt -
On June 23, 2006, the Company executed a secured note payable to Dicon for
$330,000 for 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.
8. Standby Equity Distribution Agreement and Stock Issuance Costs Expensed
On August 23, 2004, the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, LP, an investment firm. Under the terms
of the agreement, the investment firm committed to purchase up to $10,000,000 of
the Company's common stock and the equity line was to be drawn down upon a
registration statement covering the shares being declared effective by the
Securities and Exchange Commission ("SEC"). As consideration for entering into
the Standby Equity Distribution Agreement, the Company granted Cornell Capital
Partners, LP 3,266.66 shares of Series B Convertible Preferred Stock
(convertible into 2,450,000 common shares) and paid a $70,000 cash consulting
fee. In addition, the Company granted the placement agent 66.66 shares of Series
B convertible preferred stock (convertible into 50,000 common shares). The fair
value of the shares ($625,000) as well as $17,500 in fees and the $70,000 cash
consulting fee associated with this agreement were recorded on the balance sheet
as stock issuance costs in the quarter ended October 31, 2004.
On November 16, 2004 the Company filed a preliminary information statement with
the SEC to allow the Company to effect an increase the number of common shares
it is authorized to issue. This needed to be completed before the Company could
have the required registration statement declared effective by the SEC. On
January 27, 2005, a preliminary registration statement was filed. Between
December 2004 and November 2005, various comments and responses were exchanged
between the SEC and the Company on the information statement and the
registration statement. On November 4, 2005, the Company decided to withdraw the
registration statement covering the shares to be sold, thereby effectively
terminating the planned issuance of shares to Cornell Capital Partners. LP. The
Company expensed the approximately $713,000 of stock issuance costs as of April
30, 2005.
9. Customer deposits
At April 30, 2006, of the approximately $846,000 of customer deposits,
approximately $839,000 are from one customer. This customer made a
non-refundable deposit to be applied 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 would be forfeited.
F-16
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Due to related party and affiliates
Due to related party and affiliates at April 30, 2006 of approximately $506,000
consists primarily of temporary advances, unpaid rent and real estate taxes due
to an entity owned by a related party of the Company. See also, Note 13.
11. Stockholders' deficit
Capitalization
Our authorized capital consists of 25,000,000 shares of common stock $0.001 par
value. Shares outstanding at April 30, 2006 include the current outstanding
common shares in the aggregate of 20,136,225 shares less the 2,400,000 shares
which are subject to redemption (see Share Exchange below). In addition, we are
authorized to issue 850,000 shares of our Series A Convertible Preferred Stock
("Series A Preferred Stock") and 150,000 shares of our Series B Convertible
Preferred Stock ("Series B convertible preferred stock") respectively. As of
April 30, 2006, there were 67,000 shares of our Series A convertible preferred
stock outstanding and 117,054.94 shares of our Series B convertible preferred
stock outstanding.
Holders of common stock are entitled to one vote for each share of common stock
owned on all matters to be voted on by stockholders. Our Articles of
Incorporation do not contain any special voting provisions, and no corporate
action requires a greater than majority vote of stockholders. Cumulative voting
is not permitted in the election of directors. The holders of common stock are
entitled to receive such dividends, if any, as may be declared from time to time
by the Board of Directors, in its discretion, from funds legally available
therefore. The common stock has no preemptive or other subscription rights, and
there are no conversion rights or redemption provisions. All outstanding shares
of common stock are validly issued, fully paid, and non-assessable.
Each share of Series A Preferred Stock shall be automatically converted into 30
shares of our common stock upon the filing of an amendment to our Articles of
Incorporation to increase the number of shares of common stock we are authorized
to issue. Each share of our Series A Preferred Stock shall have 30 votes per
share on all matters to be voted on by all stockholders. Each share of Series A
Preferred Stock when voting as a class shall be entitled to one vote per share.
Until exchange for common shares as contemplated by the exchange agreement, upon
any liquidation or dissolution, holders of Series A Preferred Stock shall be
entitled to receive $2.00 per share plus an amount equal to all dividends
accrued but unpaid.
Each share of Series B convertible preferred stock shall be automatically
converted into 750 shares of our common stock upon the filing of an amendment to
our Articles of Incorporation to increase the number of shares of common stock
we are authorized to issue sufficient to convert the then outstanding shares of
Series B convertible preferred stock. Each share of our Series B convertible
preferred stock shall have 750 votes per share on all matters to be voted on by
all stockholders. Each share of Series B convertible preferred stock when voting
as a class shall be entitled to one vote per share. Shares of Series B
convertible preferred stock shall rank junior to shares of Series A Preferred
Stock.
Stock Options and Warrants
The Company's 1999 Stock Option Plan (the "1999 Plan") provides that key
employees are eligible to receive incentive stock options or nonqualified stock
options and that directors and advisors shall be eligible to receive
nonqualified options. Under the 1999 Plan, the Company may grant options to
purchase up to a total of 1,000,000 shares of common stock. As of April 30,
2006, there were 1,000,000 options available for future grants. For options
granted to greater than 10% stockholders, the exercise price of the options must
be fixed at not less than 110% of the fair market value on the date of grant.
The maximum term of these options may not exceed five years from the date of
grant.
F-17
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the options and warrants granted to officers,
employees consultants and convertible debt holders for the two year period ended
April 30, 2006:
Number of shares under option/warrant
-------------------------------------
HDS Warrants Weighted
Nesco ------------ Average
----- HDS Common Preferred Exercise price
Total Options Warrants Options Stock Stock per share
----- ------- -------- ------- ----- ----- ---------
Outstanding
May 1, 2004 1,070,954 - - 358,334 167,500 545,120 $3.26
Options and warrants due
to reverse acquisition 26,895,866 3, 375,000 24,591,820 (358,334) (167,500) (545,120) 0.12
Options cancelled (750,000) (750,000) - - - - 0.61
Warrants granted 24,039,484 - 24,039,484 - - - 0.21
Options granted 5,180,000 5,180,000 - - - - 0.16
-------------------------------------------------------------------------------------------
Outstanding,
April 30, 2005 56,436,304 7,805,000 48,631,304 - - - 0.16
Options expired (1,050,000) (1,050,000) - - - - 0.25
-------------------------------------------------------------------------------------------
Outstanding,
April 30, 2006 55,386,304 6,755,000 48,631,304 - - - $0.16
============================================================================================
The following table summarizes information about the stock options and warrants
granted to officers, employees, consultants and convertible debt holders at
April 30, 2006:
Options and Warrants
Options and Warrants Outstanding Exercisable
-------------------------------- -----------
Number Weighted Weighted Number Weighted
Outstanding Average Average Exercisable Average
Range of Exercise April 30, Remaining Exercise April 30, Exercise
Prices 2006 Term Price 2006 Price
------ ---- ---- ----- ---- -----
$0.05 - $0.15 37,348,798 4.3 years $0.11 35,348,798 $0.10
$0.25 - $0.39 18,037,506 3.2 years 0.27 18,037,506 0.27
----------------------------------------------------------------------------------------
55,386,304 $0.16 53,386,304 $0.16
========================================================================================
Share Exchange -
On May 25, 2004, HDS consummated 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. Because the former HDS
stockholders own a majority of the voting stock of Nesco (common stock and
Series B preferred stock convertible into common stock), HDS is considered for
accounting purposes to be the acquirer in the transaction. The accounting for
the transaction, commonly called a reverse acquisition, resulted in a
recapitalization of HDS.
F-18
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Nesco 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, Nesco does 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 convertible 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 Nesco is authorized to issue, each share of the Series B convertible
preferred stock will be automatically converted into shares of Nesco common
stock. Such amendment requires action by, or notification to, stockholders. Such
notification has been reflected in a November 16, 2004 preliminary information
statement filed with the SEC. The information statement cannot be completed
until an amended information statement is filed. Upon completion of this
process, the Company will file the Certificate of Amendment and issue the common
stock.
At the time of the transaction, HDS common stockholders exchanged 3,240,593
shares of stock for 38,887 shares of Nesco Preferred B Stock, which will be
converted into 29,165,250 shares of Nesco common stock (a ratio of approximately
9 Nesco shares for 1 share of HDS stock). The HDS preferred stockholders
exchanged 295,853 shares of stock for 14,201 shares of Nesco Preferred B Stock,
which will be converted into 10,650,750 shares of Nesco common stock (a ratio of
approximately 36 Nesco shares for 1 share of HDS stock). Approximately 97% of
the common and 90% of the preferred stockholders have exchanged their shares as
of April 30, 2006 which has resulted in approximately 54.1% of Nesco's voting
securities outstanding at the time of the exchange owned by HDS stockholders.
Assuming that all the remaining HDS stockholders exchange their shares in the
future, the former HDS stockholders would own 55.3% of Nesco's voting securities
outstanding at the time of the exchange. Upon completion of this exchange, HDS
common stockholders will exchange a total of 4,452,806 shares of stock for
53,434 shares of Nesco Preferred B Stock, which will be converted into
40,075,167 shares of Nesco common stock (a ratio of approximately 9 Nesco shares
for 1 share of HDS stock). The HDS preferred stockholders will exchange a total
of 522,487 shares of stock for 25,079 shares of Nesco Preferred B Stock which
will be converted into 18,809,574 shares of Nesco common stock (a ratio of
approximately 36 Nesco shares for 1 share of HDS stock). The HDS stockholders,
upon completion of the exchange of shares, will receive an aggregate of
58,884,741 common shares or 55.3% of the total shares outstanding at the time of
the exchange which aggregated 106,386,847 equivalent common shares on May 25,
2004.
In addition, Nesco was required to convert its outstanding stockholder debt to
equity. On May 11, 2004, prior to the date of the closing, the holders of this
debt in the aggregate principal amount of approximately $953,000 agreed to
exchange the debt for an aggregate of 20,000 shares of Nesco's Series B
convertible preferred stock, which is convertible into 15,000,000 shares of
Nesco's common stock. Nesco was also required to obtain the consent to cancel an
aggregate of 602,500 special warrants prior to the closing. Certain holders of
these special warrants were granted shares of Nesco common stock in the exchange
as part of the common advisor shares issued. Nesco's Series A Preferred
stockholders also agreed that upon completion of the exchange agreement they
would convert their shares to Nesco's common stock and that Nesco would have no
further obligations with respect to these preferred shares including payment of
any prior preferred share dividends. In addition, Nesco was required to have net
cash of approximately $350,000 at the closing of the transaction as part of the
terms of the Share Exchange. Nesco provided approximately $208,500 as a bridge
loan to HDS prior to April 30, 2004. This bridge loan was applied to the net
cash obligation of Nesco, which was satisfied at the closing.
Concurrent with the exchange, Nesco Series A Preferred stockholders agreed to
exchange 512,500 shares of stock for an aggregate of 20,500 shares of Nesco
Preferred B Stock, which will be converted into 15,375,000 shares of Nesco
common stock (a ratio of approximately 30 Nesco common shares for 1 share of
Series A preferred stock). As of April 30, 2005, 445,500 shares of Series A
Preferred shares have been exchanged for 17,820 shares of Series B Preferred
shares.
F-19
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 cannot in good faith
resell the shares of common stock in an arm's length transaction during the
twelve 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. On May 25, 2005, the Company agreed
to extend the put right granted to the transferee until May 25, 2006 subject to
the condition that the right may not be exercised until after January 1, 2006.
The repurchase of the 2,400,000 common shares, which are subject to redemption
by the transferee, are 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. Such repurchase right expired unexercised on May 25, 2006.
In connection with the Share Exchange, Nesco also issued an aggregate of
6,500,000 common shares (with a fair value of approximately $975,000 based on
the market price of $0.15 on the date of the exchange) to an advisor, a limited
liability corporation owned by an affiliate of an interim officer and
consultant, for services rendered in connection with the Share Exchange. This
advisor, under related contractual obligations, assigned an aggregate of
5,000,000 of these common shares to third parties. Approximately 2,900,000 of
these shares were issued to the parties who agreed to cancel their special
warrants of Nesco. Nesco also incurred additional costs related to the exchange
approximating $48,000. Approximately $328,000 of these costs, the net amount of
cash received from the Nesco acquisition, were charged to equity, and the
balance of $695,000 was recorded as a charge to operations in the year ended
April 30, 2005.
Prior to the transaction, Nesco had 7,627,105 common shares outstanding. After
giving effect to the transactions above and after such time that Nesco increases
the number of common shares it is authorized to issue, Nesco would have
approximately 106,387,000 shares outstanding as of the exchange date.
In addition to the exchange of shares, all outstanding options/warrants of HDS
were exchanged for Nesco options/warrants based on the same ratios as the stock
exchange. An aggregate of 525,834 options and warrants for the purchase of HDS
common stock were exchanged for an aggregate of 4,732,500 options and warrants
for the purchase of common stock of Nesco (a ratio of 9 Nesco common shares for
1 share of HDS common stock). An aggregate of 545,120 options and warrants for
the purchase of HDS preferred stock were exchanged for an aggregate of
19,624,320 options and warrants for the purchase of common stock of Nesco (a
ratio of 36 Nesco common shares for 1 share of HDS preferred stock). This
resulted in the issuance of approximately 24,357,000 Nesco options/warrants.
These options/warrants are currently exercisable at prices that range between
$0.08 -$0.39 and expire between one and seven years. Compensation expense
approximating $1,794,000 was recorded on May 25, 2004 for the increase in the
fair value of the 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.
The HDS debt holders were also granted, in consideration of an extension of term
debt, 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
issuance of 2,736,212 warrants. The total HDS term debt of approximately
$2,736,000 was also exchanged for Nesco convertible debt and the holders may
F-20
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
convert this debt to approximately 28,551,000 shares of Nesco common stock.
Approximately $156,000 of the total debt exchanged was attributed to the fair
value of the warrants and approximately $1,703,000 was attributed to the
intrinsic value of the beneficial conversion feature. These amounts were
recorded as equity components. The remaining balance of approximately $877,000
was recorded as long-term debt. For the years ended April 30, 2006 and 2005 the
amortization of the debt discount approximated $623,000 and $1,080,000,
respectively.
Prior to the transaction, Nesco had approximately 4,212,500 options and warrants
outstanding. After giving effect to the transactions above, Nesco had
approximately 30,703,000 options and warrants outstanding and debt convertible
into approximately 28,551,000 common shares as a result of the exchange
agreement.
Loss Per Share
Basic loss per share excludes dilution and is calculated by dividing the net
loss attributable to common stockholders 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 years ended
April 30, 2005 and 2004, since the effect of any potentially dilutive securities
would be antidilutive.
The loss per common share at April 30, 2006 includes the current outstanding
common shares in the aggregate of 20,136,225 shares less the 2,400,000 shares
which are subject to redemption (see Share Exchange above). It does not include
117,055 shares of Series B preferred shares which will be converted into
87,791,250 common shares, 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 on loss per share of the conversion of the Series A and
Series B convertible preferred stock for the years ended April 30, 2006 and
2005.
April 30, 2006 April 30, 2005
-------------- --------------
Net loss $ (4,399,000) $ (8,597,000)
Weighed average common shares outstanding
basic and diluted 111,020,000 104,850,000
Loss per common share, basic and diluted $ (.04) $ (.04)
The loss per common shares does not include an aggregate of 55,386,304 warrants
and options outstanding and 43,850,747 shares issuable under the terms of
convertible debt. The effect of these securities would be antidilutive.
F-21
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Income taxes
Income taxes have been accounted for under SFAS No. 109. At April 30, 2006, the
Company had net operating loss carryforwards of approximately $19,500,000 to
offset future income subject to tax. These result in an estimated $6,630,000 of
federal, and $1,170,000 of state, deferred tax assets at April 30, 2006.
A full valuation allowance ($7,800,000) has been established for these deferred
tax assets since their realization is considered unlikely. The difference
between the tax provision at the federal corporation tax statuary rate (34%) and
the rate, zero, included in the Company's consolidated financial statements
occurs because the Company has not had taxable income and does not have the
ability to utilize loss carryforwards.
The increase in valuation allowance of $735,000 and $3,480,000 for the years
ended April 30, 2006 and 2005, respectively, is primarily attributable to the
Company's additional net operating losses incurred. At April 30, 2006, the
Company has federal and state net operating loss carryforwards of approximately
$19,500,000, which expire beginning in 2012 (see, however, below).
Changes in the ownership of a majority of the fair market value of the Company's
common stock would likely delay or limit the utilization of existing net
operating loss carryforwards. The Company believes, based upon limited analysis,
that such change may have occurred in 2004. However, the amount of such
limitation has not been determined.
13. Commitments and contingencies
Employment Agreements
On May 19, 2004, the Company entered into an employment agreement with an
officer. The agreement provides for annual compensation of $120,000 increasing,
as amended to $200,000 effective January 1, 2005 with a 10% increase each year
on December 31 during the term of the agreement and bonuses to be paid as
determined by the Board of Directors. The term of the agreement, as amended,
extends until December 31, 2009. In addition, the officer was granted
nonqualified options, effective the date of the closing of the Share Exchange,
to purchase 5,000,000 shares of common stock for a period of 5 years. The option
is immediately exercisable for the purchase of 2,000,000 shares and exercisable
as to an additional 1,000,000 shares commencing on each of the first, second,
and third anniversaries of the closing date, respectively, provided that
optionee remains an employee of the Company. The options are exercisable at the
"Applicable Trading Price" in the Share Exchange which was computed to be $0.15
per share.
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 Nesco 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
based on the market price of $0.15 on the date of the agreement) was charged to
operations in the quarter ended July 31, 2004. As of the prior fiscal year end,
April 30, 2005, the Company had prepaid approximately $23,000 in consulting fees
associated with this agreement. At, April 30, 2006, approximately $35,000 was
owed under this agreement and on May 25, 2006, the agreement expired.
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
F-22
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 based
on the market price of $0.15 on the date of the agreement) 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
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. As
of April 30, 2006 the Company has accrued the monthly minimum compensation of
$1,800. 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 expense is included in current liabilities as these
shares have not been issued as of April 30, 2006. This agreement expired under
its terms at October 31, 2005.
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 $0.17 on the date of the agreement) has been
charged to operations. 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
liability. Such shares are convertible into 276,000 shares of common stock of
the Company.
On December 14, 2004, the Company entered into two four-month consulting
agreements for advisory services related to financial matters and marketing.
Each agreement provides for the payment of a monthly fee of $7,800 and the
issuance of a five-year warrant to purchase 40,000 shares of the common stock of
the Company exercisable at the closing price on the date of the agreement
($0.15). The warrants vest at the rate of 10,000 shares per month. The fair
value of the warrants ($12,000) were charged to operations in the fiscal year
ended April 30, 2005.
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 agreement date. The fair
value of the warrants were charged to operations as they vested including
approximately $20,000 and $10,000 in the fiscal years ended April 30, 2006 and
2005, respectively.
Leases, Including Leases With Related Parties
HDS leases with related parties - On January 25, 2002, HDS entered into a lease
for a manufacturing facility that was purchased by an entity owned by a related
party. This lease, as amended in 2004, provides for minimum monthly rental
payments of approximately $14,000 with increases of 5% every two years beginning
in February 2006 and expires in 2012.
Additionally, on April 1, 2004, HDS, along with other co-tenants, entered into a
month-to-month lease for office space with an entity majority-owned by a
director of the Company, which, as amended, provides for a monthly lease payment
of approximately $3,000 per month since February 28, 2004.
F-23
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Foam Manufacturing lease - In February 2006, FMI executed a six year lease for
approximately 28,000 square feet of space calling for minimum annual rentals
ranging from approximately $160,000 in the initial year to approximately
$195,000 in the sixth year plus all costs to operate the premises including
utilities, maintenance and taxes. The Company paid a lease deposit of
approximately $27,000 to secure its payment of the lease.
Rent expense and minimum lease commitments - Rent expense for the years ended
April 30, 2006 and 2005 was approximately $250,000 and $196,000, respectively,
including $210,000 and $196,000, respectively, that was payable to related
parties. Unpaid rent payable to related parties totaled approximately $312,000
at April 30, 2006 including all of the rent, insurance and taxes charged for the
fiscal year ended April 30, 2006 and approximately $101,000 of the rent and
insurance charged for the prior year.
Minimum annual lease payments on long term operating leases, excluding
utilities, maintenance and taxes are as follows:
Total FMI Lease HDS Lease
----- --------- ---------
Year ending April 30,
2007 $ 332,000 $ 161,000 $ 170,000
2008 340,000 168,000 172,000
2009 354,000 175,000 179,000
2010 363,000 182,000 181,000
2011 379,000 189,000 190,000
2012 284,000 146,000 138,000
---------- ---------- ----------
Total $2,052,000 $1,021,000 $1,030,000
========== ========== ==========
Deferred sublease income - On October 1, 1998, Nesco entered into a ten-year
lease through September 30, 2008 for the rental of office facilities. The lease
provides for escalations for scheduled rent increases and for the Company's
proportionate share of increases in real estate taxes and maintenance costs. On
March 4, 2000, Nesco entered into a sublease agreement for the October 1998
lease with a company in which a prior major stockholder of Nesco is a
stockholder. The sublease expires on September 30, 2008. The sublease rent is
being paid directly to the landlord by the sublease tenant.
Aggregate future minimum rental payments and sublease payments under the
operating lease set forth above as of April 30, 2006 are as follows:
Rent Payment Sublease income
------------ ---------------
Year ending April 30,
2007 $179,000 $179,000
2008 179,000 179,000
2009 45,000 45,000
-------- --------
Total $403,000 $403,000
======== ========
In June 2000, Nesco received a payment for future rent of approximately $398,000
from the subtenant under the sublease with respect to the October 1998 lease.
This payment was recorded as deferred sublease income and will be recognized as
revenue on a straight-line basis over the lease term. At April 30, 2006,
deferred sublease income is approximately $117,000, of which approximately
$47,000 is included in accounts payable and accrued liabilities.
F-24
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Litigation
In June 2006, the Company received a complaint from a law firm seeking payment
of approximately $72,000 of fees alleged to be billed to the Company, together
with interest and costs. The Company believes this action is subject to the
indemnification granted to the Company in connection with the transfer of the
former Nesco businesses to a former interim officer (See Share Exchange above).
Except for this claim and the claims against former subsidiaries of Nesco, as
described in Nesco's April 30, 2004 10-KSB filing, the Company and its
subsidiaries were not involved in any other material legal proceedings during
the year ended April 30, 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.
14. Significant customers
Customers accounting for 10% or more of revenue for the years ended April 30,
2006 and 2005 are as follows:
April 30,
---------
2006 2005
---- ----
Customer A $228,000 $ 8,000
Customer B 173,000 353,000
Customer C 120,000 107,000
Customer D 114,000 6,000
-------- --------
$635,000 $474,000
======== ========
Accounts receivable from these customers aggregated approximately $39,000 at
April 30, 2006. Sales to Dicon under the manufacturing agreement discussed in
Note 4 began in April 2006.
F-25
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.
F-26
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.
F-27
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.
F-28
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.
F-29
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED 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.
Dicon has allowed the Company to pay under extended credit terms due to the
F-30
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
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
========== ========== ==========
F-31
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED 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.
F-32
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED 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
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.
F-33
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
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.
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
F-34
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
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.
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
F-35
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
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.
F-36
APPENDIX A
SHARE EXCHANGE AGREEMENT
SHARE EXCHANGE AGREEMENT (this "Agreement"), by and among HYDROGEL DESIGN
SYSTEMS, INC., a Delaware corporation ("HDS") having an address at 305 Madison
Avenue, Suite 4510, New York, NY 10165, NESCO INDUSTRIES, INC., a Nevada
corporation ("Nesco") having an address at 22-09 Queens Plaza North, Long Island
City, NY 11101, certain stockholders of HDS signatory hereto (the "HDS Signatory
Stockholders"), and certain stockholders of Nesco signatory hereto (the "Nesco
Signatory Stockholders"), effective as of the date on which HDS Signatory
Stockholders holding the minimum number of shares of HDS securities, as set
forth herein, and the other parties shall have executed and delivered this
Agreement.
WHEREAS, HDS, Nesco, the HDS Signatory Stockholders and the Nesco
Signatory Stockholders wish to enter into an agreement for, inter alia, the
exchange of outstanding securities of HDS for securities of Nesco in a
transaction intended to be a tax-free exchange pursuant to Sections 351 and 368
of the Internal Revenue Code of 1986, subject to the terms and conditions set
forth in this Agreement (the "Exchange");
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and agreements contained herein, the parties hereto, intending to be legally
bound, do hereby agree as follows:
1. INCORPORATION OF RECITALS; CERTAIN DEFINITIONS; CONSTRUCTION.
1.1 Recitals. The recitals set forth above are incorporated unto this
Agreement as if they were set forth in full in the body of this Agreement.
1.2 Certain Definitions. As used in this Agreement, the following terms
shall have the following respective meanings:
"Accredited Investor" has the meaning given to such term in Rule 501 of
Regulation D.
"Additional Capitalization Amendment" has the meaning set forth in Section
4.1.
"Adviser" means Ariel Holdings, LLC, a limited liability company.
"Adviser Shares" has the meaning set forth in Section 6.3.
"Affiliate" means (i) a Person that directly, or indirectly through one or
more intermediaries, controls, or is controlled by, or is under common control
with the Person specified; or (ii) any relative or spouse of such Person, or any
relation of such spouse, who has the same home as such Person. As used in this
definition, the term "control" (including the terms "controlling," "controlled
by" and "under common control") means the possession, direct or indirect, of the
power, whether exercised or not, to direct or cause the acquisition and/or
disposition by such Person of securities of the other Person, whether through
the ownership of voting securities or otherwise.
"Applicable Trading Price" means the lesser of (i) the average closing bid
price per share of Nesco Common for the thirty (30) consecutive Trading Days
prior to the Closing Date, as adjusted to reflect the Reverse Split by
multiplying such price by the number of shares of Nesco Common that became one
share thereof in the Reverse Split, and (ii) the average closing bid price per
share of Nesco Common for the thirty (30) consecutive Trading Days commencing on
the 31st day following the effective date of the Reverse Split (the "Post-Split
Period"); provided, however, whenever this Agreement provides for application of
the Applicable Trading Price at any time prior to commencement of the Post-Split
Period, the Applicable Trading Price shall be the price determined under clause
(i) of this paragraph.
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"Blue Sky Law" means the securities laws and regulations of the various
states of the United States, Puerto Rico and the District of Columbia.
"Certificate of Designation" has the meaning set forth in Section 4.8
"Closing" means the closing of the Exchange.
"Closing Date" means the date of the Closing as set forth in Section 7.2.
"Closing Transactions" has the meaning set forth in Section 7.2.
"Code" means the United States Internal Revenue Code of 1986, as amended,
and the rules and regulations promulgated thereunder, and any successor law,
rules and regulations.
"DGCL" means the Delaware General Corporation Law.
"Employment Agreement" means the employment agreement to be entered into
by Nesco and Matthew Harriton pursuant to Section 8.1.
"Encumbrance" means any mortgage, charge, claim, community property
interest, lien, option, pledge, security interest, pre-emptive right, right of
first refusal or restriction, including restriction on use, voting, transfer,
receipt of income or exercise of any other attribute of ownership, or any other
adverse claim of any kind.
"Environmental Laws" means any federal, state, local or foreign law
(including, without limitation, common law), treaty, judicial decision,
regulation, rule, judgment, order, decree, injunction, permit or governmental
restriction or requirement or any agreement with any governmental authority or
other third party, relating to human health and safety or the environment and
arising from the use, presence, disposal, discharge or release of pollutants,
contaminants, wastes or chemicals or any toxic, radioactive, ignitable,
corrosive, reactive or otherwise hazardous substances, wastes or materials.
"Environmental Permits" mean, with respect to any person, all permits,
licenses, franchises, certificates, approvals and other similar authorization of
governmental authorities relating in any way to, the business of such person as
currently conducted.
"ERISA" means the United States Employee Retirement Income Security Act of
1974.
"Exchange" means the exchange of Nesco securities for HDS securities on
the Closing Date pursuant to the terms of this Agreement.
"Exchange Act" means the United States Securities Exchange Act of 1934, as
amended.
"GAAP" means generally accepted U.S. accounting principles consistently
applied.
"Governmental Authority" means any court, tribunal, authority, agency,
commission, bureau, department, arbitrator or official or other instrumentality
of the United States or any other country or any provincial, state, local,
county, city or other political subdivision.
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"Governmental Permit" means any license, franchise, permit or other
authorization, consent or approval of any Governmental Authority.
"Harriton Option" has the meaning set forth in Section 8.2.
"HDS" means Hydrogel Design Systems, Inc., a Delaware corporation.
"HDS Balance Sheet" has the meaning set forth in Section 10.9
"HDS Balance Sheet Date" has the meaning set forth in Section 10.9
"HDS Board" means the Board of Directors of HDS.
"HDS Common" means common stock of HDS, par value $0.0001 per share.
"HDS Common Stockholders" means the current holders of HDS Common.
"HDS Common Warrants" has the meaning set forth in Section 3.3.2.
"HDS Disclosure Schedule" means the disclosure schedule of HDS attached as
Exhibit B to this Agreement.
"HDS Officer Debt" has the meaning set forth in Section 6.2.
"HDS Options" means options outstanding on the date hereof to purchase
shares of HDS Common.
"HDS Preferred Warrants" has the meaning set forth in Section 3.3.2.
"HDS Preferred Stockholders" means the current holders of HDS Series B
Preferred.
"HDS Preferred Warrantholders" means the current holders of HDS Preferred
Warrants.
"HDS Securities" means the HDS Common, the HDS Preferred, the HDS Options,
the HDS Warrants and the HDS Term Debt.
"HDS Series B Preferred" means the Series B Convertible Preferred Stock of
HDS, par value $0.0001 per share.
"HDS Signatory Stockholders" means the current holders of HDS Common who
are identified as signatories to this Agreement in their capacity as such
holders.
"HDS Stockholders" means the HDS Signatory Stockholders and all other
holders of HDS Common and/or HDS Series B Preferred immediately prior to the
Closing.
"HDS Term Debt" has the meaning set forth in Section 6.2.
"HDS Warrants" means the HDS Common Warrants and the HDS Preferred
Warrants.
"Intellectual Property Right" means any right to use, whether through
ownership, licensing or otherwise, or any title to, any patents, trademarks,
service marks, trade names, copyrights, trade secrets and other proprietary
rights and processes.
A-3
"Investor Statement" has the meaning set forth in Section 6.1.3.
"Letter of Intent" means that certain letter of intent, dated as of
December 2003, by and among HDS and Nesco with respect to the Exchange.
"Lien" means any lien, pledge, hypothecation, levy, mortgage, deed of
trust, security interest, claim, lease, charge, option, right of first refusal,
easement, or other real estate declaration, covenant, condition, restriction or
servitude, transfer restriction under any Stockholder or similar agreement,
encumbrance, other adverse claim of any kind or any other restriction or
limitation whatsoever.
"Lock-Up" has the meaning set forth in Section 13.10.
"Material Adverse Effect" means any change, effect, event, occurrence or
state of facts that has had, or would reasonably be expected to have, a material
adverse effect on the business, financial condition or results of operations of
the entity in question and its subsidiaries, if any, taken as a whole.
"NAC Entities" means, collectively, Nesco's subsidiaries, National
Abatement Corporation, a Delaware corporation, NAC/Indoor Air Professionals,
Inc., a New York corporation, and NAC Environmental Services, Inc., a Delaware
corporation.
"NAC Shares" has the meaning set forth in Section 4.5.
"Nesco" means NESCO Industries, Inc., a Nevada corporation.
"Nesco Balance Sheet" has the meaning set forth in Section 9.1.
"Nesco Balance Sheet Date" has the meaning set forth in Section 9.1.
"Nesco Board" means the Board of Directors of Nesco.
"Nesco Common" means common stock of Nesco, par value $0.001 per share.
"Nesco Conversion Shares" has the meaning set forth in Section 4.2.
"Nesco Debentures" means convertible debentures of Nesco to be issued
pursuant to Sections 4.5 and 6.2.
"Nesco Debenture Shares" means shares of Nesco Common to be issued upon
conversion of the Nesco Debentures.
"Nesco Disclosure Schedule" means the disclosure schedule of Nesco
attached as Exhibit A to this Agreement.
"Nesco Exchange Options" has the meaning set forth in Section 6.1.4.
"Nesco Exchange Securities" means Nesco Exchange Shares, Nesco Exchange
Options and Nesco Exchange Warrants.
"Nesco Exchange Shares" means the shares of Nesco Common (including Nesco
Debenture Shares) and/or Nesco Series B Preferred to be issued by Nesco in
exchange for HDS Securities at the Closing or any Subsequent Closing(s) and the
shares of Nesco Common to be issued to the holders of Nesco Series B Preferred
A-4
following the filing of the Additional Capitalization Amendment, all pursuant to
the terms of this Agreement. Whenever this Agreement provides for conversion or
exchange of securities or debt for Nesco Common, at the option of the company,
at any time prior to the filing of the Additional Capitalization Amendment,
Nesco Series B Preferred representing such number of shares of Nesco Common may
be issued in lieu of the Nesco Common.
"Nesco Exchange Warrants" has the meaning set forth in Section 6.1.4.
"Nesco Information Statement" has the meaning set forth in Section 4.10.
"Nesco Name Change" has the meaning set forth in Section 4.7.
"Nesco Series A Preferred" means the 10% Series A Convertible Preferred
Stock, par value $0.001 per share, of Nesco.
"Nesco Preferred Conversion" means the conversion of outstanding and
issuable shares of Nesco Series A Preferred into Nesco Common as described in
Section 4.2.
"Nesco Preliminary Information Statement" has the meaning set forth in
Section 4.9.
"Nesco SEC Filings" has the meaning set forth in Section 9.9.1.
"Nesco Series B Preferred" means the convertible Series B Preferred Stock
of Nesco, par value $0.001 per share, to be issued by Nesco in connection with
the Exchange on the terms and conditions set forth in Section 4.8.
"Nesco Special Warrants" has the meaning set forth in Section 3.1.4.
"Nesco Stockholder Debt" has the meaning set forth in Section 4.4.
"Nesco's 2003 Annual Report" means the annual report of Nesco on Form
10-KSB for the year ended April 30, 2004.
"Nesco Warrant Conversion" has the meaning set forth in Section 4.3.
"Nesco Warrant Shares" means the shares of Nesco Common to be issued upon
the Nesco Warrant Conversion as provided in Section 4.3.
"Nesco Warrants" has the meaning set forth in Section 3.1.4.
"NRS" means the Nevada Revised Statutes as currently in effect or
hereafter amended, and any successor statute(s).
"OTCBB" means the Over-the-Counter Bulletin Board.
"Person" means any individual, group, corporation, company, partnership,
limited liability company or partnership, association, trust or other entity or
organization, including any government or political subdivision or any agency or
instrumentality of either.
"Regulation D" means Regulation D promulgated under the Securities Act.
"Regulation FD" means Regulation FD promulgated under the Exchange Act.
A-5
"Reverse Split" has the meaning set forth in Section 4.6.
"Reverse Split Amendment" means a certificate of amendment to the
certificate of Incorporation of Nesco to be filed by Nesco following the Closing
to change Nesco's name and effectuate the Reverse Split and any other changes to
Nesco's articles of incorporation required to consummate the Exchange and any
other transactions contemplated hereby or by the Nesco Information Statement.
"Rule 144" means Rule 144 promulgated under the Securities Act as
currently in effect or hereafter amended and any successor rule.
"SEC" means the United States Securities and Exchange Commission, or any
successor body.
"Securities Act" means the United States Securities Act of 1933, as
amended, or any successor statute.
"Seller" means each HDS Signatory Stockholder and each other Person who
participates in the Exchange, complies with the requirements for participation
set forth in this Agreement and is the beneficial owner of (i) any outstanding
voting securities of HDS or (ii) any other security or securities of HDS,
including the HDS Term Debt, which may be exchanged for any security of Nesco
pursuant to the terms of this Agreement.
"Standstill Agreement" means the covenants, representations and warranties
of the parties contained in Section 13.4.
"Subsequent Closing Date" has the meaning set forth in Section 6.1.5.
"Taxes" means any and all federal, state, local, foreign or other taxes of
any kind (together with any and all interest, penalties, additions to tax and
additional amounts imposed with respect thereto) imposed by any taxing authority
including, without limitation, taxes or other charges on or with respect to
income, franchises, windfall or other profits, gross receipts, sales, use,
capital stock, payroll, employment, social security, workers' compensation,
unemployment compensation or net worth, and taxes or other charges in the nature
of excise, withholding, ad valorem or value added.
"Termination Date" means the date of termination of this Agreement as set
forth in Section 16.2.
"Trading Day" means a day on which trades may be effected in the Pink
Sheets or any system of automated dissemination of quotations of securities
prices, including the OTCBB.
"Transaction Documents" means this Agreement (including all exhibits
hereto), the Additional Capitalization Amendment, the Reverse Split Amendment,
the Harriton Option, the Employment Agreement, the Nesco Information Statement
and all other documents and instruments delivered by HDS or Nesco pursuant to
this Agreement.
1.3 Gender; Number; Certain Definitions, References. The headings of
Sections in this Agreement are provided for convenience only and shall not
affect its construction or interpretation. In this Agreement (i) words denoting
the singular include the plural and vice versa, (ii) "it" or "its" or words
denoting any gender include all genders, (iii) the word "including" shall mean
"including, without limitation," whether or not expressed, (iv) any reference to
a statute shall mean the statute and any regulations thereunder in force as of
the date of this Agreement or the Closing, as applicable, unless otherwise
expressly provided, (v) any reference herein to a Section, Schedule or Exhibit
A-6
refers to a Section of or a Schedule or Exhibit to this Agreement, unless
otherwise stated, and (vi) when calculating the period of time within or
following which any act is to be done or steps taken, the date which is the
reference day in calculating such period shall be excluded and if the last day
of such period is not a Business Day, then the period shall end on the next day
following that is a Business Day. Each party acknowledges that such party has
been advised and represented by counsel in the negotiation, execution and
delivery of this Agreement and accordingly agrees that if an ambiguity exists
with respect to any provision of this Agreement, such provision shall not be
construed against any party because such party or its representatives drafted
such provision.
1.4 Beneficial Ownership. Except as otherwise expressly provided herein,
all references in this Agreement to beneficial ownership of any securities shall
mean beneficial ownership thereof calculated in accordance with Section 13-d of
the Exchange Act and the rules promulgated thereunder.
2. PLAN OF REORGANIZATION. The transactions contemplated by this Agreement are
intended to be a reorganization under both Sections 351 and 368(a)(1)(B) of the
Code. Upon the terms and subject to the conditions contained in this Agreement
and on the basis of the representations, warranties and covenants contained
herein: (a) at the Closing, (i) the HDS Signatory Stockholders shall exchange
and (ii) any other Seller electing to participate in the Exchange who complies
with the requirements for participation set forth in Section 6 on or prior to
the Closing Date may exchange, all of their outstanding HDS Securities for Nesco
Exchange Securities pursuant to the terms of Section 6.1; and (b) at each
closing on a Subsequent Closing Date, each additional Seller that elects to
participate in the Exchange and complies with such requirements for
participation following the Closing Date may exchange all of their outstanding
HDS Securities for Nesco Exchange Securities pursuant to the terms of Section
6.1 (the "Exchange").
3. CAPITALIZATION.
3.1 Capitalization of Nesco. Nesco covenants, represents and warrants
that:
3.1.1 On the date hereof, Nesco's authorized capital stock consists
of: 25,000,000 shares of Nesco Common and 1,000,000 shares of Nesco Series A
Preferred.
3.1.2 On the date hereof, Nesco has 6,769,963 shares of Nesco Common
issued and outstanding. On the date hereof, Nesco has 512,500 shares of Nesco
Series A Preferred issued and outstanding, and another 270,651 shares of Nesco
Series A Preferred are issuable as stock dividends in kind to the current
holders of outstanding Nesco Series A Preferred or otherwise. Each share of
Nesco Series A Preferred issued and outstanding or issuable is convertible, on
the date hereof, at the option of the holder into the number of shares of Nesco
Common set forth on Section 3.1.2 of the Nesco Disclosure Schedule.
3.1.3 On the date hereof, there are no unexpired options to purchase
shares of Nesco Common or any other security of Nesco that are currently
outstanding, whether under Nesco's 1998 Incentive Stock Option Plan or Nesco's
2001 Stock Option Plan or otherwise, and Nesco has no other stock option plans.
3.1.4 On the date hereof, there are outstanding warrants to purchase
an aggregate of 602,500 shares of Nesco Common at $0.05 per share, all of which
expire on dates through March 2007 and none of which has been exercised ("Nesco
Special Warrants"), and outstanding warrants to purchase 4,500,000 shares of
Nesco Common ("Nesco Warrants"). The Nesco Special Warrants shall be cancelled
prior to the Closing Date.
3.1.5 Nesco has no securities outstanding or any obligation to issue
any securities other than as set forth in this Section 3.1.5 or those securities
which Nesco is required to issue pursuant to the terms of this Agreement.
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3.2 Nesco Security Ownership. On the date hereof, the Nesco Signatory
Stockholders hold not less than 50.1 % of the shares of Nesco Common, on a
fully-diluted and as converted basis, or any higher percentage (on the same
basis) required by the NRS, or the articles of incorporation or by-laws of Nesco
that is required to bind Nesco to its obligations hereunder and to authorize and
effectuate the Exchange and the other transactions required by the terms of this
Agreement to be effected by Nesco on or before the Closing Date.
3.3 HDS Capitalization. HDS covenants, represents and warrants that:
3.3.1 On the date hereof, the authorized capital stock of HDS
consists of 20,000,000 shares of HDS Common, 15,000,000 shares of Series A
Preferred Stock, par value $0.0001 per share, and 5,000,000 shares of blank
check preferred stock, par value $0.0001 per share ("HDS Preferred"), of which
2,000,000 shares have been designated as HDS Series B Preferred.
3.3.2 On the date hereof, there are issued and outstanding: (i)
4,702,806 shares of HDS Common; (ii) 522,487 shares of HDS Series B Preferred;
(iii) warrants to purchase the number of shares of HDS Series B Preferred set
forth in Section 3.3.2 of the HDS Disclosure Schedule ("HDS Preferred
Warrants"); (iv) debentures convertible into the number of shares of HDS Series
B Preferred set forth in Section 3.3.2 of the HDS Disclosure Schedule; (v)
warrants to purchase the number of shares of HDS Common set forth on Section
3.3.2 of the HDS Disclosure Schedule (collectively, "HDS Common Warrants"); and
(vi) options to purchase the number of shares of HDS Common set forth on Section
3.3.2 of the HDS Disclosure Schedule (collectively, "HDS Options").
3.3.3 Outstanding shares of HDS Series B Preferred accrue dividends
of 7% per annum payable solely in HDS Common upon conversion of such shares of
HDS Series B Preferred into HDS Common. The outstanding shares of HDS Series B
Preferred and accrued dividends thereof are convertible, on the date hereof,
into the number of shares of HDS Common set forth on Section 3.3.3 of the HDS
Disclosure Schedule.
3.4 HDS Beneficial Ownership. On the date hereof, the HDS Signatory
Stockholders hold not less than fifty and one-tenths percent (50.1%) of the HDS
Common issued and outstanding and fifty and one-tenths percent (50.1%) of the
HDS Series B Preferred issued and outstanding, in each case on a fully diluted
basis.
4. CERTAIN NESCO COVENANTS.
4.1 Additional Capitalization. As soon as practicable following the
Closing Date, Nesco shall increase the number of shares of Nesco Common which it
is authorized to issue to 400,000,000 shares, by obtaining all required security
holder approvals therefor and filing an amendment to its certificate of
incorporation to such effect as provided in the NRS substantially in the form of
Exhibit 4.1 (the "Additional Capitalization Amendment"), which Amendment shall
also provide for the Nesco Name Change as required by this Agreement. By
executing this Agreement, each Nesco Signatory Stockholder acknowledges that
such Stockholder has agreed to give its written consent to (a) the increase in
the number of shares of authorized Nesco Common provided for in this Section 4.1
and (b) the filing of the Additional Capitalization Amendment, in each case, on
the terms and conditions set forth in this Agreement.
4.2 Nesco Preferred Conversion. By executing this Agreement, the Nesco
Signatory Stockholders who are beneficial owners of Nesco Series A Preferred (a)
agree to exchange, on or prior to the Closing Date, all shares of Nesco Series A
Preferred held by them or issuable to them at any time from the date through the
Closing Date as dividends payable or otherwise, for shares of Nesco Common (or,
at the option of Nesco, shares of Series B Preferred representing the number of
shares of Nesco Common) in the ratio set forth in Section 4.2 of the Nesco
Disclosure Schedule (such shares of Nesco Common and/or Nesco Preferred, "Nesco
Conversion Shares"), (b) consent to the exchange of all other shares of Nesco
Series A Preferred for shares of Nesco Conversion Shares on the same terms,
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respectively (the exchange pursuant to clauses (a) and (b) together, the "Nesco
Preferred Conversion"), (c) consent to the filing, execution and delivery by
Nesco of any and all documents and instruments, including, any amendment to the
terms of Nesco's certificate of incorporation (including the Certificate of
Voting Powers, Designations, Preferences, Limitations, Restrictions and Relative
Rights of the Nesco Series A Preferred) that may be necessary to give effect to
such consent; and (d) understand and agree that upon the exchange of any shares
of Nesco Series A Preferred as provided in this Section, Nesco shall have no
further obligation in respect of such shares of Nesco Series A Preferred, and no
Person who exchanges such Person's shares of Nesco Series A Preferred shall have
any further right to require Nesco to issue any other securities in respect
thereof. Nesco agrees that, prior to the Closing Date, it shall do all things
necessary or proper to effect the Nesco Preferred Conversion by as many holders
thereof as possible and to carry out the intent of this Section. All Nesco
Signatory Stockholders who are beneficial owners of any shares of Nesco Series A
Preferred hereby agree that, immediately following the exchange by them of their
shares of Nesco Series A Preferred and their receipt of Nesco Conversion Shares
as provided in this Section, such Stockholders shall have all of the obligations
in respect of their Nesco Conversion Shares as the other Nesco Signatory
Stockholders that are holders of shares of Nesco Common on the date hereof.
4.3 Nesco Warrant Conversion. The Nesco Signatory Stockholders include the
beneficial owners of fifty and one-tenths percent (50.1%) of the Nesco Warrants
(or such higher percentage thereof as may be required by the terms of any of the
Nesco Warrants) (the "Nesco Signatory Warrantholders"). By executing this
Agreement, the Nesco Signatory Warrantholders hereby (a) give their written
consent to the exchange or exercise of all Nesco Warrants for 4,500,000 shares
of Nesco Common or, at the option of Nesco, shares of Nesco Series B Preferred
representing such shares of Nesco Common (the "Nesco Warrant Shares") on a pro
rata basis prior to the Closing Date (the "Nesco Warrant Conversion"), (b) agree
to exercise their Nesco Warrants pursuant to the Nesco Warrant Conversion on the
terms of this Section 4.3, and (c) agree, that (i) upon their exercise or
exchange of Nesco Warrants pursuant to the Nesco Warrant Conversion and their
receipt of Nesco Warrant Shares, except as otherwise expressly provided in this
Agreement, such Warrantholders shall have all of the obligations in respect of
such Nesco Warrant Shares as the Nesco Signatory Stockholders have in respect of
their shares of Nesco Common on the date hereof. Nesco agrees to effectuate the
Nesco Warrant Conversion prior to the Closing Date, and upon exercise or
exchange of each Nesco Warrant pursuant to the Nesco Warrant Conversion, such
Warrants to purchase Nesco Common shall be cancelled and the holder(s) thereof
shall have no further rights to require Nesco to issue Nesco Warrant Shares or
any other securities in respect of any Nesco Warrants.
4.4 Conversion of Nesco Stockholder Debt. Prior to the Closing Date, Nesco
shall have exchanged the indebtedness of Nesco in the principal amount of
approximately $1,033,000 to the stockholders of Nesco identified on Section 4.4
of the Nesco Disclosure Schedule (the "Nesco Stockholder Debt"), at the election
of such stockholders, for either (i)15,000,000 shares of Nesco Common or (ii)
7,500,000 shares of Nesco Common and $500,000 in principal amount of Nesco
Debentures; such Debentures to be convertible into the number of shares of Nesco
Common determined by dividing the principal amount thereof by the Applicable
Trading Price. Upon such exchange, the Nesco Stockholder Debt shall be fully
paid and satisfied. Each holder of Nesco Stockholder Debt who executes this
Agreement hereby agrees (a) to the terms of this Section 4.4 and to convert its
portion of the Nesco Stockholder Debt prior to the Closing pursuant to the terms
of this Section 4.4, and (b) that such holder shall have all of the obligations
under this Agreement in respect of the shares of Nesco Common received upon such
exchange as the Nesco Signatory Stockholders who are beneficial owners of Nesco
Common on the date hereof.
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4.5 Disposition of NAC Entities.
4.5.1 Prior to the Closing Date, Nesco shall have transferred or
otherwise disposed of all of its right, title and interest in and to all of the
capital stock in, all indebtedness owed to it by, each NAC Entity in such manner
that each of the parties to whom any such capital stock and indebtedness
(collectively, "NAC Interests") are transferred ("NAC Transferees") shall
assume, in one or more written agreements (collectively, the "NAC Acquisition
Agreement"), all liabilities and obligations of Nesco with respect to the NAC
Entities or the NAC Interests for and in consideration of a maximum of 3,000,000
shares of Nesco Common, in the aggregate (the "NAC Shares"). The NAC Shares
shall include all shares of Nesco Common issued by Nesco to any creditors of any
NAC Entity between the date hereof and the Closing Date as consideration for the
discharge, or in payment of, any obligations of any of the NAC Entities. The NAC
Acquisition Agreement shall provide that the NAC Shares shall be deliverable to
the Transferees not later than the date of effectiveness of the Additional
Capitalization Amendment. The NAC Acquisition Agreement shall further provide
Nesco with all such assurances as Nesco or its independent certified public
accountants may require, whether in the form of an indemnity secured by liquid
assets, bonds or otherwise, (i) to enable such accountants to exclude from pro
forma, combined and audited financial statements of Nesco as of a date on or
after the Closing Date all obligations and liabilities whatsoever of any NAC
Entity or of Nesco in respect of any NAC Entity, including, without limitation,
all references to any contingent or potential liabilities arising out of or
related to any pending legal or administrative proceedings involving or any
going concern issues with respect to, any NAC Entity, other than the obligation
of Nesco to repurchase the NAC Shares pursuant to Section 4.5.3 of this
Agreement and (ii) to enable Nesco to obtain an opinion of counsel satisfactory
to HDS to the effect that Nesco has no further liability, contingent or
otherwise, arising out of or relating to any pending legal or administrative
proceedings involving or going concern issues with respect to any NAC Entity and
that the transfer or disposition by Nesco of any and all of the NAC Interests
for the NAC Shares is legally binding on the parties and complies with all
applicable laws and regulations.
4.5.2 In the event that Nesco shall not have disposed of the NAC
Interests prior to the Closing Date as provided in Section 4.5.1, HDS may
terminate this Agreement.
4.5.3 The NAC Acquisition Agreement shall provide that if the NAC
Transferees cannot in good faith resell all of the NAC Shares (in compliance
with the Securities Act and applicable Blue Sky Laws) in an arms-length
transaction during the twelve (12) months immediately following the Closing Date
for the lesser of (i) all liabilities of NAC resulting directly from the
agreement between NAC and Mason Tenders Union plus legal fees due to the firm of
Eckert et al. or (ii) $330,000, then Nesco, upon written demand of the NAC
Transferees establishing the facts required by this Section 4.5.3, shall
repurchase 2,400,000 NAC Shares for such amount or a portion of such NAC Shares
for a pro rata portion of such amount.
4.6 Reverse Split. Prior to the Closing Date, Nesco shall have obtained
all necessary authorization from its Board of Directors and security holders to
effect a 1:20 split of its issued and outstanding common stock as soon as
practicable following the Closing Date (the "Reverse Split"), including, without
limitation, authorization to file the Reverse Split Amendment. By executing this
Agreement, each of the Nesco Signatory Stockholders and the HDS Signatory
Stockholders acknowledges that such Stockholder has agreed to give its written
consent to the Reverse Split and the execution, delivery and filing of the
Reverse Split Amendment, in each case, on the terms and conditions set forth in
this Agreement and agrees to do all things necessary, proper or advisable,
including the execution and delivery of any and all further consents or other
documents and instruments, to effectuate the Reverse Split pursuant to the terms
of this Agreement.
4.7 Change of Name. As soon as practicable following the Closing Date,
Nesco shall effect the Nesco Name Change, by obtaining all required security
holder approvals therefor and executing, delivering and filing the Additional
Capitalization Amendment. By executing this Agreement, each Nesco Signatory
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Stockholder acknowledges that such Stockholder has agreed to give its written
consent to the Nesco Name Change and to the filing of the Additional
Capitalization Amendment, in each case, on the terms and conditions set forth in
this Agreement. Prior to the Closing Date, Nesco shall have obtained all
necessary authorization of the Nesco Board to the Nesco Name Change and the
filing of the Additional Capitalization Amendment.
4.8 Certificate of Designation. As soon as practicable following the date
hereof but in no event later than the Closing Date, Nesco shall file a
certificate of voting powers, designations, preferences, limitations,
restrictions and relative rights of the Nesco Series B Preferred Stock providing
for designation thereof with the following terms, and such other terms as are
set forth in Section 4.8 of the Nesco Disclosure Schedule or otherwise required
to give effect to the Exchange pursuant to the terms of this Agreement (the
"Certificate of Designation"): Each share of Nesco Series B Preferred shall
automatically convert into the number of shares of Nesco Common set forth in
said Section of the Nesco Disclosure Schedule (the "Conversion Share Number")
upon the filing of the Additional Capitalization Amendment; and, except as
otherwise required by the NRS, each share of Nesco Series B Preferred shall have
the right to vote with the Nesco Common, on any and all issues as to which
holders of Nesco Common have the right to vote, provided that each share of
Nesco Series B Preferred shall have the right to cast the number of votes equal
to the Conversion Share Number; holders of shares of Nesco Series B Preferred
shall have the right vote, and vote as a class, to the extent provided in
applicable provisions of the NRS; and no amendment or modification may be made
to the foregoing provisions of the Certificate of Designation other than as
provided in Section 4.8 of the Nesco Disclosure Schedule, without the consent of
HDS and the holders of two-thirds of the shares of the Nesco Series B Preferred
then outstanding.
4.9 Nesco Preliminary Information Statement. As soon as practicable after
the Closing Date, Nesco shall prepare and file a preliminary information
statement with SEC pursuant to Regulation 14C of the Exchange Act containing the
information necessary to effectuate (i) the Additional Capitalization Amendment
and conversion of shares of Nesco Series B Preferred to be issued pursuant to
this Agreement into Nesco Common pursuant to the Exchange and the terms of this
Agreement, (ii) the Reverse Split and the Reverse Split Amendment, (iii) the
Nesco Name Change, and (iv) any and all other transactions contemplated hereby
and by the other Transaction Documents (the "Information Statement
Transactions") requiring the filing of an information statement pursuant to
Regulation 14C under the Exchange Act (the "Nesco Preliminary Information
Statement"), and such amendments thereto as the SEC may require or Nesco or HDS
may deem necessary or proper.
4.10 Nesco Information Statement. As soon as practicable after the Closing
Date, Nesco shall prepare and file a definitive information statement pursuant
to Regulation 14C of the Exchange Act containing the information necessary to
effectuate the Information Statement Transactions.
4.11 Due Diligence. From the date hereof until the Closing Date, Nesco
shall give HDS, its counsel, financial advisers, auditors and other authorized
representatives (collectively, "HDS Representatives") (a) full access to the
offices, properties, books and records of Nesco and its subsidiaries, (b) such
financial and operating data and other information relating to Nesco and its
subsidiaries as such Persons may reasonably request, and (c) instruct the
employees of Nesco and its subsidiaries and Nesco's counsel, financial advisers,
auditors and other authorized representatives (collectively, the "Nesco
Representatives") to cooperate with HDS and the HDS Representatives in their due
diligence investigation of Nesco and its subsidiaries, their business, assets,
financial condition and other matters. No investigation by HDS or any of its
representatives shall operate as a waiver or otherwise affect any
representation, warranty or agreement given or made by Nesco or any Nesco
Signatory Stockholder hereunder.
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5. CERTAIN HDS COVENANTS.
5.1 Cooperation. Subject to compliance by the parties with the provisions
of Section 13.3, HDS and the HDS Signatory Stockholders shall cooperate with
Nesco in the preparation of the Nesco Preliminary Information Statement and the
Nesco Definitive Information Statement by providing Nesco with all information
regarding the business and financial condition of HDS any subsidiaries, their
management and security ownership as may be required to be included in such
Information Statements.
5.2 Due Diligence. Subject to compliance by the parties with the
provisions of Section 13.3, from the date hereof until the Closing Date, HDS
shall give the Nesco Representatives (a) full access to the offices, properties,
books and records of HDS and any subsidiaries, (b) such financial and operating
data and other information relating to HDS and its subsidiaries as such Persons
may reasonably request, and (c) instruct the employees of HDS and the HDS
Representatives to cooperate with Nesco and the Nesco Representatives in their
due diligence investigation of HDS and any subsidiaries, their business, assets,
financial condition and other matters. No investigation by Nesco or any of the
Nesco Representatives shall operate as a waiver or otherwise affect any
representation, warranty or agreement given or made by HDS or any HDS Signatory
Stockholder hereunder.
6. THE EXCHANGE. All references in this Agreement to numbers of shares of Nesco
Common issued and outstanding, to be issued, or issuable refer to such numbers
prior to the Reverse Split, unless otherwise expressly provided.
6.1 Exchange of Securities. Upon the terms and subject to the conditions
contained in this Agreement:
6.1.1 At the Closing, each HDS Signatory Stockholder, and each other
HDS Stockholder who elects, prior to the Closing Date, to participate in the
Exchange and complies with the requirements therefor set forth in this Section
6, shall exchange, transfer and assign all of such Person's right, title and
interest in and to its shares of HDS Common and HDS Preferred for shares of
Nesco Series B Preferred Stock by delivering to Nesco share certificates for all
such shares of HDS Common and or HDS Series B Preferred, duly endorsed in blank,
with all necessary stock transfer stamps affixed, and Nesco shall issue shares
of Nesco Series B Preferred Stock in exchange for shares of HDS Common and HDS
Series B Preferred so tendered by in the applicable ratio provided in Section
6.1.6. by delivering to each such Stockholder one or more certificates
evidencing the shares of Nesco Series B Preferred issuable to such Stockholder.
6.1.2 Each HDS Common Stockholder and each HDS Preferred Stockholder
who is not an HDS Signatory Stockholder and who elects, following the Closing
Date, to participate in the Exchange by giving written notice of its intent to
participate in the Exchange to HDS or Nesco (an "Exchange Notice"), and complies
with the other requirements for such participation set forth in this Section
6.1, shall transfer and assign all of such Person's right, title and interest in
and to its shares of HDS Common and/or HDS Series B Preferred for Nesco Series B
Preferred by delivering, on a date following the Closing Date selected for such
purpose by Nesco, but in no event more than five (5) business days following the
giving of the Exchange Notice (each such date, a "Subsequent Closing Date") (i)
share certificates for all such shares of HDS Common and/or HDS Series B
Preferred, duly endorsed in blank, with all necessary stock transfer stamps
affixed, and (ii) an executed and completed Investor Statement; and on such
Subsequent Closing Date, Nesco shall issue shares of Nesco Series B Preferred
Stock in exchange for shares of HDS Common and/or HDS Series B Preferred so
tendered in the applicable ratio pursuant to Section 6.1.6 by delivering one or
more certificates evidencing the shares of Nesco Series B Preferred issuable to
such Stockholder.
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6.1.3 Each HDS Signatory Stockholder that is the holder of HDS
Common Warrants and/or HDS Options outstanding on the date hereof hereby agrees
that all such Warrants and Options, shall, upon Closing, constitute warrants and
options, respectively, to purchase the number of shares of Nesco Series B
Preferred that such Stockholder would be entitled to receive pursuant to such
Warrants and Options, respectively, had they been exercised (to the extent the
exercise rights thereunder shall not have expired) immediately prior to the
Closing Date for shares of HDS Common.
6.1.4 Each holder of HDS Options and/or HDS Common Warrants
outstanding on the date hereof who is not an HDS Signatory Stockholder may elect
to participate in the Exchange by delivering to HDS or Nesco an Exchange Notice
and a completed Investor Statement: (i) prior to the Closing Date, in which
event, on the Closing Date, all such HDS Options and HDS Warrants shall
thereupon constitute options and warrants, respectively, to purchase the number
of shares of Nesco Series B Preferred ("Nesco Exchange Options" and "Nesco
Exchange Warrants," respectively) that such holder would be entitled to receive
had such holder exercised such HDS Options and HDS Warrants, respectively, for
shares of HDS Common immediately prior to the Closing Date; or (ii) after the
Closing Date, in which event, on the Subsequent Closing Date selected by Nesco
pursuant to the terms of Section 6.1.2, all such HDS Options and HDS Warrants
shall thereupon constitute, respectively, Nesco Exchange Options and Nesco
Exchange Warrants to purchase the number of shares of Nesco Series B Preferred
that such holder would be entitled to receive had such holder exercised such HDS
Options and HDS Warrants for shares of HDS Common immediately prior to such
Subsequent Closing Date.
6.1.5 Each HDS Stockholder and each holder of any HDS Options or HDS
Warrants that wishes to participate in the Exchange but is not an HDS Signatory
Stockholder shall execute and deliver to Nesco on or prior to the Closing Date
or the applicable Subsequent Closing Date, as the case may be, a written
statement, in the form prepared by HDS prior to the Closing Date and approved by
Nesco (which approval shall not be unreasonably withheld), providing that the
signatory represents, warrants and agrees that such signatory (i) is an
Accredited Investor, (ii) makes the representations and warranties contained in
Sections 10.22.1, 10.22.2 and 10.22.4, and (iii) consents to, and agrees to be
bound by, the provisions of this Agreement applicable to holders of HDS Common,
HDS Preferred, Nesco Exchange Warrants or Nesco Exchange Options, as the case
may be, to be performed from and after the Closing Date (or any Subsequent
Closing Date on which any such signatory participates in the Exchange), in
respect of the Nesco Exchange Shares to be received by such holder or issuable
upon exercise of such Nesco Exchange Warrants or Nesco Exchange Options, and
(iv) gives its written consent (or agrees to give such consent in respect of any
Nesco Exchange Shares it may receive upon exercise of any Nesco Exchange Options
or Nesco Exchange Warrants) to the matters which HDS Signatory Stockholders are
hereby deemed to consent to, including (A) an increase in the number of shares
of Nesco Common which Nesco is authorized to issue pursuant to the Additional
Capitalization Amendment and the execution, delivery and filing of such
Amendment, (B) the Nesco Name Change, and (C) implementation of the Reverse
Split and the filing, execution and delivery of the Reverse Split Amendment (an
"Investor Statement").
6.1.6 Section 6.1.6 of the HDS Disclosure Schedule sets forth the
number of shares of Nesco Series B Preferred which each HDS Stockholder shall be
entitled to receive for (i) each share of HDS Common and (ii) each share of HDS
Series B Preferred tendered by each HDS Stockholder in the Exchange. Section 4.8
of the HDS Disclosure Schedule sets forth the number of shares of Nesco Common
into which each share of Nesco Series B Preferred shall be convertible.
6.1.7 Anything contained herein to the contrary notwithstanding, any
Person who, is, on the date hereof or subsequently becomes (not in contravention
of the terms of this Agreement), the holder of HDS Common, HDS Preferred, any
HDS Option or HDS Warrant or any other security of HDS and is not an Accredited
Investor, may not participate in the Exchange on or prior to the Closing Date,
but may participate in the Exchange thereafter on a date selected by Nesco, but
not more than five (5) business days following the last to occur of the filing
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by Nesco of the Nesco Information Statement with the SEC and the Additional
Capitalization Amendment with the Secretary or Department of State of Nevada (a
"Subsequent Closing Date") and the giving by such Person of an Exchange Notice,
and on the other terms and conditions set forth in this Agreement, provided,
however, that such Person's Investor Statement need not represent that such
Person is an Accredited Investor.
6.1.8 As a result of the Exchange, on the Closing Date HDS shall be
a majority-owned subsidiary of Nesco.
6.2 HDS Debt. Simultaneously with the Closing:
6.2.1 The outstanding convertible debentures of HDS in the principal
amount of approximately $2,092,000 (the "HDS Term Debt") shall be exchanged for
and converted into (i) debentures of Nesco in the same principal amount having a
maturity date of December 31, 2005 (the "Maturity Date") and bearing interest at
the rate of eight percent (8%) per annum due and payable in cash at the Maturity
Date, which debentures ("Nesco Debentures"), shall be convertible into the
number shares of Nesco Common, or at the election of Company, Nesco Series B
Preferred convertible in that number of shares of Nesco Common, ("Debenture
Shares") which the holders of the HDS Term Debt would be entitled to receive in
the Exchange if they had exercised their conversion rights on the principal
amount of the HDS Term Debt immediately prior to the Closing, and (ii) a warrant
to purchase one (1) share of Nesco Common for each $1.00 in amount of HDS Term
Debt so exchanged (the "Debtholder Warrants"). The interest due on the HDS Term
Debt shall remain due and payable on the Maturity Date notwithstanding the
conversion. The Debtholder Warrants shall have an exercise price equal to the
Applicable Trading Price.;
6.2.2 the outstanding indebtedness of HDS to certain of its officers
in the aggregate principal amount of approximately $800,000 on the date hereof
("HDS Officer Debt") shall be exchanged for and converted into (i) debentures of
Nesco in the same principal amount having a maturity date of December 31, 2005
(the "Maturity Date") and bearing interest at the rate of eight percent (8%) per
annum due and payable in cash at the Maturity Date, which debentures ("Nesco
Debentures") may be exchanged for the number of shares of Nesco Common, or at
the election of Company, Nesco Series B Preferred convertible in that number of
shares of Nesco Common, determined by dividing the HDS Officer Debt by the
Applicable Trading Price, and (ii) for each $1.00 in principal amount of the HDS
Officer Debt, a Debtholder Warrant to purchase one (1) share of Nesco Common.
6.3 Adviser Shares. Immediately following the Closing, Nesco shall issue
to the Adviser shares of Nesco Series B Preferred convertible into 6,500,000
shares of Nesco Common or, at the option of Nesco, the same number of shares of
Nesco Common or any combination of Nesco Series B Preferred and Nesco Common on
such basis, as and for the fee due for providing advisory services to HDS (such
shares of Nesco Series B Preferred as convertible into such shares of Nesco
Common, the "Adviser Shares"). The Adviser is a Nesco Signatory Stockholder.
6.4 Harriton Stock Option. Immediately following the Closing, Nesco shall
issue the Harriton Option to Matthew Harriton pursuant to Section 8.2.
6.5 Reverse Split; Information Statement. As promptly as practicable
following the Closing, the effectiveness of the Additional Capitalization
Amendment and the filing with the SEC of the Information Statement, Nesco shall
consummate the Reverse Split by filing the Reverse Split Amendment in compliance
with the applicable provisions of the NRS, and upon such filing, provide
certified copies of such Amendment to HDS and its counsel.
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6.6 No Liens or Encumbrances. Except as otherwise expressly provided
herein, the HDS Exchange Shares, the HDS Preferred Exchange Shares, the Nesco
Exchange Shares, the Nesco Debentures, the Nesco Debenture Shares delivered at
the Closing on the Closing Date or on any Subsequent Closing Date, the Adviser
Shares, and the HDS Warrants and HDS Options to be converted into warrants and
options, respectively, to purchase securities of Nesco in the Exchange pursuant
to this Section 6.6, shall be free and clear of all Liens and Encumbrances other
than those created by the terms of this Agreement.
6.7 Change of Name. Immediately upon consummation of the Exchange, Nesco
shall effect the Nesco Name Change, unless the NRS requires approval thereof by
Nesco Stockholders, in which event, Nesco shall effect the Nesco Name Change
immediately upon the last to occur of filing of the Nesco Information Statement
with the SEC and the filing of the Additional Capitalization Amendment with the
Secretary or Department of State of Nevada.
6.8 Restrictions on Transfer. The parties acknowledge and agree that as of
the Closing Date:
6.8.1 None of the Nesco Exchange Shares, the Adviser Shares, the NAC
Shares, the Nesco Debentures, the Nesco Debenture Shares, or the Nesco Series B
Preferred Shares to be issued upon the Nesco Preferred Conversion or conversion
of the Nesco Stockholder Debt (or the shares of Nesco Common into which shares
of Nesco Series B Preferred shall be automatically converted as provided herein)
shall be registered under U.S. Federal or Blue Sky Laws and are intended to be
issued pursuant to an exemption therefrom under Rule 506 of Regulation D,
Section 4(2) of the Act or other applicable exemption, shall be "restricted
securities" within the meaning of Rule 144 promulgated under the Securities Act,
and may not be resold, offered for resale, transferred, pledged, distributed or
otherwise hypothecated unless registered under the Securities Act and applicable
Blue Sky Laws or exempt from such registration under the terms of Rule 144 or
otherwise, and Nesco receives an opinion of counsel satisfactory to Nesco in its
reasonable discretion to the effect that such registration is not required. Each
certificate representing any Nesco Exchange Shares, shares Adviser Shares, NAC
Shares, shares of Nesco Series B Preferred issued upon the Nesco Preferred
Conversion and conversion of the Nesco Stockholder Debt, shares of Nesco Common
issued upon automatic conversion of the Nesco Series B Preferred, and the Nesco
Debenture Shares and the Nesco Debentures shall bear a legend substantially in
the following form:
"THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER
THE U.S. SECURITIES ACT OF 1933 (THE "ACT") OR APPLICABLE STATE SECURITIES LAWS
AND ARE "RESTRICTED SECURITIES" WITHIN THE MEANING OF RULE 144 UNDER THE ACT.
THE SECURITIES MAY NOT BE OFFERED FOR SALE, SOLD, PLEDGED, ASSIGNED,
HYPOTHECATED OR OTHER-WISE TRANSFERRED EXCEPT PURSUANT TO AN EFFECTIVE
REGISTRATION STATEMENT UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS, OR
PURSUANT TO AN EXEMPTION FROM SUCH REGISTRATION, PROVIDED THAT THE ISSUER OF
THESE SECURITIES SHALL HAVE FIRST RECEIVED AN OPINION OF COUNSEL REASONABLY
ACCEPTABLE TO THE ISSUER TO THE EFFECT THAT SUCH REGISTRATION IS NOT REQUIRED."
6.8.2 The shares of HDS Common Stock and HDS Series B Preferred to
be tendered to Nesco in the Exchange or the HDS Warrants and HDS Options to be
exchanged for Nesco Exchange Warrants and Nesco Exchange Options, respectively,
have not been registered under the Securities Act or applicable Blue Sky Laws
and will be offered for exchange pursuant to this Agreement in compliance with
an exemption from such registration under Rule 506 of Regulation D, or Section
4(2) of the Act and may not be offered, resold, pledged, hypothecated or
otherwise transferred unless registered under the Securities Act and applicable
Blue Sky Laws, or exempt from such registration, provided that Nesco receives an
opinion of counsel satisfactory to Nesco in its reasonable discretion to the
effect that such registration is not required.
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6.8.3 (i) Nesco shall instruct its transfer agent to annotate the
applicable records to reflect the restrictions on transfer contained in this
Agreement (A) on the Closing Date with respect to the Nesco Exchange Shares, the
Adviser Shares, the Nesco Debentures, the Nesco Debenture Shares, the Nesco
Exchange Options and the Nesco Exchange Warrants issuable upon exchange of the
HDS Term Debt; and (B) on the respective dates of conversion or issuance prior
to the Closing with respect to the NAC Shares and the shares of Nesco Common
issuable upon the Nesco Preferred Conversion, and conversion of the Nesco
Stockholder Debt and the Nesco Debentures and Nesco Debenture Shares that may be
issued to the holder of the Nesco Stockholder Debt, and (ii) HDS shall instruct
its transfer agent, on the Closing Date, to annotate the applicable records to
reflect the restrictions on transfer contained in this Agreement with respect to
the shares of HDS Common tendered in the Exchange;
6.9 Reservation of Shares. (a) As promptly as practicable following the
Closing Date, Nesco shall file the Additional Capitalization Amendment with the
Nevada Secretary or Department of State and provided a certified copy thereof to
HDS; (b) on the Closing Date or any earlier date of issuance pursuant to the
terms of this Agreement, Nesco shall have reserved for issuance the number of
shares of Nesco Common and Nesco Series B Preferred sufficient to satisfy its
obligations to issue the Nesco Exchange Shares, the Adviser Shares, the NAC
Shares, the Nesco Debenture Shares, the Nesco Warrant Shares, all other shares
of Nesco Common issuable on or prior to the Closing Date pursuant to this
Agreement or pursuant to the exercise of Nesco Options outstanding on the date
hereof; and (c) no later than the date of effectiveness of the Capitalization
Increase Amendment, Nesco shall have reserved for issuance the number of shares
of Nesco Common sufficient to satisfy its obligations to issue Nesco Common upon
automatic conversion of the Nesco Series B Preferred issued or issuable in
connection with the Exchange, including shares of Nesco Series B Preferred
issuable upon exercise of the Harriton Option and any and all Nesco Exchange
Options and Nesco Exchange Warrants, and (ii) consummation of the transactions
contemplated by this Agreement and the other Transaction Documents.
6.10 Obligation to Participate in the Exchange; Exchange Procedures. On
the Closing Date, each HDS Signatory Stockholder shall tender to Nesco for
exchange all shares of HDS Common and HDS Series B Preferred owned by such
Stockholder on the date hereof or issued to such Stockholder (not in
contravention of this Agreement) between the date hereof and the Closing Date,
and Nesco shall issue and deliver to each such HDS Stockholder (and/or its
designees) the number and classification of Nesco Exchange Shares set forth
above in this Section 6.
6.11 Expenses of Exchange and Other Transactions. Except as otherwise
provided in Section 16.3, each party shall pay all expenses, including legal and
auditing fees, incurred by such party in connection with the execution, delivery
and performance of this Agreement and consummation of the Exchange and the other
transactions contemplated hereby or by the other Transaction Documents.
7. CLOSING; CLOSING DATE.
7.1 Closing. The Closing of the Exchange and the other transactions
contemplated hereby or by any of the other Transaction Documents to take place
on the Closing Date (the "Closing Transactions") shall take place at 10:00 a.m.,
Eastern Time, on the Closing Date at the offices of Beckman, Lieberman &
Barandes, 116 John Street, Suite 1313, New York, NY 10038, or at such other time
and place as Nesco and HDS may agree.
7.2 Closing Date. The Closing of the Exchange and the other Closing
Transactions shall take place upon five days' written notice from Nesco to HDS,
but not later than sixty (60) days from the date hereof except as modified by
agreement of Nesco and HDS or terminated pursuant to Section 16.3 (the "Closing
Date"). The parties agree to use their best efforts to cause the Nesco
Preliminary Information Statement and the Nesco Information Statement to be
filed with the SEC and the Exchange to be consummated as soon as practicable
hereafter.
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7.3 Subsequent Closing Dates. The closing of the Exchange between Nesco
and those HDS Preferred Stockholders, HDS Common Stockholders, and holders of
HDS Options and HDS Warrants who are not HDS Signatory Stockholders and who,
following the Closing Date, wish to participate in the Exchange and comply with
the applicable requirements set forth in Section 6, shall take place on
Subsequent Closing Date(s) to be selected in compliance with the terms of said
Section.
8. EMPLOYMENT AGREEMENT; HARRITON OPTION.
8.1 Employment Agreement. Immediately following the Closing, Nesco shall
enter into an employment agreement with Matthew Harriton, effective as of the
Closing Date, substantially in the form of Exhibit 8.1 hereto (the "Employment
Agreement").
8.2 Harriton Option. On the Closing Date, Nesco shall issue to Matthew
Harriton an option to purchase Nesco Common on the following terms (the
"Harriton Option"):
8.2.1 The Harriton Option shall grant Matthew Harriton the right to
purchase up to 5,000,000 shares of Nesco Common at the Applicable Trading Price
per share.
8.2.2 The Harriton Option shall be exercisable for a period of five
(5) years commencing on the Closing Date (the "Exercise Period") and shall be
immediately exercisable for the purchase of 2,000,000 shares of Nesco Common and
exercisable as to an additional 1,000,000 shares of Nesco Common commencing on
each of the first, second and third anniversaries of the Closing Date,
respectively, provided that grantee remains a consultant to or employee of Nesco
or any subsidiary of Nesco, but if Nesco exercises its right to terminate the
Employment Agreement after the Initial Term without specifying reasons for
termination that constitute grounds for termination for "cause" as defined in
the Employment Agreement, the Harriton Option shall become immediately
exercisable as to all 5,000,000 shares. Following termination of the Employment
Agreement for any reason, the Harriton Option shall thereafter remain
exercisable for the balance, if any, of the Exercise Period for the same number
of shares of Nesco Common for which the Harriton Option was exercisable upon
termination of the Employment Agreement, subject to the provisions of the
immediately preceding sentence.
8.2.3 Anything contained in this Section 8.2 to the contrary
notwithstanding, the Harriton Option shall provide that until the last to occur
of the filing of the Information Statement with the SEC and filing of the
Additional Capitalization Amendment pursuant to the NRS, to the extent that the
Harriton Option is exercisable for shares of Nesco Common as provided in Section
8.2.2, it shall instead be exercisable for the equivalent number of shares of
Nesco Series B Preferred.
9. REPRESENTATIONS AND WARRANTIES OF NESCO AND THE NESCO SIGNATORY STOCKHOLDERS.
Nesco and the Nesco Signatory Stockholders represent and warrant:
9.1 Corporate Existence and Power. Nesco is a corporation duly
incorporated, validly existing and in good standing under the laws of the State
of Nevada and has all corporate power and authority and all Governmental Permits
required to carry on its business as now conducted, except for those
Governmental Permits, the absence of which would not, individually or in the
aggregate, have a Material Adverse Effect. Nesco is duly qualified to do
business as a foreign corporation and is in good standing in each jurisdiction
where such qualification is necessary, except for those jurisdictions where
failure to be so qualified would not, individually or in the aggregate, have a
Material Adverse Effect on Nesco.
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9.2 Articles of Incorporation and By-laws; Minute Books. The copies of the
articles of incorporation and by-laws of Nesco, each as amended, provided by
Nesco to HDS are true, correct and complete. The minute books of Nesco contain
true and complete records of all meetings and consents in lieu of meetings of
its Board of Directors (and any committees thereof), or similar governing
bodies, and true, correct and complete records of all meetings and consents in
lieu of meetings of Nesco's stockholders since the time of its organization. The
stock books of Nesco are true, correct and complete.
9.3 Corporate Authorization. The execution, delivery and performance by
Nesco of this Agreement and the other Transaction Documents and the consummation
by it of the transactions contemplated hereby and thereby are within Nesco's
corporate powers and have been duly authorized by all necessary corporate
action. No vote of the holders of the outstanding shares of Nesco Common, Nesco
Series A Preferred or any other securities of Nesco is necessary in connection
with the consummation of the Exchange on the Closing Date and the other
transactions contemplated hereby to be consummated on the Closing Date. Each of
this Agreement and the other Transaction Documents constitutes a valid and
binding agreement of Nesco enforceable against Nesco in accordance with its
terms, except as such enforceability may be limited by bankruptcy, insolvency,
reorganization or other laws affecting the enforcement of creditors' rights
generally now or hereafter in effect and subject to the application of equitable
principles and the availability of equitable remedies.
9.4 Nesco Board Consent. The execution, delivery and performance by Nesco
of this Agreement and each of the other Transaction Documents has been duly
authorized by Nesco's Board of Directors which, at a meeting duly called and
held, duly (a) determined that this Agreement and the other Transaction
Documents, the Exchange and the other transactions contemplated hereby and
thereby are fair to and in the best interests of Nesco's Stockholders, and (b)
approved and adopted this Agreement, the other Transaction Documents, the
Exchange and the other transactions contemplated hereby or thereby, which
approval satisfies in full any applicable requirements of the NRS. The
resolutions of the Nesco Board attached to Exhibit 9.4 hereto are true, complete
and correct copies of the resolutions duly adopted by Nesco's Board relating to
this Agreement, the other Transaction Documents, the Exchange and the other
transactions contemplated hereby and thereby.
9.5 Governmental Authorization. The execution, delivery and performance by
Nesco of this Agreement and the other Transaction Documents and the consummation
by Nesco of the transactions contemplated hereby or thereby require no action by
or in respect of, or filing with, any Governmental Authority other than (a) the
filing of the Additional Capitalization Amendment and the Reverse Split
Amendment in accordance with the NRS, (b) filing with the SEC of Current Reports
on Form 8-K with respect to (i) the execution and delivery of this Agreement and
(ii) the Closing, (c) compliance with any applicable requirements of Regulation
D and Blue Sky Laws, and (d) any other filings, including the Nesco Information
Statement in connection with dissenters rights, if any, and/or other approvals
or authorizations which, if not obtained, would not, individually or in the
aggregate, have a Material Adverse Effect on Nesco or materially impair the
ability of Nesco to consummate the transactions contemplated by this Agreement.
9.6 Non-Contravention. The execution, delivery and performance by Nesco of
this Agreement and the other Transaction Documents and the consummation by Nesco
of the transactions contemplated hereby and thereby do not and will not (a)
violate the certificate of incorporation or bylaws of Nesco, (b) assuming
compliance with the matters referred to in Section 9.5(d), violate any
applicable law, rule, regulation, judgment, injunction, order or decree, (c)
require any consent or other action by any Person under, constitute a default
under, or give rise to any right of termination, cancellation or acceleration of
any right or obligation of Nesco or to a loss of any benefit to which Nesco is
entitled under any provision of any agreement or other instrument binding upon
Nesco or any Governmental Permit, or other similar authorization affecting, or
relating in any way to, the assets or business of Nesco, or (d) result in the
creation or imposition of any Lien or Encumbrance on any asset of Nesco except,
in the case of clauses (b), (c) and (d), for such matters as would not,
individually or in the aggregate, have Material Adverse Effect on Nesco or
materially impair the ability of Nesco to consummate the transactions
contemplated by this Agreement.
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9.7 Capitalization; Validity of Securities. As of the Closing Date, the
authorized capital stock of Nesco will consist of 25,000,000 shares of Nesco
Common and 1,000,000 shares of preferred stock, of which Nesco shall have
designated as Nesco Series B Preferred a number of shares sufficient to meet
Nesco's obligations under this Agreement and effectuate the transactions
contemplated hereby. As of the date hereof, the authorized capital stock of
Nesco is as set forth in Section 3.1.1 and the outstanding capital stock and
other securities of Nesco are as set forth in Sections 3.1.2 through 3.1.5. All
outstanding shares of capital stock and other securities of Nesco have been duly
authorized and validly issued an are fully paid and non-assessable. Except as
set forth in Sections 3.1.2 through 3.1.4, there are no outstanding (a) shares
of capital stock or voting securities of Nesco, (b) securities of Nesco
convertible into or exercisable or exchangeable for shares of capital stock or
voting securities of Nesco or (c) options, restricted stock, other stock-based
compensation awards or other rights to acquire from Nesco or other obligation of
Nesco to issue, any capital stock, voting securities or securities convertible
into or exchangeable for capital stock or voting securities of Nesco. Other than
as provided in this Agreement, there are no outstanding obligations of Nesco or
any of its subsidiaries to repurchase, redeem or otherwise acquire any
securities referred to in clauses (a), (b) or (c) above. The Nesco Exchange
Shares, the Adviser Shares, the NAC Shares, the Nesco Warrant Shares, the Nesco
Debentures, the Nesco Debentures Shares when issued, sold and delivered, and the
Nesco Exchange Options and Nesco Exchange Warrants when deemed exchanged for HDS
Options and HDS Warrants pursuant to the terms of this Agreement, will be duly
and validly issued (including compliance with Regulation D and applicable Blue
Sky Laws), fully-paid, and non-assessable and shall be free and clear of all
Liens and Encumbrances of any nature whatsoever. The Nesco Preliminary
Information Statement and the Nesco Information Statement shall provide for an
increase in the number of shares of Nesco Common which Nesco is currently
authorized to issue to 400,000,000 shares, and the same shall be set forth in
the Additional Capitalization Amendment.
9.8 Subsidiaries; No Liability for Obligations of NAC Entities. Nesco has
no subsidiaries other than the NAC Entities. Prior to the Closing, the NAC
Entities shall have been disposed of in compliance with the terms of Section
4.5.
9.9 SEC Filings.
9.9.1 Nesco has delivered to HDS (i) Nesco's Annual Report for its
1999 through 2003 fiscal years, (ii) all proxy or information statements
relating to meetings of, or actions taken without a meeting by, the stockholders
of Nesco since November 1, 1999 and (c) all of its other reports, statements,
schedules and registration statements filed by Nesco with the SEC since November
1, 1999 (all of the documents referred to in this Section 9.9.1 collectively,
the "Nesco SEC Filings").
9.9.2 As of its filing date, each Nesco SEC Filing complied as to
form and in substance in all material respects with the applicable requirements
of the Securities Act and the Exchange Act and did not contain any untrue
statement of a material fact or omit to state any material fact necessary in
order to make the statements made therein, in the light of the circumstances
under which they were made, not misleading.
9.10 Financial Statements. The audited consolidated financial statements
and unaudited consolidated interim financial statements of Nesco included in the
SEC Filings fairly present, in conformity with GAAP (except, as to application
on a consistent basis, as may be indicated in the notes thereto), the
consolidated financial position of Nesco as of the dates there of and the
consolidated results of operations and cash flows for the periods then ended
(subject to normal year-end adjustments in the case of any unaudited interim
financial statements). For purposes of this Agreement, "Nesco Balance Sheet"
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means the unaudited consolidated balance sheet of Nesco as of October 31, 2003
set forth in Nesco's Quarterly Report for the period end October 31, 2003 on
Form 10-QSB, as filed with the SEC on December 22, 2003, and "Nesco Balance
Sheet Date" means October 31, 2003.
9.11 Absence of Certain Changes. Since Nesco Balance Sheet Date, the
business of Nesco has been conducted in the ordinary course consistent with past
practices and there has not been, except as set forth in Section 9.11 of the
Nesco Disclosure Schedule or any SEC Filing made between the Balance Sheet Date
and the date hereof or required pursuant to the terms of this Agreement:
9.11.1 any event, occurrence, development or state of circumstances
or facts which would, individually or in the aggregate, have a Material Adverse
Effect on Nesco, other than adverse effects resulting from the execution and
performance of this Agreement;
9.11.2 any declaration, setting aside or payment of any dividend or
other distribution with respect to any shares of capital stock of Nesco;
9.11.3 except for the Additional Capitalization Amendment and the
Reverse Split Amendment, there has not been any amendment of any material term
of any outstanding security of Nesco.
9.11.4 any incurrence, assumption or guarantee by Nesco of any
material indebtedness for borrowed money other than in the ordinary course and
in amounts and on terms consistent with past practices;
9.11.5 any creation or other incurrence by Nesco of any Lien or
Encumbrance on any material asset other than in the ordinary course consistent
with past practices;
9.11.6 any making of any material loan, advance or capital
contributions to or investment in any Person;
9.11.7 any damage, destruction or other casualty loss (whether or
not covered by insurance) affecting the business or assets of Nesco which would,
individually or in the aggregate, have a Material Adverse Effect on Nesco;
9.11.8 any transaction or commitment made, or any contract or
agreement entered into, by Nesco relating to its assets or business (including
the acquisition or disposition of any assets) or any relinquishment by Nesco of
any contract or other right, in either case, material to Nesco as a whole, other
than transactions and commitments in the ordinary course consistent with past
practices and those contemplated by this Agreement;
9.11.9 any change in any method of accounting, method of tax
accounting, or accounting practice by Nesco except for any such change required
by reason of a concurrent change in GAAP or Regulation S-X promulgated under the
Exchange Act;
9.11.10 any (i) grant of any severance or termination pay to any
current or former director, officer or employee of Nesco, (ii) increase in
benefits payable under any existing severance or termination pay policies or
employment agreements, (iii) entering into of any employment, deferred
compensation or other similar agreement (or any amendment to any such existing
agreement) with any current or former director, officer or employee of the
Nesco, (iv) establishment, adoption or amendment (except as required by
applicable law) of any collective bargaining, bonus, profit sharing, thrift,
pension, retirement, deferred compensation, compensation, stock option,
restricted stock or other benefit plan or arrangement covering any current or
former director, officer or employee of Nesco, or (v) increase in compensation,
bonus or other benefits payable or otherwise made available to any current or
former director, officer or employee of Nesco;
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9.11.11 any material dispute or, with any officer, director or
employee of Nesco; or any tax election or any settlement or compromise of any
tax liability, that, individually or in the aggregate, are material to Nesco.
9.12 No Undisclosed Material Liabilities. As of the date hereof, there are
no liabilities of Nesco of any kind whatsoever, whether accrued, contingent,
absolute, determined, determinable or otherwise, and there is no existing
condition, situation or set of circumstances which could reasonably be expected
to result in such a liability, other than:
9.12.1 liabilities or obligations provided for in Nesco Balance
Sheet or disclosed in the notes thereto;
9.12.2 other liabilities or obligations, which would not,
individually or in the aggregate, have a Material Adverse Effect on Nesco; and
9.12.3 liabilities or obligations under this Agreement.
9.13 Compliance with Laws and Court Orders. Except as set forth in Section
9.13 of the Nesco Disclosure Schedule or in any SEC Filing made between the
Balance Sheet Date and the date hereof, Nesco is and has been in compliance
with, and to the best knowledge of Nesco, is not under investigation with
respect to and has not been threatened to be charged with or given notice of any
violation of, any applicable law, rule, regulation, judgment, injunction, order
or decree, including, without limitation, the requirements of the Exchange Act,
the Securities Act, ERISA or any federal labor laws except for such matters as
would not, individually or in the aggregate, have a Material Adverse Effect on
Nesco.
9.14 Litigation. Except as specifically set forth in any SEC Filings made
between the Nesco Balance Sheet Date and the date hereof or Section 9.14 of the
Nesco Disclosure Schedule, there is: (a) no claim, dispute, action, suit,
proceeding or investigation pending or, to the knowledge of Nesco, threatened,
against or affecting the business of Nesco, or challenging the validity or
propriety of the transactions contemplated by this Agreement or any of the other
Transaction Documents, at law or in equity or admiralty or before any federal,
state, local, foreign or other governmental authority, board, agency, commission
or instrumentality, nor to the knowledge of Nesco, has any such claim, dispute,
action, suit, proceeding or investigation been pending or threatened, during the
12 month period preceding the date hereof; (b) no outstanding judgment, order,
writ, ruling, injunction, stipulation or decree of any court, arbitrator or
federal, state, local, foreign or other governmental authority, board, agency,
commission or instrumentality, against or materially affecting the business of
Nesco; and (c) Nesco has not received any written or verbal inquiry from any
federal, state, local, foreign or other governmental authority, board, agency,
commission or instrumentality concerning the possible violation of any law, rule
or regulation or any matter disclosed in respect of its business. The disclosure
in such SEC Filings with respect to any matters covered by this Section 9.14 are
true, correct and complete in all material respects on the dates when made and
on the date hereof and do not contain any misstatement of any related material
fact or omit to state any such material fact required to be stated therein in
order to make the statements contained therein not misleading.
9.15 Finder's Fee. There is no investment banker, broker, finder or other
intermediary which has been retained by or is authorized to act on behalf of
Nesco who might be entitled to any fee or commission in connection with the
transactions contemplated by this Agreement.
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9.16 Taxes. Except as set forth in the Nesco Balance Sheet (including the
notes thereto) and except as would not, individually or in the aggregate, have a
Material Adverse Effect on Nesco, (a) all tax returns, statements, reports and
forms (collectively, the "Nesco Returns") required to be filed with any taxing
authority by, or with respect to, Nesco and each affiliated, combined,
consolidated or unitary group of which Nesco is a member are true, correct and
complete and have been filed in accordance with all applicable laws; (b) Nesco
has timely paid all taxes shown as due and payable on the Nesco Returns that
have been so filed (other than taxes which are being contested in good faith and
for which adequate reserves are reflected on the Nesco Balance Sheet) and, as of
the time of filing, the Nesco Returns correctly reflected the facts regarding
the income, business, assets, operations, activities and the status of Nesco;
(c) Nesco has made adequate provision in accordance with GAAP for all taxes
payable by Nesco for which no Nesco Return has yet been filed; (d) the charges,
accruals and reserves for taxes with respect to Nesco reflected on the Nesco
Balance Sheet are adequate under GAAP to cover the tax liabilities accruing
through the date thereof; (e) there is no action, suit, proceeding, audit or
claim now proposed or pending against or with respect to Nesco in respect of any
tax where there is a reasonable possibility of an adverse determination; (f)
Nesco is not and has not been a member of an affiliated, consolidated, combined
or unitary group other than one of which Nesco was the common parent.
9.17 Employee Benefit Plans. Other than as shall be fully described on the
Nesco Disclosure Schedule, Nesco does not maintain, nor has Nesco maintained in
the past, any "employee benefit plans" (as defined in Section 3(3) of ERISA, or
any plans, programs, policies, practices, arrangements or contracts (whether
group or individual) providing for payments, benefits or reimbursements to
employees of Nesco, former employees, their beneficiaries and dependents under
which such employees, former employees, their beneficiaries and dependents are
covered through an employment relationship with Nesco, any entity required to be
aggregated in a controlled group or affiliated service group with Nesco for
purposes of ERISA or the Code (including, without limitation, under Section
414(b), (c), (m) or (o) of the Code or Section 4001 of ERISA, at any relevant
time ("Benefit Plans").
9.18 Environmental Matters. Except as set forth in Nesco SEC Filings prior
to the date hereof and except as would not, individually or in the aggregate,
have a Material Adverse Effect on Nesco:
9.18.1 no notice, notification, demand, request for information,
citation, summons or order has been received, no complaint has been filed, no
penalty has been assessed, and no investigation, action, claim, suit, proceeding
or review is pending or, to the knowledge of Nesco, is threatened by any
governmental entity or other person relating to or arising out of any
Environmental Law;
9.18.2 Nesco is and has been in compliance with all Environmental
Laws and all Environmental Permits; and
9.18.3 There are no liabilities of or relating to Nesco of any kind
whatsoever, whether accrued, contingent, absolute, determined, determinable or
otherwise arising under or relating to any Environmental Law and there are no
facts, conditions, situations or set of circumstances which could reasonably be
expected to result in or be the basis for any such liability.
9.18.4 The terms "Nesco" shall, for purposes of this Section,
include any entity which is, in whole or in part, a corporate predecessor of
Nesco or any of the NAC Entities or any other subsidiary of Nesco.
9.19 Patents and Other Proprietary Rights. Nesco does not have any
Intellectual Property Right that is material to its business as now conducted.
To the best of Nesco's knowledge, Nesco has not and does not violate or infringe
any Intellectual Property Right of any other person, and Nesco has not received
any communication alleging that it violates or infringes any Intellectual
Property Right of any other person. Except for such matters as would not,
individually or in the aggregate, have a Material Adverse Effect on Nesco, Nesco
has not been sued for infringing any Intellectual Property Right of another
person.
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9.20 Antitakeover Statutes. Excluding any statute or regulation applicable
solely by virtue of the jurisdiction of incorporation of HDS as to which Nesco
takes no position nor makes any representation or warranty, no antitakeover or
similar statute or regulation applies to the transactions contemplated hereby.
9.21 Affiliate Transactions. Except as disclosed in Section 9.21 of the
Nesco Disclosure Statement or any SEC Filing(s) made between the Nesco Balance
Sheet Date and the date hereof, either Nesco nor any officer, director or
employee of Nesco or any of the relatives, Affiliates or Associates of any of
the aforementioned Persons) is a party to any agreement, contract, commitment or
transaction with Nesco or affecting the business of Nesco or any of its
subsidiaries, or has any interest in any property, whether real, personal or
mixed, or tangible or intangible, used in or necessary to Nesco or any of its
subsidiaries which will subject Nesco, HDS or any of the Sellers to any
liability or obligation from and after the Closing Date.
9.22 Trading; Reporting Company Status. Nesco Common is currently listed
for trading on the OTCBB, and Nesco has received no notice that the Nesco Common
is subject to being delisted therefrom. Nesco is a reporting company under
Section 12(g) of the Exchange Act and has timely filed all reports and other
documents required to be filed by it under the Exchange Act.
9.23 Investment Representations. Nesco is acquiring shares of HDS Common
and HDS Series B Preferred for investment for its own account and not as a
nominee or agent, and not with a view to the resale or distribution of any part
thereof. Nesco understands that the offer and sale of shares of HDS Common and
HDS Series B Preferred have not been and will not be registered under the
Securities Act or applicable state securities laws on the ground that the sale
and the issuance of securities hereunder is exempt from registration under the
Securities Act pursuant to Section 4(2) thereof, and that reliance by HDS on
such exemption is predicated on the representations of Nesco set forth in this
Section 9.23 and Section 9.26.
9.24 Insurance. Nesco has in effect directors' and officers' liability
insurance for the coverage amounts set forth in Section 9.24(a) of the Nesco
Disclosure Schedule. Each policy providing such directors' and officers'
liability insurance, the name(s) of the insured(s) and any additional loss
payee(s), the amounts and types of coverage and policy numbers are as set forth
in Section 9.24(a) of the Nesco Disclosure Schedule. Nesco shall take all
actions and deliver all written materials and execute such documents and
instruments as may be required to ensure that all Persons who will serve as
executive officers or directors of Nesco following the Exchange who do not serve
in such capacities on the date hereof are covered by such directors' and
officers' liability insurance policy or policies in amounts consented to by HDS,
which consent shall not be unreasonably withheld.
Nesco and/or the NAC Entities maintain in effect the liability insurance and
other business insurance policies described in Section 9.24(b) of the Nesco
Disclosure Schedule; Nesco shall do all things necessary and proper to retain
its status as an insured and additional loss payee on each such liability
insurance policy relating to any of the activities of any NAC Entity after the
date of disposition of each NAC Entity with respect to losses and claims that
may arise relating to any period on or prior to the Closing Date. Nesco has
provided to HDS true, complete and correct copies of all of the foregoing
insurance policies, each as currently in effect.
9.25 Ownership of Signatory Stockholders. On the date hereof, the Nesco
Signatory Stockholders hold a sufficient percentage of the securities of Nesco
entitled to vote (or that will be entitled to vote on the Closing Date), on a
fully-diluted basis, that is required by the NRS and the articles of
incorporation and by-laws of Nesco to bind Nesco to its obligations hereunder
and to authorize and effectuate the Exchange, the Reverse Split, the Reverse
Split Amendment, the Nesco Name Change, the Additional Capitalization Amendment
and the other transactions required to be effected by Nesco pursuant to this
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Agreement. Except as otherwise expressly provided herein, the Nesco Signatory
Stockholders shall not offer, sell, transfer, pledge, assign or otherwise
dispose of any of their shares of Nesco Common or securities convertible into or
exchangeable for Nesco Common or Nesco Series B Preferred (other than the Nesco
Warrant Shares) from the date hereof until the earlier of (a) termination of
this Agreement, (b) the date of filing of the Nesco Information Statement with
the SEC and (c) the date of filing of the Additional Capitalization Amendment
pursuant to the NRS. On the date hereof the Nesco Signatory Stockholders own,
and shall at all relevant times continue to own, a sufficient number of shares
of Nesco Common and Nesco Series A Preferred to authorize the consummation of
the Exchange and the other transactions contemplated by this Agreement and the
other Transaction Documents by written consent. There is no provision of the
articles of incorporation or by-laws of Nesco or any other agreement to which
Nesco or any security holder of Nesco is a party that would prohibit the Nesco
Signatory Stockholders from authorizing consummation of the Exchange and the
other transactions contemplated hereby and by the other transaction documents by
written consent.
9.26 Accredited Investor Status. Each Nesco creditor and each Person who,
on the date hereof, is the beneficial owner of any securities of Nesco and who,
pursuant to the terms of this Agreement, will receive any shares of Nesco Common
or any securities convertible into or exchangeable for Nesco Common pursuant to
the terms of this Agreement is an Accredited Investor. Each such Person shall
confirm in writing that such Person is an Accredited Investor prior to the
Closing.
9.27 Nesco Signatories. The Nesco Signatory Stockholders include each
officer, director and holder of 5% of each class of outstanding voting
securities of Nesco. Each Nesco Signatory Stockholder hereby consents, in
respect of all voting securities of Nesco held by such Stockholder, to the
Exchange and the other transactions contemplated hereby and by the other
Transaction Documents. Each Nesco Signatory Stockholder covenants, represents
and warrants that such Stockholder shall do all acts and things, including the
execution and delivery of all documents and instruments, necessary or proper (a)
to effectuate the Exchange and the other transactions contemplated hereby and by
any of the other Transaction Documents and (b) to cause Nesco to carry out its
obligations hereunder and under each of the other Transaction Documents, whether
by vote or written consent of such Stockholder, or otherwise.
9.28 No General Solicitation. Solicitation by Nesco of participants in the
Exchange and the exchange of currently outstanding Nesco securities for shares
of Nesco Common or Nesco Series B Preferred shall be effected without use of any
form of general solicitation or advertising and in all other respects in
compliance with the requirements for an exemption from registration pursuant to
Regulation D.
10. REPRESENTATION AND WARRANTIES OF HDS AND THE HDS SIGNATORY STOCKHOLDERS. HDS
and the HDS Signatory Stockholders that are executive officers or directors of
HDS represent and warrant that, except as otherwise set forth herein or in HDS
Disclosure Schedule:
10.1 Corporate Existence and Power. HDS is a company duly incorporated,
validly existing and in good standing under the laws of the State of Delaware
and has all corporate power and authority and all Governmental Permits required
to carry on its business as now conducted, except for those Governmental Permits
the absence of which would not, individually or in the aggregate, have a
Material Adverse Effect.
10.2 Certificate of Incorporation and By-laws; Minute Books. The copies
provided to Nesco by HDS of its certificate of incorporation and by-laws are
true, correct and complete copies thereof, each as amended to date. The minute
books of HDS contain true and complete records of all meetings and consents in
lieu of meetings of its Board of Directors (and any committees thereof), or
similar governing bodies, since the time of its organization. The stock books of
HDS are true, correct and complete.
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10.3 Corporate Authorization. The execution, delivery and performance by
HDS of this Agreement and the other Transaction Documents and the consummation
by HDS of the transactions contemplated hereby and thereby are within HDS's
corporate powers and have been duly authorized by all necessary corporate action
of HDS. If any vote of or consent by the holders of any outstanding shares of
HDS Common or any other securities of HDS is necessary in connection with the
consummation of the Exchange and the other transactions contemplated hereby,
each HDS Signatory Stockholder shall vote in favor thereof or provide written
consent thereto. This Agreement and each of the other Transaction Documents
constitutes a valid and binding agreement of HDS, enforceable against HDS in
accordance with its terms, except as such enforceability may be limited by
bankruptcy, insolvency, reorganization or other laws affecting the enforcement
of creditors' rights generally now or hereafter in effect and subject to the
application of equitable principles and the availability of equitable remedies.
This Agreement and each of the other Transaction Documents constitutes a valid
and binding agreement of each HDS Signatory Stockholder, enforceable against
each such Stockholder in accordance with its terms, except as such
enforceability may be limited by bankruptcy, insolvency, reorganization or other
laws affecting the enforcement of creditors' rights generally now or hereafter
in effect and subject to the application of equitable principles and the
availability of equitable remedies.
10.4 HDS Board Consent. The execution, delivery and performance by HDS of
this Agreement and each of the other Transaction Documents to which HDS is a
party have been duly authorized by HDS's Board of Directors, which, approved and
adopted this Agreement, such other Transaction Documents, the Exchange and the
other transactions contemplated hereby or thereby and involving HDS. The
resolutions of the HDS Board attached as Exhibit 10.4 hereto are true, complete
and correct copies of resolutions duly adopted by HDS's Board relating to this
Agreement, the other Transaction Documents, the Exchange and the other
transactions contemplated hereby and thereby.
10.5 Governmental Authorization. The execution, delivery and performance
by HDS and each HDS Signatory Stockholder of this Agreement and the other
Transaction Documents to be executed by HDS and the consummation by HDS of the
transactions contemplated hereby or thereby involving HDS require no action by
or in respect of, or filing with, any Governmental Authority other than
compliance with any applicable requirements of Regulation D and Blue Sky Laws,
and any other filings, approvals or authorizations which, if not obtained, would
not, individually or in the aggregate, have a material adverse effect on HDS or
materially impair the ability of HDS or any of the HDS Signatory Stockholders to
consummate the transactions contemplated by this Agreement or any of the other
Transaction Documents.
10.6 Non-Contravention. The execution, delivery and performance by HDS or
any of the HDS Signatory Stockholders of this Agreement and the other
Transaction Documents and the consummation by HDS of the Exchange and the other
transactions involving HDS contemplated hereby or thereby do not and will not
(a) violate the certificate of incorporation or by-laws of HDS, (b) assuming
compliance with the matters referred to in Sections 9.5 and 10.5, violate any
applicable law, rule, regulation, judgment, injunction, order or decree, (c)
require any consent or other action by any Person under, constitute a default
under, or give rise to any right of termination, cancellation or acceleration of
any right or obligation of HDS or a loss of any benefit to which HDS is entitled
under any provision of any agreement or other instrument binding upon HDS (other
than the Certificate of Designation with respect to the HDS Series B Preferred)
or any Governmental Permit other similar authorization affecting, or relating in
any way to, the assets or business of HDS or any of its subsidiaries, or (d)
result the creation or imposition of any Lien or Encumbrance on any asset of HDS
except, in the case of clauses (b), (c) and (d), for such matters as would not,
individually or in the aggregate, have Material Adverse Effect on HDS or
materially impair the ability of HDS to consummate the transactions contemplated
by this Agreement or any of the other Transaction Documents.
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10.7 Capitalization; Validity of Securities. As of the date hereof, the
authorized capital stock of HDS is as set forth in Section 3.1.3 hereof. As of
the date hereof, the outstanding capital stock and other securities of HDS are
as set forth in Section 3.3.2. All outstanding shares of capital stock of HDS
have been duly authorized and validly issued an are fully paid and
non-assessable. Except as set forth in this Agreement, there are no outstanding
(a) shares of capital stock or voting securities of HDS, (b) securities of HDS
convertible into exchangeable for shares of capital stock or voting securities
of HDS or (c) options, restricted stock, other stock-based compensation awards
or other rights to acquire from HDS or other obligation of HDS to issue, any
capital stock, voting securities or securities convertible into or exercisable
or exchangeable for capital stock or voting securities of HDS. There are no
outstanding obligations of HDS or any of its subsidiaries to repurchase, redeem
or otherwise acquire any securities referred to in clauses (a), (b) or (c)
above. The shares of HDS Common and HDS Series B Preferred, when transferred and
delivered pursuant to the terms of this Agreement, will be duly and validly
issued (including, without limitation, compliance with Regulation D and
applicable Blue Sky Laws), fully-paid, and non-assessable. The assignments,
endorsements, stock powers and other instruments of transfer to be delivered by
each Seller to Nesco at the Closing will be sufficient to transfer such Seller's
entire interest, legal and beneficial, in such HDS shares. Each HDS Signatory
Stockholder has full power and authority to transfer its shares of HDS Common
and/or HDS Series B Preferred, and upon transfer to Nesco of the instruments
representing such shares, Nesco will receive good and marketable title to such
shares, free and clear of all Liens and Encumbrances.
10.8 Subsidiaries. HDS does not as of the date hereof own, directly or
indirectly, any capital stock, equity or interest in any corporation, firm,
partnership, joint venture or other entity other than those listed in Section
10.8 of the HDS Disclosure Schedule.
10.9 Financial Statements; Absence of Certain Changes. For purposes of
this Agreement, "HDS Balance Sheet" means the unaudited balance sheet of HDS, as
of October 31, 2003 included as Exhibit 10.9 to this Agreement, and "HDS Balance
Sheet Date" means October 31, 2003. Except as otherwise set forth in Section
10.9 of the HDS Disclosure Schedule or required by the terms of this Agreement
or any of the other Transaction Documents, since the HDS Balance Sheet Date, the
business of HDS and its subsidiaries has been conducted in the ordinary course
consistent with past practices and there has not been:
10.9.1 any even, occurrence, development or state of circumstances
or facts which would, individually or in the aggregate, have a Material Adverse
Effect on HDS, other than adverse effects resulting from the execution and
performance of this Agreement;
10.9.2 any declaration, setting aside or payment of any dividend or
other distribution with respect to any shares of capital stock of HDS;
10.9.3 there has not been any amendment of any material term of any
outstanding security of HDS or any of its subsidiaries;
10.9.4 any incurrence, assumption or guarantee by HDS or any of its
subsidiaries of any material indebtedness for borrowed money other than in the
ordinary course and in amounts and on terms consistent with past practices;
10.9.5 any creation or other incurrence by HDS or any of its
subsidiaries of any Lien or Encumbrance on any material asset other than in the
ordinary course consistent with past practices;
10.9.6 any making of any material loan, advance or capital
contributions to or investment in any person other than loans, advances or
capital contributions made in the ordinary course consistent with past
practices;
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10.9.7 any damage, destruction or other casualty loss (whether or
not covered by insurance) affecting the business or assets of HDS or any of its
subsidiaries which would, individually or in the aggregate, have a Material
Adverse Effect on HDS.
10.9.8 any transaction or commitment made, or any contract or
agreement entered into, by HDS or any of its subsidiaries relating to its assets
or business (including the acquisition or disposition of any assets) or any
relinquishment by HDS or any of its subsidiaries of any contract or other right,
in either case, material to HDS and its subsidiaries, taken as a whole, other
than transactions and commitments in the ordinary course consistent with past
practices and those contemplated by this Agreement;
10.9.9 any (i) grant of any severance or termination pay to any
current or former director, officer or employee of HDS or any of its
subsidiaries, (ii) increase in benefits payable under any existing severance or
termination pay policies or employment agreements, (iii) entering into of any
employment, deferred compensation or other similar agreement (or any amendment
to any such existing agreement) with any current or former director, officer or
employee of the Nesco or any of its subsidiaries, (iv) establishment, adoption
or amendment (except as required by applicable law) of any collective
bargaining, bonus, profit sharing, thrift, pension, retirement, deferred
compensation, compensation, stock option, restricted stock or other benefit plan
or arrangement covering any current or former director, officer or employee of
HDS or any of its subsidiaries, or (v) increase in compensation, bonus or other
benefits payable or otherwise made available to any current or former director,
officer or employee of HDS or any of its subsidiaries;
10.9.10 any material dispute or, with any officer, director or
employee of HDS; or any tax election or any settlement or compromise of any tax
liability, in either case that is material to HDS and its subsidiaries, taken as
a whole.
10.10 No Undisclosed Material Liabilities. As of the date hereof, there
are no liabilities of HDS or any of its subsidiaries of any kind whatsoever,
whether accrued, contingent, absolute, determined, determinable or otherwise,
and there is no existing condition, situation or set of circumstances which
could reasonably be expected to result in such a liability, other than:
10.10.1 liabilities or obligations provided for in HDS Balance Sheet
or disclosed in the notes thereto;
10.10.2 other liabilities or obligations, which would not,
individually or in the aggregate, have a Material Adverse Effect on HDS;
10.10.3 liabilities or obligations under this Agreement; and
10.10.4 liabilities or obligations described in this Agreement or in
Section 10.10 of the HDS Disclosure Schedule.
10.11 Compliance with Laws and Court Orders. HDS and each of its
subsidiaries is and has been in compliance with, and to the best knowledge of
HDS, is not under investigation with respect to and has not been threatened to
be charged with or given notice of any violation of, any applicable law, rule,
regulation, judgment, injunction, order or decree, except for such matters as
would not, individually or in the aggregate, have a Material Adverse Effect on
HDS.
10.12 Litigation. There is no claim, dispute, action, suit, proceeding or
investigation pending or, to the knowledge of HDS, threatened, against or
affecting the business of HDS, or challenging the validity or propriety of the
transactions contemplated by this Agreement, at law or in equity or admiralty or
before any federal, state, local, foreign or other governmental authority,
board, agency, commission or instrumentality, nor to the knowledge of HDS, has
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any such claim, dispute, action, suit, proceeding or investigation been pending
or threatened, during the 12 month period preceding the date hereof; (b) there
is no outstanding judgment, order, writ, ruling, injunction, stipulation or
decree of any court, arbitrator or federal, state, local, foreign or other
governmental authority, board, agency, commission or instrumentality, against or
materially affecting the business of HDS ; and (c) HDS has not received any
written or verbal inquiry from any federal, state, local, foreign or other
governmental authority, board, agency, commission or instrumentality concerning
the possible violation of any law, rule or regulation or any matter disclosed in
respect of its business.
10.13 Finder's Fee. There is no investment banker, broker, finder or other
intermediary which has been retained by or is authorized to act on behalf of HDS
or any of its subsidiaries who might be entitled to any fee or commission in
connection with the transactions contemplated by this Agreement other than
Adviser. Adviser has agreed that its sole compensation for acting as an adviser
to HDS in connection with the Exchange and any other transactions contemplated
hereby or by any other Transaction Document shall be the Adviser Shares.
10.14 Taxes. Except as set forth in the HDS Balance Sheet (including the
notes thereto) or Section 10.14 of the HDS Disclosure Schedule and except as
would not, individually or in the aggregate, have a Material Adverse Effect on
HDS, (a) all tax returns, statements, reports and forms (collectively, the "HDS
Returns") required to be filed with any taxing authority by, or with respect to,
HDS and its subsidiaries and each affiliated, combined, consolidated or unitary
group of which HDS is a member are true, correct and complete and have been
filed in accordance with all applicable laws; (b) HDS and its subsidiaries have
timely paid all taxes shown as due and payable on the HDS Returns that have been
so filed (other than taxes which are being contested in good faith and for which
adequate reserves are reflected on the HDS Balance Sheet) and, as of the time of
filing, the HDS Returns correctly reflected the facts regarding the income,
business, assets, operations, activities and the status of HDS and its
subsidiaries; (c) the charges, accruals and reserves for taxes with respect to
HDS and its subsidiaries reflected on the HDS Balance Sheet are adequate under
GAAP to cover the tax liabilities accruing through the date thereof; (d) there
is no action, suit, proceeding, audit or claim now proposed or pending against
or with respect to HDS or any of its subsidiaries in respect of any tax where
there is a reasonable possibility of an adverse determination; and (e) neither
HDS nor any of its subsidiaries has been a member of an affiliated,
consolidated, combined or unitary group other than one of which HDS was the
common parent.
10.15 Employee Benefit Plans. Except as set forth in Section 10.15 of the
HDS Disclosure Schedule, HDS does not maintain, nor has HDS maintained in the
past, any "employee benefit plans" as defined in Section 3(3) of ERISA, or any
plans, programs, policies, practices, arrangements or contracts (whether group
or individual) providing for payments, benefits or reimbursements to employees
of HDS, former employees, their beneficiaries and dependents under which such
employees, former employees, their beneficiaries and dependents are covered
through an employment relationship with HDS, any entity required to be
aggregated in a controlled group or affiliated service group with HDS for
purposes of ERISA or the Code (including, without limitation, under Section
414(b), (c), (m) or (o) of the Code or Section 4001 of ERISA), at any relevant
time.
10.16 Environmental Matters. Except as would not, individually or in the
aggregate, have a Material Adverse Effect on HDS: (a) no notice, notification,
demand, request for information, citation, summons or order has been received,
no complaint has been filed, no penalty has been assessed, and no investigation,
action, claim, suit, proceeding or review is pending or, to the knowledge of
HDS, is threatened by any governmental entity or other person relating to or
arising out of any Environmental Law; and (b) there are no liabilities of or
relating to HDS or any of its subsidiaries of any kind whatsoever, whether
accrued, contingent, absolute, determined, determinable or otherwise arising
under or relating to any Environmental Law and there are no facts, conditions,
situations or set of circumstances which could reasonably be expected to result
in or be the basis for any such liability.
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10.17 Patents and Other Proprietary Rights. HDS has all Intellectual
Property Rights material to its business as currently conducted. To the best of
HDS's knowledge, neither HDS nor any of its subsidiaries has not and does not
violate or infringe any Intellectual Property Right of any other person, and
neither HDS nor any of its subsidiaries has received any communication alleging
that it violates or infringes any Intellectual Property Right of any other
person. Except for such matters as would not, individually or in the aggregate,
have a Material Adverse Effect on HDS, neither HDS nor any of its subsidiaries
has been sued for infringing any Intellectual Property Right of another person.
10.18 Antitakeover Statutes. Excluding any statute or regulation
applicable solely by virtue of the jurisdiction of incorporation of Nesco as to
which HDS takes no position nor makes any representation or warranty, and except
as provided in Section 10.5, no antitakeover or similar statute or regulation
applies to the transactions contemplated hereby.
10.19 Beneficial Ownership of Signatory Stockholders. The HDS Signatory
Stockholders own, in the aggregate, not less than 50.1% of (a) the shares of HDS
Common and (b) the shares of HDS Series B Preferred, in each case, issued and
outstanding on the date hereof. Except as otherwise expressly provided herein,
the HDS Signatory Stockholders shall not offer, sell, transfer, pledge, assign
or otherwise dispose of any of their shares of HDS Common, HDS Series B
Preferred or securities convertible into or exchangeable for HDS Common (and any
Nesco Exchange Shares received in accordance with this Agreement) from the date
hereof until the earlier of (a) termination of this Agreement and (b)
effectuation of the Exchange Transactions.
10.20 HDS Signatories. The HDS Signatory Stockholders include each
officer, director and holder of 5% of any class of outstanding voting securities
of HDS. Each HDS Signatory Stockholder agrees to vote all voting securities of
HDS held by such Stockholder (and any Nesco Exchange Shares received in
accordance with this Agreement) in favor of and/or to consent in writing to, the
Exchange and the other transactions contemplated hereby and by the other
Transaction Documents. Each HDS Signatory Stockholder covenants, represents and
warrants that such Stockholder shall do all acts and things, including the
execution and delivery of all documents and instruments, necessary or proper (a)
to effectuate the Exchange, effectuate the Exchange Transactions and the other
transactions contemplated hereby and by any of the other Transaction Documents
and (b) to cause HDS to carry out its obligations hereunder and under each of
the other Transaction Documents.
10.21 No General Solicitation. Solicitation by HDS of participants in the
Exchange shall be effected without use of any form of general solicitation or
advertising and in all other respects in compliance with the requirements for an
exemption from registration pursuant to Regulation D.
10.22 Investment Representations.
10.22.1 Each HDS Signatory Stockholder is acquiring Nesco Exchange
Shares for investment for such Stockholder's own account and not as a nominee or
agent, and not with a view to the resale or distribution of any part thereof.
10.22.2 Each HDS Signatory Stockholder understands, and each other
Seller shall execute and deliver, at or prior to the Closing, a statement that
such Seller understands, that the offer and sale of the Nesco Exchange Shares
have not been and will not be registered under the Securities Act on the ground
that the sale and the issuance of securities hereunder is exempt from
registration under the Securities Act pursuant to Section 4(2) thereof, and that
Nesco's reliance on such exemption is predicated on such Seller's
representations set forth in Sections 10.22.2 and 10.22.4 hereof.
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10.22.3 Each HDS Signatory Stockholder hereby confirms that such
Stockholder is an Accredited Investor.
10.22.4 Each HDS Signatory Stockholder acknowledges, and each other
Seller shall acknowledge in writing on or prior to the Closing Date, that such
Person can bear the economic risk of this investment, and has such knowledge and
experience in financial and business matters that it is capable of evaluating
the merits and risks of the Exchange and the related investment in Nesco
Exchange Shares.
11. COVENANTS OF NESCO AND NESCO SIGNATORY STOCKHOLDERS PENDING CLOSING. Each of
(a) the Nesco Signatory Stockholders, to the extent within such Stockholder's
control, and (b) Nesco covenants that, except as otherwise provided in this
Agreement, from the date hereof until the first to occur of the Closing Date and
the Termination Date:
11.1 Preservation. Nesco shall:
11.1.1 maintain its corporate existence in good standing;
11.1.2 preserve intact in all material respects its business
organization, preserve its goodwill, exercise reasonable efforts to keep
available the services of Nesco's current officers and employees, to preserve
the goodwill of those having business relations with Nesco, and perform all
contracts to which Nesco is a party; and
11.1.3 maintain in effect all of its currently existing insurance
coverage, if any, or substantially equivalent insurance coverage; and
11.1.4 notify HDS immediately of any litigation or other proceeding
in which Nesco or any of its executive officers or directors is named as a
defendant or respondent and any claim for insurance not disclosed in detail in
any Nesco SEC Filing made prior to January 1, 2004.
11.2 Negative Covenants. Nesco shall not and the Nesco Signatory
Stockholders agree they shall not, except as contemplated by this Agreement or
as may be necessary to effectuate the transactions contemplated by this
Agreement or any other Transaction Document, do or propose to do or vote their
shares in favor of or consent to any of the following:
11.2.1 amend or otherwise modify its certificate of incorporation or
by-laws;
11.2.2 issue, sell, dispose of or subject to any Lien or Encumbrance
or authorize the issuance, sale, disposition, or creation or sufferance of any
Lien or Encumbrance on, or grant or issue any option, warrant or other right to
acquire, or make any agreement with respect to, any shares of any class of
Nesco's capital stock or any security convertible into or exercisable for any
such shares, or alter any of the terms of any outstanding security or make any
change in its authorized or outstanding capital stock or its capitalization,
whether by reason of any reclassification, recapitalization, stock split,
combination, exchange or readjustment of shares, any stock dividend or
otherwise, or permit the exercise of any outstanding options;
11.2.3 declare, set aside, make or pay any dividend or other
distribution to any Nesco Stockholder with respect to any class of capital stock
of Nesco or any NAC Entity; or
11.2.4 redeem, purchase or otherwise acquire any of its outstanding
securities;
11.2.5 encumber any of its material assets or properties;
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11.2.6 increase the compensation or other remuneration or benefits
payable or to become payable to any director or executive officer, or increase
the compensation or other remuneration of benefits payable or to become payable
to any other employee, consultant or agent;
11.2.7 adopt or, except as required by applicable law, amend or make
any unscheduled contribution to any employee benefit plan for or with employees,
or hire any employees;
11.2.8 enter into any material contracts or terminate or modify any
contract, other than in furtherance of the purposes of this Agreement, except
for any termination upon the expiration of any contract prior to the earlier of
the Closing Date or Termination Date in accordance with the terms of such
contract;
11.2.9 create, incur, assume or otherwise become liable for any
indebtedness in an aggregate amount in excess of $5,000, other than indebtedness
directly in furtherance of the transactions contemplated by any of the
Transaction Documents;
11.2.10 commence any new operations, whether by acquiring or
developing any line of business;
11.2.11 cancel, compromise, release or waive any material
receivable, claim or right;
11.2.12 change its method of accounting or the accounting principles
or practices used in the preparation of the Nesco Financial Statements, other
than as required by GAAP or SEC accounting rules or as may be requested in
writing by HDS's auditors;
11.2.13 make any loan or advance to any person or acquire any
capital stock or other securities or ownership interest in or any material
amount of assets of any other business enterprise, or make any material capital
investment or expenditure or capital improvement;
11.2.14 institute or settle any action or proceeding before any
Governmental Authority relating to Nesco, the issuance of any securities of
Nesco, or any of its material assets or properties;
11.2.15 adopt any plan of dissolution or liquidation;
11.2.16 make any new election or change in any current election with
respect to any Taxes, or settle or compromise any federal, state local or
foreign Tax liability or agree to the extension of any statute of limitations;
11.2.17 take any action that would render any of the representations
or warranties of Nesco or the Nesco Signatory Stockholders contained in this
Agreement misleading, untrue or incorrect in any material respect (subject to
any limitations on materiality set forth therein), or cause Nesco or any Nesco
Signatory Stockholder to breach or fail to satisfy or comply with any covenant,
condition or agreement of Nesco or any Nesco Signatory Stockholder contained
herein or in any of the other Transaction Documents in any material respect.
11.2.18 violate the terms of the Standstill Agreement.
11.3 Access and Information. Subject to the provisions of Section 13.3,
Nesco shall comply with the provisions of Section 4.10.
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11.4 Reservation of Shares of Nesco Common. Prior to the Closing, Nesco
shall have reserved for issuance pursuant to this Agreement the number of shares
of Nesco Common sufficient to meet all of Nesco's obligations hereunder.
11.5 Board of Directors.
11.5.1 Nesco and each Nesco Signatory Stockholder who is a member of
the Nesco Board hereby covenant and agree that from and after the Closing, the
two (2) current members of the Nesco Board shall appoint Matthew Harriton and
another Person to be designated by HDS (the "HDS Designees") to fill two (2) of
the three (3) vacancies currently existing of Nesco's Board of Directors; the
foregoing to be acceptable to the Nesco Board in the good faith exercise of its
reasonable business judgment, which right shall not be assignable. Nesco and
each Nesco Signatory Stockholder who is a member of the Nesco Board further
agrees that they shall take all action necessary to nominate the HDS Designees
to stand for election as directors of Nesco at the initial annual meeting of
Nesco Stockholders held after the Closing and at every annual meeting thereafter
unless waived by the HDS Signatory Stockholders.
11.5.2 The HDS Designees may not be removed or replaced without the
prior written consent of the HDS Signatory Stockholders (other than any such
Stockholders who, at the time consent is requested, are no longer holders of
Nesco Common or officers or directors of HDS) except for removal for Cause (but
subject to the rights of such HDS Signatory Stockholders to designate the
individual to fill any such vacancy and of the Board of Directors to accept the
HDS Designee, as provided herein).
11.5.3 Nesco agrees that the HDS Designees shall be entitled to and
shall receive the same compensation as other members of the Nesco Board receive
for serving on the Nesco Board.
11.5.4 Anything contained in this Section 11.5 to the contrary
notwithstanding, Nesco, the Nesco Board and each Nesco Signatory Stockholder who
is a member of the Nesco Board shall not have any obligation under this Section
11 to do any act or thing which violates any provision of applicable law, rule
or regulation whether of Nevada or applicable Federal or state securities law,
rule or regulation.
11.5.5 The parties shall comply with the Exchange Act, including
Rule 14-f-1 promulgated thereunder, in connection with the changes to be made in
the composition of the Nesco Board pursuant to this Section 11.5.
12. COVENANTS OF HDS AND HDS SIGNATORY STOCKHOLDERS PENDING CLOSING. HDS and the
HDS Signatory Stockholders, as applicable, covenant and agree that except as
otherwise provided in this Agreement, from the date hereof until the first to
occur of the Closing Date and the Termination Date:
12.1 Preservation. HDS shall:
12.1.1 maintain its corporate existence in good standing;
12.1.2 preserve intact in all material respects its business
organization, preserve its goodwill, exercise reasonable efforts to keep
available the services of its current officers and perform all contracts to
which HDS is or becomes a party;
12.1.3 maintain in effect all of its currently existing insurance
coverage, if any, or substantially equivalent insurance coverage; and
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12.1.4 notify Nesco immediately of any litigation or other
proceeding in which HDS or any of its executive officers or directors is named
as a defendant or respondent.
12.2 Negative Covenants. HDS shall not and the HDS Signatory Stockholders
agree they shall not, except as contemplated by this Agreement or as may be
necessary to effect the transactions contemplated by this Agreement, do or
propose to do or vote their shares of HDS Common or HDS Series B Preferred or
otherwise consent to any of the following:
12.2.1 amend or otherwise modify its certificate of incorporation or
by-laws;
12.2.2 issue, sell, dispose of or subject to any Lien or Encumbrance
or authorize the issuance, sale, disposition, or imposition of any Lien or
Encumbrance on, or grant or issue any option, warrant or other right to acquire,
or make any agreement with respect to, any shares of any class of capital stock
of HDS or any security convertible into or exercisable for any such securities,
or alter any of the terms of any outstanding security or make any change in its
authorized or outstanding capital stock or its capitalization, whether by reason
of any reclassification, recapitalization, stock split, combination, exchange or
readjustment of shares, any stock dividend or otherwise, or permit the exercise
of any outstanding options;
12.2.3 declare, set aside, make or pay any dividend or other
distribution to any HDS Stockholder in respect of any class of capital stock of
HDS;
12.2.4 redeem, purchase or otherwise acquire any of its outstanding
securities;
12.2.5 increase the compensation or other remuneration or benefits
payable or to become payable to any director or executive officer, or increase
the compensation or other remuneration of benefits payable or to become payable
to any other employee or consultant or agent;
12.2.6 adopt or, except as required by applicable law, amend or make
any unscheduled contribution to any employee benefit plan for or with employees,
or hire any employees;
12.2.7 terminate or modify any contract, other than in furtherance
of the purposes of this Agreement, except for any termination upon the
expiration of any contract prior to the earlier of the Closing Date or
Termination Date in accordance with the terms of such contract;
12.2.8 create, incur, assume or otherwise become liable for any
indebtedness in an aggregate amount in excess of $5,000, other than indebtedness
in furtherance of the transactions contemplated by any of the Transaction
Documents, any indebtedness to Nesco or any of its Affiliates and indebtedness
incurred in the ordinary course of business consistent with past practices;
12.2.9 cancel, compromise, release or waive any material receivable,
claim or right of HDS;
12.2.10 adopt accounting principles or practices other than as
required by GAAP or SEC accounting rules or as may be recommended by HDS's
auditors;
12.2.11 make any loan or advance to any person or acquire any
capital stock or other securities, or ownership interest in or any material
amount of assets, of any other business enterprise, or make any material capital
investment or expenditure or capital improvement;
12.2.12 adopt any plan of dissolution or liquidation;
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12.2.13 settle or compromise any federal, state local or foreign Tax
liability or agree to the extension of any statute of limitations;
12.2.14 take any action that would render any of the representations
or warranties of HDS contained in this Agreement misleading, untrue or incorrect
in any material respect (subject to any limitations on materiality set forth
herein), or cause HDS or any HDS Signatory Stockholder to breach or fail to
satisfy or comply with any covenant, condition or agreement of HDS or any HDS
Signatory Stockholder contained herein or in any of the other Transaction
Documents in any material respect; or
12.2.15 violate the terms of the Standstill Agreement.
12.3 Access and Information. Subject to the provisions of Section 10.2
hereof, HDS shall comply with the provisions of Section 5.2.
12.4 Covenants of HDS Signatory Stockholders. The HDS Signatory
Stockholders agree to vote their respective shares of HDS Common and/or HDS
Series B Preferred in favor of, or consent to, an action that may be required to
be taken by HDS Stockholders in connection with the transactions contemplated by
this Agreement or any other Transaction Document.
13. CERTAIN COVENANTS OF THE PARTIES PENDING AND FOLLOWING CLOSING.
13.1 Covenants of Nesco Signatory Stockholders and HDS Signatory
Stockholders. By executing this Agreement, the Nesco Signatory Stockholders and
the HDS Signatory Stockholders agree, subject to filing of the Information
Statement, to vote their respective shares of voting securities of Nesco
(whether held on the date hereof or acquired at any time from the date hereof
through the Closing Date) in favor of, or to consent to, the following: (i) the
Nesco Name Change, (ii) an increase in the number of authorized shares of Nesco
Common pursuant to the Additional Capitalization Amendment and such Amendment,
(iii) the Reverse Split and the Reverse Split Amendment and (iv) election of the
two HDS Directors to the Nesco Board as provided in Section 11.5 and any other
actions that may be necessary or proper to effectuate any of the foregoing (the
"Exchange Transactions"). Each of the Nesco Signatory Stockholders and the HDS
Signatory Stockholders further acknowledges and agrees that except for the
exercise or exchange of securities contemplated by this Agreement, such
Stockholders may not offer, sell, transfer, pledge, assign, hypothecate or
otherwise dispose of their respective securities of Nesco (whether held on the
date hereof or acquired at any time from the date hereof through the Closing
Date) until the Exchange Transactions shall have been effected. Each Nesco
Signatory Stockholder who is and each HDS Signatory Stockholder who becomes a
member of the Nesco Board agrees to act in furtherance of the obligations
provided in Section 11.5, provided, however, that anything contained in this
Section 13.1 to the contrary notwithstanding, no such Stockholder shall have any
obligation under this Section to do any act or thing which violates its duties
as a director under applicable law or any other provision of applicable laws,
rules or regulations, whether applicable state corporate law or applicable state
or Federal securities laws, rules or regulations.
13.2 Initial 8-K. Upon execution and delivery of this Agreement, Nesco
shall prepare and cause its counsel to prepare and provide to HDS and its
counsel for review, a Current Report on Form 8-K for filing with the SEC with
respect to such execution and delivery (the "Initial 8-K"). HDS and its counsel
shall provide Nesco and its counsel with any comments on the Initial 8-K no
later than one business day prior to the due date for filing same with the SEC,
provided that HDS and its counsel shall have received a draft of same no later
than five (5) business days prior to such due date. HDS shall provide Nesco with
such information as Nesco may reasonably request in connection with the
preparation of the Initial 8-K.
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13.3 Confidentiality. Each of the parties covenants and agrees to keep
confidential any and all material non-public information which it has heretofore
obtained or shall hereafter obtain, directly or indirectly, from Nesco or HDS
pursuant to this Agreement or otherwise, and agrees to use the same only for the
purposes of this Agreement but without disclosing the same to any party except
as provided below, without Nesco's prior written consent; provided that the
terms of this Section 13.3 shall not extend to any such information that: (a) is
already publicly known; (b) has become publicly known without any fault of the
disclosing party or anyone to whom HDS or Nesco has made disclosure in
compliance with the terms of this Section 13.3; or (c) is required to be
disclosed to any Governmental Authority as a result of operation of law,
regulation, or court order; provided, however, that party wishing to make any
disclosure pursuant to this clause (c) shall have first given prompt written
notice, if permitted, of such requirement to HDS and Nesco and cooperates with
Nesco and HDS to restrict such disclosure and/or obtain confidential treatment
thereof. The foregoing notwithstanding, each of HDS and Nesco may disclose such
information to its Affiliates and its directors, officers and employees and
representatives or the directors, officers, employees and representatives of any
of its Affiliates that have a need to know such information (collectively, the
"HDS Parties" and the "Nesco Parties," respectively); provided that HDS or
Nesco, as the case may be, informs such Persons of the restrictions set forth in
this Section 13.3 with respect to such information and such Persons agree to
comply with the provisions of this Section 13.3. Each of HDS and Nesco further
agrees to give prompt notice to the other of any disclosure made by any of the
HDS Parties or the Nesco Parties, respectively, in breach of this Section 13.3,
to the extent HDS or Nesco, respectively, has knowledge of such disclosure;
provided that HDS or Nesco, respectively, shall have no liability for losses
incurred by the other party or any of its Affiliates or their respective
officers, directors, stockholders, employees, or representatives solely as the
result of the failure by Nesco or HDS, respectively, following its actual
receipt of notice from HDS or Nesco, respectively, of disclosure of information
in breach of this Agreement, to make prompt public disclosure of the information
so disclosed. For purposes of this Section 13.3, the knowledge of HDS shall mean
the actual knowledge of Matthew Harriton or any successors to him as Chief
Executive Officer of HDS and the knowledge of Nesco shall mean the actual
knowledge of its Chief Executive Officer.
13.4 Standstill Agreement. Except as otherwise provided in this Agreement,
the parties agree that the following affirmative and negative covenants apply
between the date hereof and the first to occur of (a) the Closing Date and (b)
termination of this Agreement (the "Standstill Agreement"):
13.4.1 neither Nesco or any of the Nesco Signatory Stockholders
shall discuss or negotiate with any other Person, or entertain or consider any
inquiries, or proposals relating to any the possible issuance of any capital
stock or other securities of Nesco in connection with any acquisition of another
Person by Nesco or Nesco's acquisition by another Person, whether through an
exchange of securities, stock or asset acquisition, merger, consolidation or
otherwise; and Nesco shall, and the Nesco Signatory Stockholders shall cause
Nesco to, conduct business only in the ordinary course.
13.4.2 neither HDS or any of the HDS Signatory Stockholders shall
discuss or negotiate with any other Person, or entertain or consider any
inquiries, or proposals relating to any the possible issuance of any capital
stock or other securities of HDS in connection with any acquisition of another
Person by HDS or HDS's acquisition by another Person, whether through an
exchange of securities, stock or asset acquisition, merger, consolidation or
otherwise; and HDS shall, and the HDS Signatory Stockholders shall cause HDS to,
conduct business only in the ordinary course.
13.4.3 Notwithstanding the foregoing provisions of this Section
13.4, Nesco and HDS shall be free to engage in activities described in Sections
13.4.1 and 13.4.2, respectively, which are designed to further the mutual
interests of the parties for the contemplated Exchange, their reorganization and
advancement of HDS's business plan.
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13.5 Notification as to Certain Events. Each party shall promptly notify
the others of (a) the occurrence or non-occurrence of any fact or event of which
such party has knowledge that would be reasonably likely (i) to cause any
representation or warranty of such party contained in this Agreement to be
untrue or incorrect in any material respect at any time from the date hereof to
the Closing or (ii) to cause any covenant, condition or agreement of such party
in this Agreement not to be complied with or satisfied in any material respect
and (b) any failure of such party to comply with or satisfy any covenant,
condition or agreement to be complied with or satisfied by it hereunder in any
material respect; provided, however, that no such notification shall affect any
of the representations or warranties of such party, or the right of the other
party to rely thereon, or the conditions to the obligations of the parties, or
the remedies available hereunder, except as otherwise provided in Section 16.
The parties shall give prompt notice to the other parties of any notice or other
communication from any third Person alleging that the consent of such third
Person is or may be required in connection with the transactions contemplated by
this Agreement.
13.6 Reasonable Efforts; Further Action. Upon the terms and subject to the
conditions contained herein, each of the parties hereto shall use its reasonable
efforts (exercised diligently and in good faith) to take, or cause to be taken,
all actions and to do, or cause to be done, all other things reasonably
necessary, proper or advisable to consummate and make effective as promptly as
practicable the transactions contemplated by this Agreement, to obtain in a
timely manner all necessary authorizations and approvals and to effect all
necessary registrations and filings, and otherwise to satisfy or cause to be
satisfied all conditions precedent to its obligations under this Agreement. If,
at any time after the Closing, any such further action is necessary or desirable
to carry out the purposes of this Agreement, the officers and directors of Nesco
and HDS immediately prior to the Closing are fully authorized in the name of
their respective companies or otherwise to take, and will take, all such lawful
and necessary or desirable action.
13.7 Nesco Charter Amendments. As promptly as practicable following the
Closing and otherwise in compliance with the terms of this Agreement, Nesco
shall increase to 400,000,000 the number of shares of Nesco Common which it is
authorized to issue and thereafter effectuate the Reverse Split. Prior to the
Closing Date, Nesco shall file the Certificate of Designation in Nevada in
compliance with the applicable provisions of the NRS.
13.8 Closing Report. Upon Closing, Nesco shall prepare and cause its
counsel to prepare and provide to HDS and its counsel for review, a Current
Report on Form 8-K for filing with the SEC with respect to the consummation of
the transactions contemplated by this Agreement (the "Closing Report"). HDS and
its counsel shall provide Nesco and its counsel with any comments on the draft
of the Closing 8-K no later than one business day prior to the due date for
filing same with the SEC, provided that HDS and its counsel shall have received
a draft of same no later than five (5) business days prior to such due date. HDS
shall provide Nesco with such information as Nesco may reasonably request in
connection with the preparation of the Closing 8-K. HDS and Nesco shall, and
shall cause their respective auditors to, cooperate in the preparation of the
financial statements required to be filed with or as an amendment to the Closing
Report (the "Exchange Financial Statements").
13.9 Additional Filings. The parties shall cooperate with respect to all
other filings, applications and notices required to be submitted to any
Governmental Authorities and other Persons, or necessary or proper to carry out
the transactions contemplated by any of the Transaction Documents.
13.10 Lock-Up. Each participant in the Exchange, other than holders of
Nesco Series A Preferred and Nesco Warrants, agrees not to offer, sell,
transfer, assign pledge, hypothecate or otherwise dispose of the Nesco Common or
Nesco Series B Preferred (or the Nesco Common same will convert into upon filing
of the Additional Capitalization Amendment) such stockholder receives in the
Exchange for a period commencing on the date on which such holder receives such
securities in the Exchange and continuing until the first anniversary of the
Closing Date (the "Lock-Up").
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13.11 Underwritten Public Offering. In the event that shares of Nesco
Common are registered in connection with an underwritten public offering
undertaken at any time after one hundred twenty (120) days following the Closing
Date, all shares of Nesco Common held by the Nesco Signatory Stockholders, the
HDS Signatory Stockholders, the holder of the Nesco Stockholder Debt, and the
holders of the NAC Shares, the Nesco Warrants and the Nesco Series A Preferred
shall be entitled to include their shares of Nesco Common outstanding or
issuable on the date hereof or immediately following the Closing, subject to
underwriter cutbacks, in the underwriter's sole discretion (an "Underwritten
Offering"). In the event that Nesco does not have a written agreement providing
for an Underwritten Offering by the 180th day following the Closing Date, the
Nesco Signatory Stockholders holding 50.1% or more, in the aggregate, of the
then outstanding voting securities held by them, shall have the right to demand
that Nesco register their shares for resale under the Securities Act.
14. DELIVERIES AT CLOSING.
14.1 Nesco Deliveries. Nesco and the Nesco Signatory Stockholders shall
deliver to HDS at Closing:
14.1.1 certificates representing the Nesco Exchange Shares, duly
endorsed in blank for transfer;
14.1.2 the Nesco Exchange Debentures issuable to the holders of the
HDS Term Debt and the holder of the Nesco Stockholder Debt, if such holder
exercises its option to receive debentures in exchange for such Debt;
14.1.3 a certificate of an executive officer of Nesco certifying
that the representations and warranties of Nesco contained in this Agreement are
true and correct on the Closing Date (except those representations and
warranties which by their terms refer to another date or dates and that Nesco
has satisfied all of the conditions to Closing which it is required to satisfy
pursuant to this Agreement;
14.1.4 a copy of a certificate of good standing for Nesco issued not
more than five (5) days prior to Closing by the Nevada Secretary or Department
of State; and
14.1.5 a certificate of the Secretary of Nesco certifying as to the
incumbency and signatures of the officers of Nesco executing and delivering
documents at Closing, and that attached to such certificate are true and correct
copies of the certificate of incorporation and by-laws of Nesco, each as amended
to the Closing Date, and including the Additional Capitalization Amendment.
14.1.6 opinion of counsel to Nesco to be annexed as Exhibit 14.1.6
hereto, in form and substance substantially as delivered in transactions of this
nature and legally satisfactory to counsel for HDS, in the exercise of its
reasonable legal judgment, provided that such opinion may be given by Nesco's
New York State counsel and may refer to, and rely upon, an opinion of Nevada
counsel to Nesco as to matters of Nevada law.
14.2 HDS Deliveries. HDS and/or the HDS Signatory Stockholders shall
deliver to Nesco at Closing:
14.2.1 certificates representing their shares of HDS Common and HDS
Series B Preferred or other evidence of issuance and ownership thereof;
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14.2.2 Evidence of the HDS Term Debt for cancellation upon
conversion;
14.2.3 a certificate of an executive officer of HDS certifying that
the representations and warranties of HDS contained in this Agreement are true
and correct on the Closing Date (except those representations and warranties
which by their terms refer to another date or dates and that HDS has satisfied
all of the conditions to Closing which it is required to satisfy pursuant to
Section 15 hereof;
14.2.4 a copy of a certificate of good standing for HDS issued not
more than five (5) days prior to Closing by the Department or Secretary of State
of Delaware; and
14.2.5 a certificate of the Secretary of HDS certifying as to the
incumbency and signatures of the officers of HDS executing and delivering
documents at Closing, and that attached to such certificate are true and correct
copies of the certificate of incorporation and by-laws of HDS, each as amended
to the Closing Date; and
14.2.6 an opinion of counsel to HDS to be annexed as Exhibit 14.2.6
hereto, in form and substance substantially as delivered in transaction of this
nature and legally satisfactory to counsel for Nesco, in the exercise of its
reasonable legal judgment.
15. CONDITIONS PRECEDENT TO THE OBLIGATIONS OF THE PARTIES.
15.1 Conditions Precedent to Obligations of All Parties. The obligations
of the parties to consummate the Exchange and the other transactions
contemplated hereby are subject to the satisfaction of the following conditions:
15.1.1 Nesco shall have filed Form 99 and all other documents
required to be filed by it in connection with the Exchange under New York Blue
Sky Laws;
15.1.2 there shall be no default subsisting under the secured
equipment debt of HDS to Becton, Dickinson in the outstanding principal amount
of $800,000 which shall not have been waived or cured, and the note evidencing
such debt shall have been restructured on terms which Nesco and HDS agree can be
serviced and amortized by Nesco in the ordinary course of business;
15.1.3 HDS shall have entered into an amended deposit agreement with
Cygnus Corp., pursuant to which the $800,000 deposit shall have become
non-refundable and terms for applying the deposit or otherwise satisfying the
deposit obligation shall have been set forth; and
15.1.4 All required approvals of or consents to the Exchange and
this Agreement of any Governmental Authority shall have been obtained which may
be legally obtained on or before Closing Date.
15.2 Conditions Precedent to Obligations of Nesco and the Nesco Signatory
Stockholders. The obligations of Nesco and the Nesco Signatory Stockholders to
consummate the Exchange and the other transactions contemplated hereby are
subject to the satisfaction of the following conditions:
15.2.1 Each of HDS and the HDS Signatory Stockholders shall have
performed, in all material respects, all of their respective obligations under
this Agreement required to be performed by it or them prior to the Closing Date;
15.2.2 the respective representations and warranties of HDS and the
HDS Signatory Stockholders contained in this Agreement and in any certificate or
other writing delivered by HDS or any such Stockholder pursuant to this
Agreement shall be true in all material respects at and as of the Closing Date
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as if made at and as of such time, except to the extent that particular
representations or warranties are made as of other specified date or dates, in
which event, they shall be true in all material respects as of such other date
or dates, respectively, and Nesco shall have received a certificate signed by an
executive officer of HDS (which certificate shall not impose any personal
liability on such officer) to the foregoing effect;
15.2.3 there shall have occurred no material adverse changes in the
business or financial condition of HDS between the date hereof and the Closing
Date; and
15.2.4 the holder (s)of the HDS Term Debt shall have agreed to
effect the HDS Term Debt Conversion upon Closing.
15.3 Conditions to Obligations of HDS and the HDS Signatory Stockholders.
The obligations of HDS and the HDS Signatory Stockholders to consummate the
Exchange and the other transactions contemplated hereby are subject to the
satisfaction of the following conditions, any of which may be waived by the HDS
Board with the consent of HDS Signatories holding a majority of the HDS Common
and HDS Series B Preferred held by such HDS Signatories:
15.3.1 Each of Nesco and the Nesco Signatory Stockholders shall have
performed, in all material respects, all of their respective obligations under
this Agreement required to be performed by it at or prior to the Closing or the
Closing Date;
15.3.2 the respective representations and warranties of Nesco and
the Nesco Signatory Stockholders contained in this Agreement and in any
certificate or other writing delivered by Nesco or any such Stockholder pursuant
to this Agreement shall be true in all material respects at and as of the
Closing Date as if made at and as of such time, except to the extent that
particular representations or warranties are made as of other specified date or
dates, in which event, they shall be true in all material respects as of such
other date or dates, respectively, and Nesco shall have received a certificate
signed by an executive officer of Nesco (which certificate shall not impose any
personal liability on such officer) to the foregoing effect;
15.3.3 there shall have occurred no material adverse changes in the
business or financial condition of Nesco between the date hereof and the Closing
Date; and
15.3.4 The Nesco Warrant Conversion shall have been effected and the
Nesco Special Warrants shall have been cancelled prior to the Closing Date;
15.3.5 The Nesco Stockholder Debt shall have been converted into
Nesco Debentures as provided in this Agreement prior to the Closing Date;
15.3.6 Nesco shall have disposed of all of its right, title and
interest in the NAC Entities on the terms set forth in Section 4.6 hereof prior
to the Closing Date;
15.3.7 Nesco shall use its best efforts to have its shares of Nesco
Common re-admitted for quotation on the OTCBB as soon as practicable, and there
shall be no inquiry pending or threatened that could bar such readmission or
result in de-listing of Nesco Common for quotation or trading on the OTCBB;
Nesco and the Nesco Signatory Stockholders shall be current in filing all
reports and other documents required to be filed by them, respectively, with the
SEC;
15.3.8 On the Closing Date, Nesco shall have cash on hand of not
less than $550,000 and outstanding payables or debt not exceeding $200,000,
after giving effect to conversion of the Nesco Stockholder Debt as provided in
Section 4.4 hereof. The outstanding principal and accrued interest on the
Secured Term Loan in the principal amount of $125,000 between Hydrogel, as
borrower, and Nesco, as lender, shall be deemed part of the cash on hand as
required hereby;
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15.3.9 The Exchange shall not violate any Federal or state law, rule
or regulation to which Nesco is subject, and Nesco shall have received all
necessary approvals and consents of the Nesco Board and its Stockholders, if
applicable.
15.3.10 Other than as provided in this Agreement, immediately prior
to the Closing, the number of shares of Nesco Common outstanding shall be no
greater than the number outstanding on the date hereof and no other securities
of Nesco shall be outstanding and there shall be no commitment outstanding to
issue any such securities.
16. TERMINATION.
16.1 Right to Terminate. This Agreement may be terminated prior to
Closing, and the contemplated transactions abandoned at any time prior to the
Closing Date without liability to either party, except as specified below in
this Section 16:
16.1.1 by mutual written agreement of Nesco and HDS;
16.1.2 by Nesco or HDS if (a) any provision of any applicable law or
regulation or (b) any judgment, injunction, order or decree of a court of
competent jurisdiction that prohibits the consummation of the Exchange is
entered and shall have become final and non-appealable, which law, regulation,
judgment, injunction, order or decree is not based upon the requirement of
approval of Nesco's Stockholders, provided that the party seeking to terminate
this Agreement pursuant to the foregoing provisions of paragraph (b) of this
Section 16.1.2 shall have used its reasonable best efforts to remove any such
injunction, order or decree.
16.1.3 by Nesco if: (i) any of the conditions precedent to the
obligations of Nesco set forth in Section 16.2 hereof shall not have been
satisfied in any material respect by the Closing Date or any other date prior to
the Closing provided herein for satisfaction thereof; or (ii) if, on or prior to
the Closing Date, the due diligence review by Nesco or its representatives of
the books and records of HDS reveals a material breach of any of the
representations and warranties of HDS or any HDS Signatory Stockholder contained
herein or in any certificate delivered pursuant to this Agreement or there is
any material adverse change in the financial condition or results of operations
of HDS from those as presented in the HDS Balance Sheet, unless such change is
reflected herein or in the HDS Disclosure Schedule.
16.1.4 by HDS (i) if any of the conditions to the obligations of HDS
set forth in Section 16.3 hereof shall not have been satisfied in any material
respect by the Closing Date or any other date prior to the Closing provided
herein for satisfaction thereof; (ii) if, on or prior to the Closing Date, the
due diligence review by HDS or its representatives of Nesco's books and records
reveals a material breach of any of the representations and warranties of Nesco
or any Nesco Signatory Stockholder contained herein or in any certificate
delivered pursuant to this Agreement or there is any material adverse change in
the business or financial condition or its results of operations of Nesco from
those as presented in the Nesco Annual Report and the Nesco 10-QSB for the
period ended October 31, 2003; or (iii) pursuant to Section 4.5.2.
16.2 Termination Date; Notice of Termination. Any party may exercise its
right under Section to terminate this Agreement by giving notice thereof in
writing to each of the other parties (the "Termination Notice"). This Agreement
shall terminate on the date on which the first Termination Notice shall have
been given by HDS or Nesco pursuant to Section 18.
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16.3 Effects of Termination. In the event of termination of this Agreement
pursuant to this Section 16 ("Termination"), each of the parties hereby
expressly waive their rights to recover all other damages, fees, costs, and
expenses, including incidental, consequential and punitive damages, from any of
the other parties as a result of any termination of this Agreement; provided,
however, that: (a) If either HDS or Nesco terminates this Agreement in bad
faith, the non-terminating party shall be entitled to recover reasonable
attorneys' and auditors' fees, costs and expenses expended in connection with
the Exchange; and (b) HDS may terminate this Agreement pursuant to the
provisions of Section 4.5.2. Effective as of the Termination Date, this
Agreement shall forthwith become void and of no further force or effect, except
for (i) the obligations set forth in this Section 16.3; and (ii) the obligations
of confidentiality set forth in Section 13.3 hereof.
17. NATURE AND SURVIVAL OF REPRESENTATIONS. All representations, warranties and
covenants of the parties contained herein or in any certificate or other
instrument delivered by or on behalf of any of the parties pursuant hereto, or
in connection with the transactions contemplated hereby, shall be deemed
representations and warranties by such party, respectively, but shall not
survive the Closing, provided, however, that representations of any party with
respect to any Tax matter, any Environmental Liability, any ERISA matter or
matter related to any employee benefit plan shall survive until expiration of
the applicable statute of limitations.
18. NOTICES. All notices, requests and other communications to any party
hereunder shall be in writing (including facsimile transmission) and shall be
given,
If to Nesco or any Nesco Signatory Stockholder, to:
Nesco Industries, Inc.
22-09 Queens Plaza North
Long Island City, NY 11101
Fax No.:
--------------------
Attention: ------------------
with a copy to:
Davidoff & Malto LLP
605 Third Avenue
34th Floor
New York, NY 10158
Fax No.: (212) 557-7200
Attention: Jeffrey Citron
If to HDS or any HDS Signatory Stockholder, to:
Hydrogel Design Systems, Inc.
305 Madison Avenue
Suite 4510
New York, NY 10165
Fax No.: (212) 808-0113
Attention: Matthew Harriton
Chief Executive Officer
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with a copy to:
Beckman, Lieberman & Barandes
116 John Street
Suite 1313
New York, New York 10038
Fax No.: (212) 608-9687
Attention: Robert Barandes, Esq.
or to such other address or fax number as such party may hereafter specify for
purposes of notice by giving notice to the other parties hereto. All such
notices, requests and other communications shall be deemed given on the date of
receipt by the recipient thereof, if received prior to 5 p.m. in the place of
receipt and such day is a business day in the place of receipt, or if received
later, the next succeeding business day in the place of receipt.
19. AMENDMENTS; NO WAIVERS. Any provision of this Agreement may be amended or
waived prior to the first to occur of the Closing Date and the Termination Date
but only if such amendment or waiver is in writing and is signed, in the case of
an amendment, by each party to this Agreement, or in the case of a waiver, by
the party against whom the waiver is to be effective. No failure or delay by any
party in exercising any right, power or privilege hereunder shall operate as a
waiver thereof nor shall any single or partial exercise thereof preclude any
other or further exercise thereof or the exercise of any other right, power or
privilege.
20. GOVERNING LAW; ARBITRATION. This Agreement has been prepared, negotiated and
delivered in the State of New York and shall be governed by, and construed in
accordance with, the laws of that State, without giving effect to the principles
thereof relating to the conflict of laws. Any dispute arising pursuant to or in
any way related to this Agreement or the transactions contemplated hereby shall
be settled by arbitration, provided, however, that nothing in this Section shall
restrict the right of either party to apply to a court of competent jurisdiction
for emergency relief pending final determination of a claim by arbitration in
accordance with this Section. All arbitration shall be conducted in New York,
New York, in accordance with the rules and regulations of the American
Arbitration Association then obtaining. The laws of New York shall govern the
disposition of any such arbitration. The decision of the arbitrator shall be
binding upon the parties and judgment in accordance with that decision may be
entered in any court of competent jurisdiction. Each party hereby submits to the
jurisdiction of the American Arbitration Association and consents to the venue
stated in this Section.
21. ENFORCEABILITY. Any provision of this Agreement which is prohibited or
unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective
to the extent of such prohibition or unenforceability without invalidating the
remaining provisions hereof and any such prohibition or unenforceability in any
jurisdiction shall not invalidate or render unenforceable such provision in any
other jurisdiction. To the extent permitted by applicable law, the parties
hereto hereby waive any provision of law which renders any provision hereof
prohibited or unenforceable in any respect.
22. SUCCESSORS AND ASSIGNS; NO THIRD PARTY BENEFICIARIES. The provisions of this
Agreement shall be binding upon and inure to the benefit of the parties hereto
and their respective successors and assigns; provided that no party may assign,
delegate or otherwise transfer any of its rights or obligations under this
Agreement without the consent of the other parties hereto.
23. ENTIRE AGREEMENT. This Agreement, including all Exhibits and Schedules
hereto, constitutes the entire agreement between the parties with respect to the
subject matter of this Agreement and supersede all prior agreements and
understandings, both oral and written between or among any of the parties with
respect to the subject matter hereof and thereof.
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24. COUNTERPARTS. This Agreement may be executed in two or more counterparts,
each of which shall be deemed an original, but all of which together shall
constitute one and the same instrument.
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APPENDIX B
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AMENDMENT TO THE COMPANY'S ARTICLES OF INCORPORATION
CHANGING THE NAME OF THE COMPANY
The following sets forth the changes to Article FIRST of the Company's
articles of incorporation:
FIRST; The name of the Corporation is: AQUAMATRIX, INC.
AMENDMENT TO THE COMPANY'S ARTICLES OF INCORPORATION INCREASING THE NUMBER OF
AUTHORIZED SHARES OF COMMON STOCK
The following sets forth the changes to Article FOURTH of the Company's
articles of incorporation:
FOURTH: That the total number of shares of stock which the corporation is
authorized to issue is:
(a) Common. 400,000,000 shares of Common Stock having a par value of $.001
per share.
(b) Preferred. 1,000,000 shares of Preferred Stock having a par value of
$.001 per share and to be issued in such series and to have such rights,
preferences, and designations as determined by the Board of Directors of the
Corporation.
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