UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For quarterly period ended July 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-28307
NESCO INDUSTRIES, INC.
----------------------
(Exact name of Registrant as specified in its charter)
Nevada 13-3709558
(State or other jurisdiction of (State or I.R.S. Employer
incorporation of organization) Identification Number)
305 Madison Avenue, Suite 4510
New York, New York
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(Address of principal executive offices)
10165
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(Zip Code)
(212) 986-0886
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(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
---
Class Outstanding at October 18, 2004
- --------------------------------------------------------------------------------
Common Stock 19,127,105
NESCO INDUSTRIES, INC.
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FORM 10-QSB
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QUARTERLY REPORT
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For the Three Months Ended July 31, 2004
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TABLE OF CONTENTS
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Page to Page
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Part I - Financial Information
Item 1. Consolidated Financial Statements:
Consolidated Balance sheet...................................... 1-2
Consolidated Statements of operations........................... 3
Consolidated Statements of cash flows........................... 4
Notes to consolidated financial statements...................... 5-10
Item 2. Management's discussion and analysis
of financial condition and results
of operations................................................... 11-14
Item 3. Controls and Procedures................................ 15
Part II. - Other information.................................... 16-17
Signatures...................................................... 18
Exhibit 31
Exhibit 32
Item 1. Financial Statements
NESCO INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEET
- ------------------------------------------------------------------------------------------------------------------------------
July 31,
2004
(unaudited)
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash $ 157,026
Accounts receivable 109,727
Inventories 88,222
Prepaid expenses and other current assets 45,090
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Total current assets 400,065
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Property and equipment, net of accumulated depreciation of $1,541,090 533,674
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Other assets
Purchased technology, net of accumulated amortization of $740,227 56,941
Deferred financing costs 402,086
Investments 6,000
Other 9,697
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Total other assets 474,724
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$ 1,408,463
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LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Note payable $ 217,500
Interest payable, convertible debentures 2,378
Customer deposits 841,153
Accounts payable and accrued expenses 322,858
Due to affiliate 235,585
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Total current liabilities 1,619,474
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Long-term liabilities
Note and interest payable 609,379
Deferred sublease income 152,100
Convertible debentures and interest payable, related party, net of debt discount of $1,058,882 410,599
Convertible debentures and interest payable, other, net of debt discount of $1,016,697 432,128
Convertible debentures and interest payable, officers, net of debt discount of $81,252 733,755
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Total long-term liabilities 2,337,961
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1
See notes to consolidated financial statements.
NESCO INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEET (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------
July 31,
2004
(unaudited)
- ------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' deficit
Series A convertible preferred stock, $.001 par value, authorized
850,000 shares, 512,500 issued and outstanding 513
Series B convertible preferred stock, $.001 par value, authorized
150,000 shares, 73,088 issued and outstanding 73
Common stock, $.001 par value, authorized 25,000,000 shares,
19,127,105 issued and outstanding 19,127
Additional paid-in-capital 11,724,579
Accumulated other comprehensive loss (69,000)
Accumulated deficit (14,224,264)
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Total stockholders' deficit (2,548,972)
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$ 1,408,463
==================
2
See notes to consolidated financial statements.
NESCO INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended July 31,
---------------------------
2004 2003
(unaudited) (unaudited)
- ------------------------------------------------------------------------------------------------------------------------------
Revenues $ 188,114 $ 92,506
Cost of revenues 210,466 202,527
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Gross margin (22,352) (110,021)
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Operating expenses
General and administrative 231,903 155,345
Amortization and other expenses 31,110 29,150
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263,013 184,495
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Loss from operations (285,365) (294,516)
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Other income (expenses)
Sublease income 11,700 -
Amortization of debt discount (264,668) (62,473)
Non-cash stock compensation (2,892,608) -
Interest expense (37,977) (34,267)
Interest expense, related parties (38,171) (26,761)
Amortization of financing costs (32,305) -
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(3,254,029) (123,501)
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Net loss $ (3,539,394) $ (418,017)
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Weighted average common shares outstanding
Basic and diluted 94,935,188 58,884,741
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Loss per common share
Basic and diluted $ (0.04) $ (0.01)
========================================
3
See notes to consolidated financial statements.
NESCO INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended July 31,
--------------------------
2004 2003
(unaudited) (unaudited)
- ------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net loss $ (3,539,394) $ (418,017)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash stock compensation 2,892,608 -
Depreciation and amortization 69,837 85,747
Amortization of debt discount 264,668 62,473
Amortization of financing costs 32,305 -
Gain on sale of equipment - (950)
Changes in operating assets and liabilities:
Accounts receivable (36,035) 19,355
Inventories 116 (52,852)
Prepaid expenses and other current assets 12,929 (7,754)
Other assets 209 (1,048)
Customer deposits (6,500) 247,000
Accounts payable and accrued expenses (133,624) (25,611)
Deferred sublease income (11,700) -
Due to affiliates 6,907 7,126
Interest payable (8,805) 62,023
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Net cash used in operating activities (456,479) (22,508)
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Cash flows from investing activities,
Net cash acquired from merger 86,183 -
Proceeds from sale of equipment - 2,000
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Net cash provided by investing activities 86,183 2,000
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Cash flows from financing activities
Proceeds from issuance of convertible debentures, other 568,870 -
Payments on notes payable (20,500) -
Proceeds from loan from officer - 43,000
Payments on loan from officer (7,000) -
Payments to affiliate (14,876) (34,115)
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Net cash provided by financing activities 526,494 8,885
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Net increase (decrease) in cash 156,198 (11,623)
Cash
Beginning of period 828 44,854
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End of period $ 157,026 $ 33,231
=======================================
Supplemental disclosure of cash flow information,
cash paid during the period for interest $ 84,986 $ 617
=======================================
4
See notes to consolidated financial statements.
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
Organization
NESCO Industries, Inc. (hereinafter referred to as "OLDCO"), a Nevada publicly
traded corporation, prior to ceasing business operations and becoming inactive
in May 2003, was a provider of asbestos abatement and indoor air quality
testing, monitoring and remediation services. In the fiscal year ended April 30,
2003, OLDCO consolidated the operations of its various subsidiaries, through
which it provided services, into a single environmental services operating unit
organized under the banner of its wholly-owned subsidiary National Abatement
Corporation. Prior to consolidation, OLDCO operated through its wholly-owned
subsidiaries, National Abatement Corporation ("NAC"), NAC/Indoor Air
Professionals, Inc. ("IAP") and NAC Environmental Services, Inc. ("NACE").
On April 29, 2004, OLDCO entered into a share exchange agreement with Hydrogel
Design Systems, Inc. ("HDS"), a Delaware privately held corporation, whereby HDS
became a majority-owned subsidiary of OLDCO and the holders of HDS common stock
and debt acquired a majority interest of OLDCO. 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 OLDCO were carried forward at their historical values which
approximates 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 (hereinafter referred to as "NEWCO" or the "Company"). HDS is engaged in
the manufacture, marketing, selling and distribution of hydrogel, an aqueous
polymer-based radiation ionized gel which is used in various medical and
cosmetic consumer products.
NEWCO's fiscal year ends on April 30 and, therefore, references to fiscal 2005
and fiscal 2004 refer to the fiscal years ending April 30, 2005 and April 30,
2004, respectively.
The accompanying condensed 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 NEWCO subsequent to the
acquisition date of May 25, 2004.
The common stock and per share information in the consolidated financial
information and related notes have been retroactively adjusted to give effect to
the reverse acquisition on May 25, 2004.
The accompanying interim 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 financial
statements and should be read in conjunction with the audited financial
statements and the notes thereto of HDS and Nesco Industries, Inc. for the year
ended April 30, 2004. Included in the Form 8-K/A of Nesco Industries, Inc., as
filed on August 9, 2004 with the SEC, is HDS's audited financial statements for
the year ended April 30, 2004. The Form 10-KSB of Nesco Industries, Inc., as
filed on September 16, 2004 with the SEC, sets forth Nesco Industries, Inc.'s
audited financial statements for the year ended April 30, 2004. These statements
reflect all adjustments which are of a normal recurring nature and which, in the
opinion of management, are necessary for a fair statement of the results for the
fiscal quarters ended July 31, 2004 and 2003. The results of the first quarter
of fiscal 2005 are not necessarily indicative of the results for the full year.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company and
its wholly-owned subsidiaries on a consolidated basis. All significant
intercompany accounts and transactions have been eliminated.
5
Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles 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.
Note 2. Acquisition
On May 25, 2004, HDS consummated the Share Exchange with OLDCO whereby HDS
became a majority-owned subsidiary of OLDCO, and the holders of HDS common stock
and debt acquired a majority interest of NEWCO. Because the former HDS
stockholders own a majority of the common stock, HDS is considered to be the
accounting acquirer in the transaction. The accounting for the transaction,
commonly called a reverse acquisition, resulted in a recapitalization of HDS.
NEWCO 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, because NEWCO did not have the required number of authorized
shares of common stock to complete the exchange on this basis, 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 NEWCO is
authorized to issue, each share of the Series B Preferred Stock will be
automatically converted into shares of NEWCO common stock.
HDS common shareholders exchanged 3,240,593 shares of stock for 38,887 shares of
NEWCO Preferred B Stock, which will be converted into 29,165,250 shares of NEWCO
common stock (a ratio of approximately 9 NEWCO shares for 1 share of HDS stock).
The HDS preferred shareholders exchanged 295,853 shares of stock for 14,201
shares of NEWCO Preferred B Stock, which will be converted into 10,650,750
shares of NEWCO common stock (a ratio of approximately 36 NEWCO shares for 1
share of HDS stock). Approximately 72% of the common and 57% of the preferred
shareholders have exchanged their shares as of July 31, 2004 which has resulted
in approximately 44.6% of NEWCO's voting securities exchanged and owned by HDS
stockholders. The Company anticipates that the majority of the remaining
shareholders will exchange their shares in the near future, which will result in
54.3% of NEWCO's voting securities owned by HDS stockholders upon exchange of
all outstanding HDS securities. Upon completion of this exchange, HDS common
shareholders will exchange a total of 4,452,806 shares of stock for 53,434
shares of NEWCO Preferred B Stock, which will be converted into 40,075,167
shares of NEWCO common stock (a ratio of approximately 9 NEWCO shares for 1
share of HDS stock). The HDS preferred shareholders will exchange a total of
522,487 shares of stock for 25,079 shares of NEWCO Preferred B Stock which will
be converted into 18,809,574 shares of NEWCO common stock (a ratio of
approximately 36 NEWCO shares for 1 share of HDS stock).
In addition, OLDCO was required to convert its outstanding shareholder 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 $952,501 agreed to exchange the debt
for an aggregate of 20,000 shares of OLDCO's Series B Preferred Stock, which is
convertible into 15,000,000 shares of NEWCO's common stock. OLDCO 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 NEWCO common stock in the exchange as part of the common
advisor shares issued. OLDCO's Series A Preferred shareholders also agreed, that
upon completion of the exchange agreement, they would convert their shares to
NEWCO's common stock and that NEWCO would have no further obligations with
respect to these preferred shares including payment of any prior preferred share
dividends. In addition, OLDCO was required to retain net cash of approximately
$350,000 as part of the terms of the agreement, of which approximately $208,500
was paid as a bridge loan to HDS prior to April 30, 2004. This bridge loan was
applied to the net cash obligation of OLDCO which was satisfied at the closing.
Concurrent with the merger, OLDCO Series A Preferred shareholders agreed to
exchange 512,500 shares of stock for an aggregate of 20,500 shares of NEWCO
Preferred B Stock, which will be converted into 15,375,000 shares of NEWCO
common stock (a ratio of approximately 30 NEWCO common shares for 1 share of
Series A preferred stock).
6
As part of this transaction, OLDCO conditionally transferred its three wholly
owned subsidiaries, NAC, IAP and NACE, to a consultant and interim officer of
OLDCO 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 NEWCO against any claims and, in exchange
therefore, received 3,000,000 shares of common stock of OLDCO and certain
related registration rights. As additional consideration for the indemnification
by the transferee, NEWCO 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.
In connection with the share exchange agreement, NEWCO 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 an interim officer and
consultant, for services rendered in connection with the 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 of OLDCO. NEWCO also incurred additional merger costs related to the
exchange approximating $48,000. Merger costs of approximately $328,000, the net
amount of cash received from the OLDCO acquisition, were charged to equity, and
the balance of $695,000 was recorded as a charge to operations in the three
months ended July 31, 2004.
Prior to the transaction, the OLDCO had 7,627,105 common shares outstanding.
After giving effect to the transactions above and after such time that NEWCO
increases the number of common shares it is authorized to issue, NEWCO will have
approximately 106,387,000 shares outstanding.
In addition to the exchange of shares, all outstanding options/warrants of HDS
were exchanged for NEWCO options/warrants based on the same ratios as the stock
exchange. This resulted in the issuance of approximately 25,137,000
options/warrants. These options/warrants are currently exercisable at prices
that range between $.08 -$.39 and expire between one and eight 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 merger.
The HDS debt holders were also granted, in consideration of an extension of term
debt, a warrant to acquire one share of NEWCO Common Stock at an exercise price
of $.15 for a term of five years for each dollar of HDS debt, for an aggregate
of the issuance of 2,736,212 warrants. The total HDS term debt of $2,736,212 was
also exchanged for NEWCO convertible debt and the holders may convert this debt
to approximately 28,551,000 shares of NEWCO common stock. Approximately $156,000
of the total 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. For the three months ended July 31,
2004 the amortization of debt discount approximated $213,000.
Prior to the transaction, OLDCO had approximately 4,212,500 options and warrants
outstanding. After giving effect to the transactions above, NEWCO had
approximately 31,483,000 options and warrants outstanding and debt convertible
into approximately 28,551,000 common shares.
The following supplemental pro forma information is presented to illustrate the
effects of the acquisition of HDS on the historical operating results for the
three months ended July 31, 2004 and 2003 as if the acquisition had occurred at
the beginning of the respective period:
Three Months Ended July 31,
2004 2003
----------------- ---------------
Revenues $ 188,114 $ 92,506
Net loss $ (3,633,852) $ (3,741,625)
Net loss per share $ (0.03) $ (0.04)
7
The above unaudited pro forma condensed financial 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 OLDCO been a combined company during the specified periods.
Included in the proforma information for the three months ended July 31, 2004
and 2003 net loss is a one-time charge for warrant revaluation of approximately
$1,794,000.
Note 3. Liquidity and Going Concern
The accompanying 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.
At July 31, 2004, the Company had an accumulated deficit of approximately
$14,224,000, a working capital deficit of approximately $1,219,000 and incurred
a net loss of approximately $3,539,000 for the three months then ended. The
recoverability of a major portion of the recorded asset amounts shown in the
accompanying consolidated balance sheet is dependent on the Company's ability to
obtain financing on an as needed basis. The Company has obtained additional
financing as described in Note 4 and has completed an acquisition as described
in Note 2. In addition, the Company is seeking additional financing as described
in Note 7. However, the Company's financial condition raises substantial doubt
about the Company's ability 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 in existence.
Note 4. Long-Term Debt
HDS Debt Conversion
Concurrent with the May 25, 2004 Share Exchange, HDS liabilities consisting of
convertible debentures due to a related party ($1,308,000), convertible
debentures due to third parties ($625,000), an amount due to an officer
($258,000), and accrued payroll ($544,000) were exchanged for NEWCO convertible
8% debentures which mature, with interest, on December 31, 2005. Accrued
interest as of July 31, 2004 related to these debentures was approximately
$292,000.
Bridge Loans
In June 2004 the Company borrowed $100,000 under bridge loans bearing interest
at 8%. The lenders were also granted warrants to acquire 666,667 common shares
at $.15 per share. These loans were converted into convertible debentures in
connection with the July 2004 investment banking agreement. The fair value of
these warrants of approximately $40,000 was charged to debt discount in the
three months ended July 31, 2004.
Investment Banking Agreement
On July 1, 2004, the Company entered into an investment banking agreement with a
third party for the sale of up to $3,000,000 principal amount of the Company's
8% senior convertible notes due December 1, 2005, with interest payable on
December 1 and June 1 semi-annually and convertible into common stock at $.15
per share. Each note is issued with a five- year warrant to purchase shares of
the Company's common stock at $.25 per share or 666,667 warrants for each
$100,000 of principal amount of notes purchased. As of July 31, 2004 , the
Company received $705,000 in gross proceeds in connection with this agreement
and issued warrants to purchase 4,700,000 shares. Under the terms of the private
placement the Company has agreed to undertake to register the common stock
issuable upon the conversion of the notes and the exercise of the warrants.
Approximately $191,000 of the proceeds as of July 31, 2004 was attributed to the
fair value of the warrants and $332,000 to the intrinsic value of the beneficial
conversion feature of the convertible debt. These amounts were recorded as a
equity components. The remaining balance of $183,000 was recorded as long-term
debt. For the three months ended July 31, 2004 the amortization of debt discount
was approximately $11,000. Interest expense for the three months ended July 31,
2004 was approximately $2,400.
8
Financing fees in connection with this agreement approximated $136,000 at July
31, 2004 which are being amortized over the term of the convertible notes. For
the three months ended July 31, 2004, the amortization of financing costs
approximated $4,000.
Upon termination of the offering on September 30, 2004, a total of $2,295,000
principal amount of the 8% senior convertible notes and warrants to purchase
15,300,006 shares of common stock were issued.
In connection with this agreement, the Company issued the broker warrants to
acquire 4,452,600 shares of NEWCO common stock at an exercise price of $.15 per
share. The fair value of the warrants ($298,000) will be charged to operations
over the life of the underlying debt. For the three months ended July 31, 2004,
approximately $28,000 was charged to operations as financing costs for these
warrants. In August 2004, the broker was issued an additional 500,000 warrants
as related to the additional capital raise as per the terms of the agreement.
Note 5. Commitments and Contingencies
Employment Agreement
On May 19, 2004, the Company entered into a three-year employment agreement with
an officer. The agreement provides for annual compensation of $120,000 with a
10% increase each year on December 31 during the term of the agreement and
bonuses based on the Company's annual operating profit as defined in the
agreement. 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 is the lesser of (i) the average closing bid price per
share of the Company's common stock for 30 consecutive trading days prior to the
closing date and (ii) the average closing bid price per share of the Company's
common stock for 30 consecutive trading days commencing on the 31st day
following the effective date of the reverse split as defined in the share
exchange agreement; provided however, the exercise price shall be the price
determined under (i) at any time prior to the reverse split. The average bid
closing price for the 30 consecutive trading days prior to the closing was $.15.
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 OLDCO which provided for
the issuance of 2,000,000 shares of common stock and a minimum monthly
consulting fee of $7,500 to be credited against any other cash fees earned under
the terms of the agreement. The agreement also provides for certain transaction
fees to be paid to the consultant based on sales and contracts with strategic
alliances. The fair value of the 2,000,000 shares of common stock ($300,000) was
charged to operations in the quarter ended July 31, 2004.
On May 25, 2004, the Company entered into a one-year advisory services agreement
which provided for the issuance of 681,667 shares of common stock and a minimum
monthly consulting fee of $6,250 to be credited against any other cash fees
earned under the terms of the agreement. The agreement also provides for certain
transaction fees to be paid to the consultant based on sales and contracts with
strategic alliances. The fair value of the shares ($102,250) was charged to
operations in the quarter ended July 31, 2004. This expense is included in
current liabilities as these shares have not been issued at July 31, 2004.
Litigation
Except for the claims against former subsidiaries of OLDCO, as mentioned in the
OLDCO's April 30, 2004 10-KSB filing, the Company and its subsidiaries were not
involved in any other material legal proceedings in the three months ended July
31, 2004.
9
Note 6. Stockholders' Equity
Loss Per Share
Basic loss per share excludes dilution and is calculated by dividing the net
loss attributable to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted loss per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock and resulted in the
issuance of common stock. Because the Company incurred a net loss, diluted net
loss per share was the same as basic net loss per share for the three months
ended July 31, 2004 and 2003, since the effect of any potentially dilutive
securities would be antidilutive.
The loss per common share includes the current outstanding common shares in the
aggregate of 19,127,105 shares, 73,088 shares of Series B preferred shares which
will be converted into 54,816,000 common shares, 512,500 shares of Series A
preferred shares which will be converted into 15,375,000 common shares, and
19,068,741 common shares for the prior HDS common and preferred holders who have
not yet exchanged their shares. In the aggregate, 108,386,846 total common
shares were used to compute net loss per share. 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.
The loss per common shares does not include an aggregate of 45,052,299 warrants
and options outstanding and 33,250,747 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. The Company uses the
intrinsic value method set forth in APB Opinion 25, "Accounting for Stock Issued
to Employees", and related Interpretations in accounting for its plans. The
following table illustrates the effect on net loss and earnings per share for
the three months ended July 31, 2004 and 2003 as if the Company had applied the
fair value recognition provisions of FASB Statement 123, "Accounting for
Stock-Based Compensation".
Three Months Ended July 31,
2004 2003
------------ -----------
Net loss as reported $ (3,539,394) $ (418,017)
Add: Total stock-based employee compensation expense determined
under fair value based method, net of related tax effects 151,311 -
------------ -----------
Pro-forma net loss $ (3,690,705) $ (418,017)
============ ===========
=============================
Net loss per share as reported $ $
(.04) (.01)
============ ============
Pro-forma net loss per share $ $
(.04) (.01)
============ ===========
Note 7. Subsequent Event
On August 23, 2004, the Company entered into a Standby Equity Distribution
Agreement with an investment firm. Under the terms of the agreement, the
investment firm has committed to purchase up to $10,000,000 of the Company's
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. As
consideration for entering into this agreement, the Company granted the
investment firm 3,333.33 shares of Series B Preferred shares (convertible into
2,500,000 common shares) and $70,000 cash.
10
Item.2 Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
Information provided by Nesco Industries in this report may contain,
"forward-looking" information, as that term is defined by the Private Securities
Litigation Reform Act of 1995 (the "Act"). In particular, the information
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operation Liquidity and Capital Resources" contains information
concerning the ability of the Company to service its obligations and other
financial commitments as they become due. The forward looking statements are
qualified in their entirety by these cautionary statements, which are being made
pursuant to the provisions of the Act and with the intention of obtaining the
benefits of the "safe harbor" provisions of the Act.
The Company cautions investors that any forward-looking statements it makes are
not guarantees of future performance and that actual results may differ
materially from those in the forward-looking statements.
Share Exchange Agreement and Acquisition
NESCO Industries, Inc. (hereinafter referred to as "OLDCO"), a Nevada publicly
traded corporation, prior to ceasing business operations and becoming inactive
in May 2003, was a provider of asbestos abatement and indoor air quality
testing, monitoring and remediation services.
On April 29, 2004, OLDCO entered into a share exchange agreement with Hydrogel
Design Systems, Inc. ("HDS"), a Delaware privately held corporation, whereby HDS
became a majority-owned subsidiary of OLDCO and the holders of HDS common stock
and debt acquired a majority interest of OLDCO. 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 OLDCO were carried forward at their historical values which
approximates 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 (hereinafter referred to as "NEWCO" or the "Company"). HDS is engaged in
the manufacture, marketing, selling and distribution of hydrogel, an aqueous
polymer-based radiation ionized gel which is used in various medical and
cosmetic consumer products.
NEWCO 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, because NEWCO did not have the required number of authorized
shares of common stock to complete the exchange on this basis, 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 NEWCO is
authorized to issue, each share of the Series B Preferred Stock will be
automatically converted into shares of NEWCO common stock.
HDS common shareholders exchanged 3,240,593 shares of stock for 38,887 shares of
NEWCO Preferred B Stock, which will be converted into 29,165,250 shares of NEWCO
common stock (a ratio of approximately 9 NEWCO shares for 1 share of HDS stock).
The HDS preferred shareholders exchanged 295,853 shares of stock for 14,201
shares of NEWCO Preferred B Stock, which will be converted into 10,650,750
shares of NEWCO common stock (a ratio of approximately 36 NEWCO shares for 1
share of HDS stock). Approximately 72% of the common and 57% of the preferred
shareholders have exchanged their shares as of July 31, 2004 which has resulted
in approximately 44.6% of NEWCO's voting securities exchanged and owned by HDS
stockholders. The Company anticipates that the majority of the remaining
shareholders will exchange their shares in the near future, which will result in
54.3% of NEWCO's voting securities owned by HDS stockholders upon exchange of
all outstanding HDS securities. Upon completion of this exchange, HDS common
shareholders will exchange a total of 4,452,806 shares of stock for 53,434
shares of NEWCO Preferred B Stock, which will be converted into 40,075,167
shares of NEWCO common stock (a ratio of approximately 9 NEWCO shares for 1
share of HDS stock). The HDS preferred shareholders will exchange a total of
522,487 shares of stock for 25,079 shares of NEWCO Preferred B Stock which will
be converted into 18,809,574 shares of NEWCO common stock (a ratio of
approximately 36 NEWCO shares for 1 share of HDS stock).
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In addition, OLDCO was required to convert its outstanding shareholder 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 $952,501 agreed to exchange the debt
for an aggregate of 20,000 shares of OLDCO's Series B Preferred Stock, which is
convertible into 15,000,000 shares of NEWCO's common stock. OLDCO 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 NEWCO common stock in the exchange as part of the common
advisor shares issued. OLDCO's Series A Preferred shareholders also agreed, that
upon completion of the exchange agreement, they would convert their shares to
NEWCO's common stock and that NEWCO would have no further obligations with
respect to these preferred shares including payment of any prior preferred share
dividends. In addition, OLDCO was required to retain net cash of approximately
$350,000 as part of the terms of the agreement, of which approximately $208,500
was paid as a bridge loan to HDS prior to April 30, 2004. This bridge loan was
applied to the net cash obligation of OLDCO which was satisfied at the closing.
Concurrent with the merger, OLDCO Series A Preferred shareholders agreed to
exchange 512,500 shares of stock for an aggregate of 20,500 shares of NEWCO
Preferred B Stock, which will be converted into 15,375,000 shares of NEWCO
common stock (a ratio of approximately 30 NEWCO common shares for 1 share of
Series A preferred stock).
As part of this transaction, OLDCO conditionally transferred its three wholly
owned subsidiaries, NAC, IAP and NACE, to a consultant and interim officer of
OLDCO 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 NEWCO against any claims and, in exchange
therefore, received 3,000,000 shares of common stock of OLDCO and certain
related registration rights. As additional consideration for the indemnification
by the transferee, NEWCO 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.
In connection with the share exchange agreement, NEWCO 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 an interim officer and
consultant, for services rendered in connection with the 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 of OLDCO. NEWCO also incurred additional merger costs related to the
exchange approximating $48,000. Merger costs of approximately $328,000, the net
amount of cash received from the OLDCO acquisition, were charged to equity, and
the balance of $695,000 was recorded as a charge to operations in the three
months ended July 31, 2004.
Prior to the transaction, the OLDCO had 7,627,105 common shares outstanding.
After giving effect to the transactions above and after such time that NEWCO
increases the number of common shares it is authorized to issue, NEWCO will have
approximately 106,387,000 shares outstanding.
In addition to the exchange of shares, all outstanding options/warrants of HDS
were exchanged for NEWCO options/warrants based on the same ratios as the stock
exchange. This resulted in the issuance of approximately 25,137,000
options/warrants. These options/warrants are currently exercisable at prices
that range between $.08 -$.39 and expire between one and eight 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 merger.
The HDS debt holders were also granted, in consideration of an extension of term
debt, a warrant to acquire one share of NEWCO Common Stock at an exercise price
of $.15 for a term of five years for each dollar of HDS debt, for an aggregate
of the issuance of 2,736,212 warrants. The total HDS term debt of $2,736,212 was
also exchanged for NEWCO convertible debt and the holders may convert this debt
to approximately 28,551,000 shares of NEWCO common stock. Approximately $156,000
of the total 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. For the three months ended July 31,
2004 the amortization of debt discount approximated $213,000.
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Prior to the transaction, OLDCO had approximately 4,212,500 options and warrants
outstanding. After giving effect to the transactions above, NEWCO had
approximately 31,483,000 options and warrants outstanding and debt convertible
into approximately 28,551,000 common shares.
NEWCO's fiscal year ends on April 30 and, therefore, references to fiscal 2005
and fiscal 2004 refer to the fiscal years ending April 30, 2005 and April 30,
2004, respectively.
The condensed 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 Newco subsequent to the acquisition date
of May 25, 2004.
Results of Operations
Revenues for the three months ended July 31, 2004 increased to $188,000 from
$93,000 for the three months ended July 31, 2003. This increase of $95,000 is
due to the revenue derived primarily from one customer developing a new product
in the current quarter. Cost of revenues for the three months ended July 31,
2004 increased by $7,000 from $203,000 to $210,000. Cost of revenues consists
primarily of direct labor and other manufacturing fixed costs. The increase
relates to material costs which are attributable to the increased revenue.
General and administrative expenses for the three months ended July 31, 2004
increased to $232,000 from $155,000 for the three months ended July 2003. This
increase of $77,000 is primarily due to ongoing consulting fees and executive
salaries from agreements entered into as a result of the merger and increased
professional fees as a result of increased reporting requirements and other
services needed as a result of the merger.
The net loss for the three months ended July 31, 2004 increased to $3,539,000
from $418,000 for the three months ended July 2003. This increase of $3,121,000
includes a non-cash stock compensation charge of $2,893,000 which is
attributable to a charge of $1,794,000 for the increase in the fair value of the
HDS warrants which were exchanged for NEWCO warrants at the time of the merger
and a charge of $1,099,000 for the issuance of shares issued to advisors and
consultants in connection with the merger. The loss for the three months ended
July 31, 2004 also includes a non-cash debt discount charge of $265,000, an
increase of $202,000 from the three months ended July 31, 2003. This increase is
primarily due to a charge of $231,000 for the fair value of additional warrants
issued to the HDS debt holders for the extension of their term debt and for the
intrinsic value of the beneficial conversion feature as related to the exchange
of the HDS term debt for NEWCO convertible debt at the time of the merger.
Liquidity, Capital Resources and Going Concern
The Company's cash at July 31, 2004 increased to $157,000 as compared to $1,000
in the prior fiscal year. This increase is primarily attributable to the
additional net cash provided by OLDCO at the closing of the share exchange and
the cash remaining from the issuance of convertible debentures in the current
fiscal quarter.
Net cash used in operating activities in the three months ended July 31, 2004
was $456,000 as compared with $23,000 in the prior fiscal quarter ended July 31,
2003. The net cash used by operations in the three months ended July 31, 2004
was used to fund current expenses and pay accounts payable. In the three months
ended July 31, 2003, cash provided by customer deposits was used to fund the
operations. Net cash provided by investing activities in the three months ended
July 31, 2004 was $86,000 as compared with $2,000 in the three months ended July
31, 2003. The net cash provided by investing activities was due to the cash
received from OLDCO at the closing of the share exchange, net of closing costs.
OLDCO had previously advanced HDS $208,000 in the prior fiscal year. The net
cash provided by financing activities in the three months ended July 31, 2004
was $526,000 as compared with $9,000 in the three months ended July 31, 2003.
The net cash provided by financing activities was primarily provided by the
issuance of convertible debentures.
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On July 1, 2004, the Company entered into an investment banking agreement with a
third party for the sale of up to $3,000,000 principal amount of the Company's
8% senior convertible notes due December 1, 2005, with interest payable on
December 1 and June 1 semi-annually and convertible into common stock at $.15
per share. Each note is issued with a five- year warrant to purchase shares of
the Company's common stock at $.25 per share or 666,667 warrants for each
$100,000 of principal amount of notes purchased. As of July 31, 2004 , the
Company received $705,000 in gross proceeds in connection with this agreement
and issued warrants to purchase 4,700,000 shares. Under the terms of the private
placement the Company has agreed to undertake to register the common stock
issuable upon the conversion of the notes and the exercise of the warrants.
Approximately $191,000 of the proceeds as of July 31, 2004 was attributed to the
fair value of the warrants and $332,000 to the intrinsic value of the beneficial
conversion feature of the convertible debt. These amounts were recorded as a
equity components. The remaining balance of $183,000 was recorded as long-term
debt. For the three months ended July 31, 2004 the amortization of debt discount
was approximately $11,000. Interest expense for the three months ended July 31,
2004 was approximately $2,400.
Financing fees in connection with this agreement approximated $136,000 at July
31, 2004 which are being amortized over the term of the convertible notes. For
the three months ended July 31, 2004, the amortization of financing costs
approximated $4,000.
Upon termination of the offering on September 30, 2004, a total of $2,295,000
principal amount of the 8% senior convertible notes and warrants to purchase
15,300,006 shares of common stock were issued.
In connection with this agreement, the Company issued the broker warrants to
acquire 4,452,600 shares of NEWCO common stock at an exercise price of $.15 per
share. The fair value of the warrants ($298,000) will be charged to operations
over the life of the underlying debt. For the three months ended July 31, 2004,
approximately $28,000 was charged to operations as financing costs for these
warrants. In August 2004, the broker was issued an additional 500,000 warrants
as related to the additional capital raise as per the terms of the agreement.
On August 23, 2004, the Company entered into a Standby Equity Distribution
Agreement with an investment firm. Under the terms of the agreement, the
investment firm has committed to purchase up to $10,000,000 of the Company's
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. As
consideration for entering into this agreement, the Company granted the
investment firm 3,333.33 shares of Series B Preferred shares (convertible into
2,500,000 common shares and $70,000 cash.
At July 31, 2004, the Company had an accumulated deficit of approximately
$14,224,000, a working capital deficit of approximately $1,219,000 and incurred
a net loss of approximately $3,539,000 for the three months then ended. The
recoverability of a major portion of the recorded asset amounts shown in the
consolidated balance sheet is dependent on the Company's ability to meet its
financing requirements on an as needed basis. The Company has obtained
additional financing and has completed an acquisition as mentioned above. In
addition, the Company is seeking additional financing. However, the Company's
financial condition raises substantial doubt about the Company's ability 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 in existence.
Management intends to focus its efforts in the next twelve months on building
the business of HDS which it believes will be possible as a result of the
additional financing as described above. Management believes this will enable
the Company to expand its current operations, develop new products and explore
new markets and increase its current sales force to achieve theses objectives.
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Item 3. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation of the Company's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a
date within 90 days of the filing date of this Quarterly Report on Form 10-QSB,
our chief executive officer and chief financial officer have concluded that our
disclosure controls and procedures are designed to ensure that the information
we are required to disclose in the reports we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms and are operating in an effective manner.
(b) Changes in internal controls. There were no significant changes in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their most recent evaluation.
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PART II- OTHER INFORMATION
Item 1. - Legal Proceedings
We are not currently involved in any material legal proceedings.
Item 2. - Changes in Securities.
Not applicable.
Item 3. - Defaults Upon Senior Securities.
Not applicable.
Item 4. - Submission Of Matters To A Vote Of Security Holders.
Not applicable.
Item 5. - Other Information.
Not applicable.
Item 6. - Exhibits And Reports on Form 8-K.
(A) Exhibits:
3.1 Amendment to Certificate of Designations Series A Preferred
Stock.
3.2 Amendment to Certificate of Designations Series B Preferred
Stock.
10.1 Stock Purchase and Assumption Agreement dated as of May 13, 2004,
as amended between Registrant and Nac Calabria Acquisition
Corporation
10.2 Accounts Receivable Transfer Agreement dated as of May 28, 2004
between Registrant and the NAC Entities.
10.3 Employment Agreement between Registrant and Matthew Harriton
dated as of May 19, 2004.
10.4 Stock Option Agreement between Registrant and Matthew Harriton
dated as of May 25, 2004.
Exhibit 31 -- Certification of Principal Executive and Financial
Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002
Exhibit 32 -- Certification of Principal Executive and Financial
Officer pursuant to Section 906 of the Sarbanes- Oxley Act of 2002
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(B) Reports on Form 8-K:
Current Reports on Form 8-K filed during the quarter ended July 31, 2004
and the subsequent interim period ended October 18, 2004 are as follows:
-- Report on Form 8-K, filed with the SEC on June 9, 2004, announcing the
completion of the transactions contemplated by the Share Exchange
Agreement and a Change of Address under Items 1, 2 and 5, Changes in
Control of Registrant, Acquisition or Disposition of Assets and Other
Events, respectively.
-- Report on Form 8-K/A, filed with the SEC on August 9, 2004 to amend
the Report 8-K filed with the SEC on June 9, 2004 to provide the
required financial information under Item 7 (a) and (b).
-- Report on Form 8-K filed with the SEC on August 27, 2004 announcing
the unregistered sales of equity securities under Item 3.02 under a
Securities Purchase Agreement with Ocean Drive Holdings, LLC for the
issuance of 8% senior convertible promissory notes and warrants.
-- Report on Form 8-K, filed with the SEC on October 6, 2004, announcing
the change in registrant's certifying accountant under Item 4.01,
announcing the unregistered sales of additional equity securities
under Item 3.02 under a Securities Purchase Agreement with Ocean Drive
Holdings, LLC for the issuance of 8% senior convertible promissory
notes and warrants previously reported on August 27, 2004, and
announcing the election of a new Director under Item 5.02.
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Signatures
----------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned there unto duly authorized.
NESCO INDUSTRIES, INC.
By: /s/ Matthew L. Harriton
-----------------------
Matthew L. Harriton
President and Chief
Executive Officer
Dated: October 18, 2004
18