As filed with the Securities and Exchange Commission on January 31, 2005
Registration No. 333-_______
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
Form SB-2
Registration Statement Under The Securities Act of 1933
NESCO INDUSTRIES, INC.
(Exact name of small business issuer as specified in its charter)
Nevada 3842 13-3709558
(State or other Jurisdiction (Primary Standard Industrial (IRS Employer
of Incorporation or Organization) Classification Code Number) Identification
Number)
305 Madison Avenue, Suite 4510, New York, New York 10165 (212) 986-0886
(Address and Telephone Number of Principal Executive Offices)
305 Madison Avenue, Suite 4510, New York, New York 10165 (212) 986-0886
(Address of Principal Place of Business or Intended Principal
Place of Business)
Matthew Harriton
305 Madison Avenue, Suite 4510
New York, New York 10165 (212) 986-0886
(Name, Address and Telephone Number of Agent for Service)
Copies to:
Robert Barandes, Esq.
Beckman, Lieberman & Barandes, LLP
116 John Street, Suite 1313
New York, New York 10038
(212) 608-3500
(212) 608-9687 Fax
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the Registration Statement becomes effective.
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering [ ].
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.[ ]___________________
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box [ ].
CALCULATION OF REGISTRATION FEE
======================================= ================= ===================== ======================== ======================
Proposed Maximum Proposed Maximum
Title of Each Class of Amount to be Offering Price Per Aggregate Offering Amount of
Securities to be Registered Registered(1) Security Price (1) Registration Fee
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Common Stock, $0.001 par value, to be
registered by Selling Stockholders 109,330,644 $0.17 $18,586,209.48 $2,187.60
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Common Stock, $0.001 par value,
issuable upon exercise of Common
Stock Purchase Warrants and Options
to be registered by Selling
Stockholders 52,976,304 $0.17 $9,005,971.68 $1,060.00
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Common Stock, $0.001 par value,
issuable to holders of Convertible
Debt 44,462,747 $0.17 $7,558,666.99 $889.66
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Common Stock, $0.001 par value,
issuable upon use of Standby Equity
Distribution Agreement and for future
issuance of advisor shares 30,646,155 $0.17 $5,209,846.35 $613.20
======================================= ================= ===================== ======================== ======================
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Total 237,415,850 $40,360,694.50 $4,750.45
======================================= ================= ===================== ======================== ======================
(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457 under the Securities Act of 1933, as amended (the "Securities
Act"). Pursuant to Rule 457(c) under the Securities Act, the proposed
maximum offering price of each share of the Registrant's common stock is
estimated to be the average of the high and low sales price of a share as
of a date five business days before the filing of this registration
statement. Accordingly, the Registrant has used $.17 as such price per
share, which is the average of the high and low of $.17 reported by the OTC
Bulletin Board on January 26, 2005.
We hereby amend this Registration Statement on such date or dates as may be
necessary to delay its effective date until we have filed a further amendment
which specifically states that this Registration Statement shall thereafter
become effective in accordance with Section 8(a) of the Securities Act of 1933,
as amended, or until this Registration Statement shall become effective on such
date as the Commission, acting pursuant to said Section 8(a), may determine.
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement is filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell or a solicitation of an offer to buy these securities in any state where
the offer is not permitted.
SUBJECT TO COMPLETION, DATED JANUARY 31, 2005
Preliminary Prospectus
237,415,850 Shares
NESCO INDUSTRIES, INC.
Common Stock
This is an offering of shares of common stock of Nesco Industries, Inc.
(hereinafter the "Company"; "we", "us", and "our" will each refer to Nesco
Industries, Inc.). Certain of our stockholders (the "Selling Security Holders"
or "selling stockholders") are offering to sell 237,415,850 shares of common
stock (the "Resale Shares"). We will not receive any proceeds from the sale of
shares by the Selling Security Holders.
The Resale Shares are being offered for sale from time to time by the
Selling Security Holders at the prevailing market price or in negotiated
transactions. Of the Resale Shares offered:
up to 109,330,644 shares are being offered for sale by existing
stockholders;
up to 52,976,304 shares are issuable upon the exercise of our common stock
purchase warrants and options;
up to 44,462,747 shares are issuable to holders of debt ;
up to 30,646,155 shares are issuable in connection with a Standby Equity
Distribution Agreement between the Company and Cornell Capital Partners,
LP, and in connection with advisor compensation shares pending completion
of this registration statement.
The Resale Shares may be sold by the Selling Security Holders from time to
time in transactions (which may include block transactions) in the
over-the-counter market, in negotiated transactions, or a combination of such
methods of sale, at fixed prices which may be changed, at market prices
prevailing at a time of sale, or at negotiated prices. The Selling Security
Holders may effect such transactions by selling shares directly to purchasers or
through broker dealers who may act as agent or principals. Such broker dealers
may receive compensation in the form of discounts, concessions or commission for
the Selling Security Holders and/or the purchasers of the Selling Security
Holders shares, for whom they may sell as principles or both (which compensation
as to a particular broker dealer might be in excess of customary commissions).
The Securities Act of 1933, as amended (the "Act"), may impose liability on
the Selling Security Holders or any broker/dealer who may be used by the Selling
Security Holders for violations of federal securities laws. If the registration
statement contains untrue statements or omissions of material facts, liability
may be imposed on the Selling Security Holders or any broker/dealer used the
Selling Security Holder. Generally, if any liability is found, the investors
purchasing the shares will have a claim for damages against the Selling Security
Holders and/or the broker/dealer.
3
Our common stock is quoted on the OTC Bulletin Board under the symbol NESK.
The closing bid price for the common stock on January 26, 2005 as reported by
the OTC Bulletin Board was $0.17 per share. See "Price Range of Common Stock."
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE 'RISK FACTORS' BEGINNING
ON PAGE 9.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THE PROSPECTUS. ANY REPRESENTATIONS MADE TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS ________________
TABLE OF CONTENTS
PROSPECTUS SUMMARY 7
Historical Background 7
Our Business 7
SUMMARY SELECTED FINANCIAL INFORMATION 8
RISK FACTORS 9
Financial Risks 9
Risks Related to our Business 9
Risks Related to Our Industry 10
Other Risks 11
FORWARD LOOKING STATEMENTS 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 13
Historical Background 13
Our Operations 14
Liquidity and Capital Resources 14
Results of Operations 16
Critical Accounting Policies 18
Revenue Recognition 18
Stock Compensation 18
New Accounting Pronouncements 19
DESCRIPTION OF BUSINESS 20
Background 20
Overview of Business of HDSI 22
Business Strategy 23
Products and Services 25
HDSI Manufacturing Process 26
Applications for Hydrogel Patches 28
Customers and Markets for Hydrogel 29
Competition 30
Protection of Intellectual Property and Proprietary Technology 30
Employees 30
Properties 31
Legal Proceedings 31
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 32
Market Information 32
Holders 32
Dividends 33
Equity Compensation Plan Information 33
BENEFICIAL OWNERSHIP 34
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 37
Disclosure of Commission Position of Indemnification for
Securities Act Liabilities. 41
SELLING SECURITY HOLDERS 41
Investment Banking Agreement 47
Standby Equity Distribution Agreement 47
USE OF PROCEEDS 47
PLAN OF DISTRIBUTION 47
DESCRIPTION OF SECURITIES 49
Common Stock 49
5
Series A Preferred 49
Conversion 49
Voting Rights 49
Liquidation 50
Series B Preferred 50
Conversion 50
Voting Rights 50
Rank 50
MANAGEMENT 50
Directors and Officers 50
Summary Compensation 52
Options/SAR Grants in Last Fiscal Year 53
Aggregated Option/SAR Exercises and Fiscal Year-End Option/SAR Value 54
Long-Term Incentive Plans 54
Compensation of Directors 54
Employment Contracts and Termination of Employment and Change in
Control Arrangements 55
Report on Repricing of Options/SARS 55
EXPERTS 56
WHERE YOU CAN FIND MORE INFORMATION 56
FINANCIAL INFORMATION 57
6
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in the prospectus.
You should read the entire prospectus carefully; especially the risks of
investing in the securities discussed under "Risk Factors" on pages 9-12 and our
financial statements and related notes beginning on page F-1 before deciding to
invest in our common stock.
Historical Background
We were incorporated in Nevada in March, 1993 and were inactive for a
number of years. In March, 1998, through a series of acquisitions, we became a
provider of asbestos abatement and indoor testing, monitoring and remediation
services. In fiscal year ended 2003, we consolidated these operations into a
single environmental services unit under the name National Abatement Corporation
("NAC"). In the fourth quarter of our 2003 fiscal year, we elected to cease
operations in order to conserve financial and other resources until a new
business focus was identified.
Effective May 25, 2004, pursuant to a Shareholder Exchange Agreement
("Exchange Agreement") dated as of April 29, 2004, among us, Hydrogel Design
Systems, Inc., a Delaware Corporation ("HDSI"), then a privately held company,
and certain signatory stockholders of these entities, HDSI became our majority
owned subsidiary. These stockholders and the holders of derivative securities
pursuant to which they may at a later date acquire common stock, are including
their shares in this offering. In addition, in connection with the Exchange
Agreement, shares were issued to advisors for services rendered, and for the
sale of our subsidiaries, and these shares are also being offered for sale in
this offering.
As part of this transaction, we transferred all of our wholly owned
subsidiaries, including NAC, 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 of
us. The transferee assumed all liabilities and obligations with respect to 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. In support of the value of the common stock
delivered, we agreed that the transferee, at its election, may demand we
repurchase from the transferee up to 2,400,000 of the common shares upon written
notice from the transferee 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.
Our Business
Through HDSI, our majority owned subsidiary, we develop, manufacture and
market electron beam cross-linked aqueous polymer sheet hydrogels, hereafter
referred to as "HDSI gels". A polymer is a substance made of many repeating
chemical units or molecules. A hydrogel is a polymer network having an affinity
for water and other materials. The HDSI gels we manufacture are designed to be
highly compatible with skin, the largest organ of the human body. HDSI's gels
exhibit the following product characteristics: painless adhesion to the human
body; stability of form and composition; purity; reproducibility, compatibility
with active ingredients; and high water content. HDSI gels have application in
select fields of wound care, medical diagnostics, transdermal drug delivery and
cosmetics.
HDSI is exploiting its proprietary manufacturing technologies in the
development of high margin, specification sensitive transdermal applications,
for selected pharmaceutical and medical manufacturers.
7
Customers for HDSI product include manufactures of medical devices; wound
healing bandages; cosmetics and OTC consumer products. HDSI products are
primarily distributed by agreement with third party marketers. Unless otherwise
stated, references to our operations refer to the operations of HDSI and not to
environmental services business previous conducted by the Company.
SUMMARY SELECTED FINANCIAL INFORMATION
The financial information as presented below and elsewhere in this
registration statement reflect the historical results of our predecessor entity,
HDSI, prior to May 25, 2004, the date of the Exchange Agreement, and our
consolidated results of operations subsequent to the acquisition date of May 25,
2004.
Six Months Ended
Years ended April 30, October 31, 2004
2002 2003 2004 (Unaudited)
---- ---- ---- -----------------
Statement of Operations Data:
Total revenues $1,043,995 $1,130,995 $623,349 $332,086
Total costs and expenses 2,439,956 2,204,555 1,690,032 1,185,357
Other income (expense) (573,537) (589,360) (432,358) (4,103,582)
Net loss (1,969,498) (1,662,920) (1,499,041) (4,956,853)
Net loss per share ($0.44) ($0.37) ($0.34) ($.05)
Balance Sheet Data:
Total Assets 1,518,536 1,234,674 924,295 2,607,947
Working capital (deficit) (3,229,395) (4,222,237) (1,368,544) (417,208)
Total liabilities 3,376,359 4,424,683 5,482,465 4,252,497
Stockholders' equity (deficit) (1,857,823) (3,190,009) (4,558,170) (1,644,550)
8
RISK FACTORS
You should carefully consider the factors described below and other information
contained in this report. The risks and uncertainties described below are not
the only ones we face. Additional risks and uncertainties not presently known to
us, which we currently deem immaterial or which are similar to those faced by
other companies in our industry or business in general, may also impair our
business operations. If any of the following risks actually occurs, our
business, financial condition or results of operations could be materially and
adversely affected. In such case, the trading price of our common stock could
decline, and you may lose all or part of your investment. This report also
contains forward- looking statements that involve risks and uncertainties.
Please refer to "Forward-Looking Statements" included elsewhere in this
prospectus.
Financial Risks
We have a limited operating history; anticipation of continued losses.
We have achieved only limited revenues to date and there is no assurance
that we will be able to generate substantial revenues or be profitable in the
future. We have incurred net losses since inception, including net losses of
$1,662,920, $1,499,041 and $4,956,853 for the years ended April 30, 2003 and
2004 and for the six months ended October 31, 2004, respectively. We expect to
continue to incur significant losses on a quarterly and annual basis at least
through 2005. As of October 31, 2004, we had an accumulated deficit of
$15,641,723 and a working capital deficiency of $417,208. We can offer no
assurance that we will achieve revenue growth or profitability.
Our financial condition raises substantial doubt about our ability to continue
as a going concern.
Although we intend to have additional financing available upon the
effectiveness of this registration statement, our financial statements do not
include any adjustments that might be necessary if we are unable to continue
operations due to our inability to raise sufficient funds to maintain current
and proposed operations.
Risks Related to our Business
We are dependent on proprietary know-how. We hold limited patents.
Competitors may develop or market technologies that are more effective or
more commercially attractive than ours. Our manufacturing know-how as to mixing,
coating and cross-linking can be duplicated even if it is difficult to do so.
There is no assurance that should we apply for intellectual property protection,
that we would be able to obtain such protection. Despite our efforts to protect
proprietary rights, there is no assurance that such protections may not
precluded competitors from developing and/or marketing similar products. While
we are not aware of any third party intellectual property that would materially
affect our business, our failure or inability to obtain patents and protect our
proprietary information could result in our business being adversely affected.
We are dependent on the services of key personnel the loss of which would have a
material adverse effect on us.
The operations and future success of our company depends upon the efforts
of our key employees. Because of the specialized nature of our business, we are
9
dependent on our ability to attract and retain qualified personnel. We have no
key man insurance for any of our employees. We face competition for personnel
from other companies with greater resources than we have. There can be no
assurance that we will be successful in hiring or retaining qualified personnel,
and our failure to do so could have a material adverse effect on our business
and financial condition.
We are dependent on outside suppliers for raw materials.
Our products are manufactured using proprietary polymers that we obtain
from outside suppliers. It is possible that the outside suppliers may be unable
to meet our demands or may be unable to supply us with the materials necessary
for us to manufacture our products.
Risks Related to Our Industry
We are subject to governmental regulations
Inherent in the development of new medical products is the potential for
delay in that product testing, including clinical evaluation, is required before
most products can be used with humans. The manufacture, marketing, labeling,
record-keeping, claims and advertising of medical devices as well as
prescription drugs, non-prescription drugs that claims to have certain
therapeutic properties, and cosmetics are subject to regulation by the Food &
Drug Administration (the "FDA") and the Federal Trade Commission (the "FTC"). We
are also subject to state regulation on electron beam radiation services and
facilities. The expansion of our business into the manufacture and distribution
of products for consumer use will subject us to additional governmental
regulation. While Hydrogel patches are classified as Class I exempt devices by
the FDA, there can be no assurances that the FDA will not seek to regulate this
product in the future. Such action by the FDA could have a material, adverse
effect on our prospects as such approval requires a number of years, costly and
time-consuming tests and other procedures.
Our products are subject to obsolescence; competition in the medical products
field is intense and we represent a very small presence.
The field of medical and health products is characterized by rapid and
significant changes. We can give no assurance that any existing or future
product of ours will be competitive and will not be come obsolete in light of
future technological developments. Most of our competitors have far greater
financial, research, marketing and distribution resources and more established
channels of distribution than we do. In addition, many of our current and
potential competitors offer greater variety of products and services and can
therefore offer discounts and other incentive programs unavailable to us at this
time.
Our failure to meet the prices offered by competitors, or to be unable to
meet production demands for our products could have material adverse effect on
our business, financial condition or results of operations. The relative speed
with which we can introduced products and expand our distribution are also a
competitive factor. Additionally, many of our customers have financial
wherewithal to establish in-house manufacturing capabilities similar to ours.
Our products risk exposure to product liability claims.
If successful in developing testing and commercializing our products, we
will be exposed to potential product liability risks, which are inherent in the
testing, manufacturing and marketing of topical therapeutic and skin care
products. It is likely we will be contractually obligated, under any license
10
agreements we enter into to indemnify the individuals and/or entities to whom we
have licensed the technology against claims relating to the manufacturer and
sale of products sold by licensees. This indemnification liability, as well as
direct liability to consumers for any defects in the products sold, could expose
us to substantial risks and losses. We have obtained $1,000,000 of product
liability insurance; however, there can be no assurance that we will be able to
maintain such insurance on acceptable terms or that such insurance will provide
adequate coverage against potential liabilities.
Other Risks
Recent trading in our stock has been limited, so investors may not be able to
sell as much stock as they want at prevailing market prices.
Recent trading volume has been limited with an average daily volume for the
22 trading days from December 6 through January 6 of 5,932 shares. By contrast,
we are registering 237,415,850 shares with this registration statement. If
limited trading in our stock continues, it may be difficult for the Selling
Security Holders to sell their shares in the public market at any given time at
prevailing prices.
Future sales of shares of our common stock, including sales of shares following
the registration of shares we issued in a recent financing, may negatively
affect our stock price.
As a result of our recent private offering, upon conversion of 8%
debentures and exercise of warrants, the investors in the offering will or have
been issued approximately 30,600,006 shares of our common stock.
This registration statement covers the shares issued to private investors
and issuable upon the exercise of the warrants. In the future, we may issue
additional options, warrants, or other derivative securities convertible into
our common stock. Sales of substantial amounts of our common stock, or even the
potential for such sales, would lower the market price of our common stock and
impair our ability to raise capital through the sale of equity securities.
Our common stock may be affected by limited trading volume and may fluctuate
significantly which may affect the value of our shares of common stock
Prior to this offering, there has been a limited public market for our
common stock and there can be no assurance that a more active trading market for
our common stock will develop. An absence of an active trading market could
adversely affect our stockholders' ability to sell our common stock in short
time periods, or possibly at all. Our common stock has experienced, and is
likely to experience in the future, significant price and volume fluctuations,
which could adversely affect the market price of our common stock without regard
to our operating performance. In addition, we believe that factors such as
quarterly fluctuations in our financial results and changes in the overall
economy or the condition of the financial markets could cause the price of our
common stock to fluctuate substantially. These fluctuations may also cause short
sellers to enter the market from time to time in the belief that we will have
poor results in the future. We cannot predict the actions of market participants
and, therefore, can offer no assurances that the market for our stock will be
stable or appreciate over time.
Our common stock is deemed to be "Penny Stock" which may make it more difficult
for investors to sell their shares.
Because we may be subject to the "penny stock" rules, the level of trading
activity in our stock may be reduced. Broker-dealer practices in connection with
11
transactions in "penny stocks' are regulated by certain penny stock rules
adopted by the Securities and Exchange Commission. Penny stocks, like shares of
our common stock, generally are equity securities with a price of less than
$5.00, other than securities registered on certain national securities exchanges
or quoted on NASDAQ. The penny stock rules require a broker-dealer, prior to a
transaction in a penny stock not otherwise exempt from the rules, to deliver a
standardized risk disclosure document that provides information about penny
stocks and the nature and level of risks in the penny stock market. The
broker-dealer also must provide the customer with current bid and offer
quotations for the penny stock, the compensation of the broker-dealer and its
salesperson in the transaction, and, if the broker-dealer is the sole market
maker, the broker-dealer must disclose this fact and the broker-dealer's
presumed control over the market, and monthly account statements showing the
market value of each penny stock held in the customer's account. In addition,
broker-dealers who sell these securities to persons other than established
customers and "accredited investors" must make a special written determination
that the penny stock is a suitable investment for the purchaser and receive the
purchaser's written agreement to the transaction. Consequently, these
requirements may have the effect of reducing the level of trading activity, if
any, in the secondary market for a security subject to the penny stock rules,
and investors in our common stock may find it difficult to sell their shares.
FORWARD LOOKING STATEMENTS
The statements contained in this prospectus that are not historical fact
are "forward-looking statements," which can be identified by the use of
forward-looking terminology such as "believes," "expects," "may," "should," or
"anticipates," the negatives thereof or other variations thereon or comparable
terminology, and include statements as to the intent, belief or current our
expectations with respect to the future operations, performance or position.
These forward-looking statements are predictions. We cannot assure you that the
future results indicated, whether expressed or implied, will be achieved. While
sometimes presented with numerical specificity, these forward-looking statements
are based upon a variety of assumptions relating to our business, which,
although currently considered reasonable by us, may not be realized. Because of
the number and range of the assumptions underlying our forward-looking
statements many of which are subject to significant uncertainties and
contingencies beyond our reasonable control, some of the assumptions inevitably
will not materialize and unanticipated events and circumstances may occur
subsequent to the date of this prospectus. These forward-looking statements are
based on current information and expectation, and we assume no obligation to
update them at any stage. Therefore, our actual experience and results achieved
during the period covered by any particular forward-looking statement may differ
substantially from those anticipated. Consequently, the inclusion of
forward-looking statements should not be regarded as a representation by us or
any other person that these estimates will be realized, and actual results may
vary materially. We cannot assure that any of these expectations will be
realized or that any of the forward-looking statements contained herein will
prove to be accurate.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Historical Background
We were incorporated in Nevada in March 1993, and were inactive for a
number of years. In March 1998, we acquired National Abatement Corporation
("NAC") and NAC Environmental Services, Inc.("NACE"). By virtue of this
acquisition, which was the result of arms length negotiations between previously
non-affiliated parties, the former stockholders of NAC and NACE acquired
5,000,000 shares of our common stock, or 80% of the total outstanding,
immediately following the acquisition. The former stockholders of NAC were the
same as the former stockholders of NACE. For accounting purposes, NAC was
treated as the acquiring corporation. Thus, the historical financial statements
of NAC prior to that acquisition date were deemed to be our historical financial
statements.
We were 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, through which it
provided services, into a single environmental services operating unit organized
under the banner of its wholly-owned subsidiary NAC. Prior to this
consolidation, we also operated through two other wholly-owned subsidiaries,
NAC/Indoor Air Professionals, Inc. ("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. As a
result of ceasing business operations, we wrote-off goodwill, fixed assets and
inventory in fiscal 2003.
On April 29, 2004, we entered into a share exchange agreement with Hydrogel
Design Systems, Inc. ("HDSI"), a Delaware privately held corporation, whereby
HDSI would become our majority-owned subsidiary and upon completion of the
exchange, the holders of HDSI common stock and debt would hold a majority
interest in us . This exchange was completed on May 25, 2004. The accounting for
the transaction is a recapitalization of HDSI, with HDSI treated as the
acquirer. The acquired assets and assumed liabilities, if any, of us are carried
forward at their historical values. HDSI's historical financial statements are
carried forward as those of the combined entity. HDSI is engaged in the
manufacture, marketing, selling and distribution of an aqueous polymer-based
radiation ionized gel, commonly referred to as a "hydrogel", which is used in
various medical and cosmetic consumer products.
As part of this transaction, we transferred all of our wholly owned
subsidiaries, including NAC, 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 of
us. The transferee assumed all liabilities and obligations with respect to 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. In support of the value of the common stock
delivered, we agreed that the transferee, at its election, may demand we
repurchase from the transferee up to 2,400,000 of the common shares upon written
notice from the transferee 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.
13
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 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 Preferred Stock for, among others,
equity and debt. Upon filing of a Certificate of Amendment to the Certificate of
Incorporation to increase the number of shares of common stock which we are
authorized to issue, each share of the Series B Preferred Stock will be
automatically converted into shares of our common stock.
Our condensed consolidated financial statements reflect the historical
results of the predecessor entity, HDSI, prior to May 25, 2004 and our
consolidated results of operations subsequent to the acquisition date of May 25,
2004.
Our Operations
Through HDSI, our majority owned subsidiary, we develop, manufacture and
market electron beam cross-linked aqueous polymer sheet hydrogels, hereafter
referred to as "HDSI gels". A hydrogel is a polymer network (essentially
repeating structural units) having an affinity for water and other materials.
The HDSI gels we manufacture are designed to be highly compatible with skin, the
largest organ of the human body. HDSI's gels exhibit the following product
characteristics: painless adhesion to the human body; stability of form and
composition; purity; reproducibility, compatibility with active ingredients; and
high water content. HDSI gels have application in select fields of wound care,
medical diagnostics, transdermal drug delivery and cosmetics.
HDSI is exploiting its proprietary manufacturing technologies in the
development of high margin, specification sensitive transdermal applications,
for selected pharmaceutical and medical manufacturers.
Customers for HDSI product include manufactures of medical devices; wound
healing bandages; cosmetics and OTC consumer products. HDSI products are
primarily distributed by agreement with third party marketers. Unless otherwise
stated, references to our operations refer to the operations of HDSI and not to
environmental services business previous conducted by the Company.
Liquidity and Capital Resources
The following table sets forth our working capital (deficiency) position as
at October 31, 2004:
As at October 31,
2004
-----------------
Current assets $ 805,819
Current liabilities 1,223,027
Working capital (deficiency) $ (417,208)
===========
Our cash at October 31, 2004 increased to $514,000 as compared to $15,000
in the prior fiscal period. This increase is primarily attributable to the
additional net cash provided by the issuance of convertible debentures in the
current fiscal period
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Net cash used in operating activities in the six months ended October 31,
2004 was $1,231,000 as compared with $54,000 in the prior fiscal period ended
October 31, 2003. The net cash used in operations in the six months ended
October 31, 2004 was used to fund current operations and pay down accounts
payable and amounts due to affiliates. In the six months ended October 31, 2003,
cash provided by customer deposits was used to fund the operations. Net cash
provided by investing activities in the six months ended October 31, 2004 was
$82,000 as compared with $2,000 in the six months ended October 31, 2003. The
net cash provided by investing activities was due to the cash received from
Nesco at the closing of the share exchange, net of closing costs. Nesco had
previously advanced HDSI $208,000 in the prior fiscal year. The net cash
provided by financing activities in the six months ended October 31, 2004 was
$1,661,000 as compared with $23,000 in the six months ended October 31, 2003.
The net cash provided by financing activities was primarily provided by the
issuance of convertible debentures.
On July 1, 2004, we entered into an investment banking agreement with Sloan
Securities Corp. for the sale of up to $3,000,000 principal amount of our 8%
senior 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 $.15 per share. Each note was issued with a five-year warrant to
purchase shares of our common stock at $.25 per share or 666,667 warrants for
each $100,000 of principal amount of notes purchased. As a result of the
agreement, which terminated on September 30, 2004, we received $2,295,000 in
gross proceeds and issued warrants to purchase 15,300,000 shares. Under the
terms of the private placement we have agreed to undertake to register the
common stock issuable upon the conversion of the notes and exercise of the
warrants. Approximately $1,108,000 of the proceeds as of October 31, 2004 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. These
amounts were recorded as a equity components. The remaining balance of $183,000
was recorded as long-term debt. For the six months ended October 31, 2004 the
amortization of debt discount was approximately $355,000. Interest expense for
the six months ended October 31, 2004 was approximately $43,000.
Financing fees in connection with this agreement approximated $286,000 at
October 31, 2004 which are being amortized over the term of the convertible
notes. For the six months ended October 31, 2004, the amortization of financing
costs approximated $52,000.
In connection with this agreement, we issued the broker, Sloan Securities
Corp., warrants to acquire 5,052,600 shares of our common stock at an exercise
price of $.15 per share. The fair value of the warrants ($405,000) will be
charged to operations over the life of the underlying debt. For the six months
ended October 31, 2004, approximately $96,000 was charged to operations as
financing costs for these warrants.
On August 23, 2004, we 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
our 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 can be drawn upon by us after the effectiveness of
this registration statement. As consideration for entering into this agreement,
we granted the investment firm 3,333.33 shares of Series B Preferred shares
(convertible into 2,500,000 common shares). The investment firm concurrently
received $70,000 cash consideration for consulting services.
At October 31, 2004, we had an accumulated deficit of approximately
$15,642,000, a working capital deficit of approximately $417,000 and incurred a
net loss of approximately $4,957,000 for the six months then ended. The
recoverability of a major portion of the recorded asset amounts shown in the
consolidated balance sheet is dependent on our ability to obtain financing on an
as needed basis. We completed an acquisition as mentioned above. In addition, we
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anticipate having additional financing available as described above, upon
completion of the filing of this registration statement with the SEC. However,
our financial condition raises substantial doubt about our 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 we be unable to continue in existence.
We intend to focus our efforts in the next twelve months on building the
business of HDSI which we believe will be possible as a result of the additional
financing as described above. We believe this will enable us to expand our
current operations, develop new products, explore new markets and increase our
current sales force to achieve theses objectives.
Results of Operations
For the six months ended October 31, 2004
Revenues for the six months ended October 31, 2004 decreased from $397,000
for the six months ended October 31, 2003 to $332,000 in the current period.
This decrease of $65,000 is due to the revenue derived primarily from two
customers in the prior period which aggregated $212,000 that did not place any
orders in the current period. This was offset by revenue of approximately
$169,000 derived from a different customer developing a new product in the
current period. Cost of revenues for the six months ended October 31, 2004
decreased by $26,000 from $447,000 to $421,000. Cost of revenues consists
primarily of direct labor and other manufacturing fixed costs. The decrease
relates to material costs which are attributable to the decreased revenue.
General and administrative expenses for the six months ended October 31,
2004 increased to $657,000 from $344,000 for the six months ended October 2003.
This increase of $313,000 is primarily due to ongoing consulting fees and
executive salaries from agreements entered into as a result of the exchange
agreement of approximately $125,000 and increased professional fees as a result
of increased reporting requirements and other services needed as a result of the
exchange agreement of approximately $187,000.
The net loss for the six months ended October 31, 2004 increased to
$4,957,000 from $733,000 for the six months ended October 2003. This increase of
$4,224,000 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
HDSI warrants which were exchanged for our 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 six months ended
October 31, 2004 also includes a non-cash debt discount charge of $901,000, an
increase of $742,000 from the six months ended October 31, 2003. This increase
is primarily due to a charge of $505,000 for the fair value of additional
warrants issued to the HDSI 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 HDSI term debt for our convertible debt at the time of the
merger and a charge of $355,000 for the intrinsic value of the beneficial
conversion feature as related to the issuance of convertible debentures and
warrants in connection with the investment banking agreement. The increase in
the net loss also includes a charge of $149,000 in the current period for
amortization of various financing costs. The rest of the increase is primarily
attributable to the increase in general and administrative expenses and decrease
in revenue as described above.
Revenues for the three months ended October 31, 2004 decreased from
$304,000 for the three months ended October 31, 2003 to $144,000 in the current
period. This decrease of $160,000 is due to the revenue derived primarily from
two customers in the prior period which aggregated $187,000 that did not place
16
any orders in the current period. Cost of revenues for the three months ended
October 31, 2004 decreased by $34,000 from $245,000 to $211,000. Cost of
revenues consists primarily of direct labor and other manufacturing fixed costs.
The decrease relates to material costs which are attributable to the decreased
revenue.
General and administrative expenses for the three months ended October 31,
2004 increased to $425,000 from $188,000 for the three months ended October
2003. This increase of $237,000 is primarily due to ongoing consulting fees and
executive salaries from agreements entered into as a result of the merger of
approximately $72,000 and increased professional fees as a result of increased
reporting requirements and other services needed as a result of the merger of
approximately $154,000.
The net loss for the three months ended October 31, 2004 increased to
$1,417,000 from $315,000 for the three months ended October 2003. This increase
of $1,102,000 includes a non-cash debt discount charge of $636,000, an increase
of $540,000 from the three months ended October 31, 2003. This increase is
primarily due to a charge of $292,000 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 convertible debt at the time of the merger and a charge
of $344,000 for the intrinsic value of the beneficial conversion feature as
related to the issuance of convertible debentures in connection with the
investment banking agreement. The increase in the net loss also includes a
charge of $117,000 in the current period for amortization of various financing
costs. The rest of the increase is primarily attributable to the increase in
general and administrative expenses and decrease in revenue as described above.
Fiscal years ended April 30, 2004 and 2003
Revenues for the year ended April 30, 2004 decreased by $508,000 to
$623,000, or 45% as compared with revenues of $1,131,000 for the prior fiscal
year. This decline is due primarily to revenue derived from one customer in the
prior period which aggregated $557,000 as compared to $57,000 in the current
period. This customer ceased production of the product for which HDSI was a
supplier in the year ended April 30, 2004 due to problems with production and
its parent Company. Cost of revenues for the year ended April 30, 2004 decreased
by $117,000 from $1,029,000 to $912,000 in the prior fiscal year. Cost of
revenues consists primarily of direct labor and other manufacturing fixed costs.
The decrease relates to material costs which are attributable to the decreased
revenue. Material costs generally range between 10-20% of revenue depending on
the type of gel related product.
General and administrative expenses for the year ended April 30, 2004
decreased to $662,000 from $1,057,000 for the prior fiscal year. This decrease
of $395,000 is primarily due to reduction of salaries and layoffs aggregating
approximately $295,000 inclusive of payroll taxes and benefits and reduction of
professional fees and other administrative costs as a result of the loss of a
major customer as described above.
The net loss for the year ended April 30, 2004 decreased to $1,499,000 from
$1,663,000 for the year ended April 30, 2003. The loss from operations remained
relatively the same as the decrease in revenues and corresponding decrease in
gross margin of approximately $390,000 was offset by the savings in general and
administrative expenses of $395,000. This decrease of $164,000 is primarily
attributable to the decrease in amortization of debt discount of $161,000 as
most of the debt was fully amortized in 2003 and was due in early fiscal 2004.
17
Fiscal years ended April 30, 2003 and 2002
Revenues for the year ended April 30, 2003 increased by $87,000 to
$1,131,000, or 8% as compared with revenues of $1,044,000 for the prior fiscal
year. This increase is due primarily to revenue derived from one customer in the
current period which aggregated $557,000 as compared to $202,000 in the prior
period. This customer increased production of the product for which HDSI was a
supplier in the year ended April 30, 2003. This increase was offset by a
decrease in revenue from another customer of $62,000 in the current period as
compared to $238,000 in the prior period as this customer has downsized its
operations. The remainder of the change in revenues is a result of the customer
mix changing as there were some new customers entering into development
contracts and some prior customers either reducing production or completing
developmental work for which no product was finalized. Cost of revenues for the
year ended April 30, 2003 increased by $41,000 to $1,029,000 from $988,000 in
the prior fiscal year. 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 and also to an increase in certain
fixed costs. Material costs generally range between 10-20% of revenue depending
on the type of gel related product.
General and administrative expenses for the year ended April 30, 2003
decreased to $1,057,000 from $1,339,000 for the prior fiscal year. This decrease
of $282,000 is primarily due to reduction of salaries aggregating approximately
$110,000 inclusive of payroll taxes and benefits and reduction of consulting
fees of approximately $150,000 due to the termination of a sales consultant
contract.
The net loss for the year ended April 30, 2003 decreased by $306,000 to
$1,663,000 from $1,969,000 for the year ended April 30, 2002. The loss from
operations decreased by approximately $322,000 as a result of the reduction of
general and administrative costs as described above of $282,000 and the increase
in gross margin of $46,000 due to increased revenues as described above.
Critical Accounting Policies
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.
Stock Compensation
Stock options and warrants issued to non-employees are valued using the
fair value of the securities issued. This valuation is made using the
Black-Scholes option-pricing model.
The Company applies APB No. 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for its employee stock option plans
and, accordingly, no compensation cost has been recognized because all stock
options granted to employees under the plans were at exercise prices which were
equal or above the market value of the underlying stock at date of grant.
On December 16, 2004, the FASB issued Statement No. 123 (revised)
("Statement No. 123(R)"), Share-Based Payment, an Amendment of FASB Statements
No. 123 and APB No. 25, that addressed the accounting for share-based awards to
employees, including employee-stock-purchase plans, or ESPPs. Statement No.
123(R) requires companies to recognize the fair value of stock options and other
18
stock- based compensation to employees. The statement eliminates the ability to
account for share-based compensation transactions using APB Opinion No. 25,
Accounting for Stock Issued to Employees, and generally requires instead, that
such transactions be accounted for using a fair-value-based method. The
requirements of Statement No. 123(R) will be effective for the Company effective
February 1, 2006.
New Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 clarifies the application
of Accounting Research Bulletin 51, Consolidated Financial Statements, for
certain entities that do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns, or both. FIN 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. We are currently evaluating
the impact, if any, of FIN 46 on its financial position, results of operations
and cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 requires that certain financial instruments, which under previous
guidance were accounted for as equity, be accounted for as liabilities. The
financial instruments affected include mandatory redeemable stock, certain
financial instruments that require or may require the issuer to buy back some of
its shares in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003.
On December 16, 2004, the FASB issued Statement No. 123 (revised)
("Statement No. 123(R)"), Share-Based Payment, an Amendment of FASB Statements
No. 123 and APB No. 25, that addressed the accounting for share-based awards to
employees, including employee-stock-purchase plans, or ESPPs. Statement No.
123(R) requires companies to recognize the fair value of stock options and other
stock- based compensation to employees. The statement eliminates the ability to
account for share-based compensation transactions using APB Opinion No. 25,
Accounting for Stock Issued to Employees, and generally requires instead, that
such transactions be accounted for using a fair-value-based method. The
requirements of Statement No. 123(R) will be effective for the Company effective
February 1, 2006. Had this pronouncement been in effect as of May 1, 2003, the
Company's net losses for the year ended April 30, 2004 and the six months ended
October 31, 2004 would be increased by $-0- and $181,457, respectively.
19
DESCRIPTION OF BUSINESS
Background
Nesco Industries, Inc. was incorporated in Nevada in March 1993, and was
inactive for a number of years. In March 1998, Nesco acquired National Abatement
Corporation ("NAC") and NAC Environmental Services, Inc. ("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, NAC/Indoor Air Professionals, Inc.
("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.
On April 29, 2004, we entered into a share exchange agreement with Hydrogel
Design Systems, Inc. ("HDSI"), a Delaware privately held corporation, whereby
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. This exchange was completed on May 25, 2004. The accounting
for the 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. HDSI is engaged
in the manufacture, marketing, selling and distribution of an aqueous
polymer-based radiation ionized gel, commonly referred to as a "hydrogel", which
is used in various medical and cosmetic consumer products.
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 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 its newly designated Series B Preferred Stock for, among others,
equity and debt of HDSI and us. Upon filing of a Certificate of Amendment to the
Certificate of Incorporation to increase the number of shares of common stock
which we are authorized to issue, each share of our Series B Preferred Stock
will be automatically converted into shares of our common stock.
As part of this 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 of us. The
transferee assumed all liabilities and obligations with respect to 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. In support of the value of the common stock
delivered, we agreed that the transferee, at its election, may demand that we
repurchase from the transferee up to 2,400,000 of the common shares upon written
notice from the transferee if the transferee cannot in good faith resell the
20
shares of common stock in an arms-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.
In addition to the transfer of its subsidiaries, we were required to
convert our 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 our Series B Preferred Stock which will be converted 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. The holders of these
special warrants were granted shares in the exchange as part of the common
advisor shares issued. Our Series A Preferred shareholders also agreed, that
upon completion of the exchange agreement, they would convert their shares to
common stock and that we would have no further obligations in respect to these
preferred shares. In addition, we were 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 prior to April 30, 2004 and is
included in assets at April 30, 2004. This bridge loan became part of the
closing requirements in May 2004.
At the time of the transaction, HDSI common shareholders exchanged
3,240,593 shares of stock for 38,887 shares of our Series B Preferred Stock,
which will be converted into 29,165,250 shares of common stock (a ratio of
approximately 9 of our shares for 1 share of HDSI stock). The HDSI preferred
shareholders exchanged 295,853 shares of stock for 14,201 shares of our Series B
Preferred Stock, which will be converted into 10,650,750 shares of common stock
(a ratio of approximately 36 of our shares for 1 share of HDSI stock).
Approximately 94% of the common and 88% of the preferred shareholders have
exchanged their shares as of October 31, 2004 which has resulted in
approximately 51.1% of our voting securities outstanding at the time of the
exchange owned by HDSI stockholders. We anticipate that the remaining
shareholders will exchange their shares in the near future, which will result in
55.3% of our voting securities outstanding at the time of the exchange being
owned by HDSI stockholders. Upon completion of this exchange, HDSI common
shareholders will exchange a total of 4,452,806 shares of stock for 53,434
shares of our Series B Preferred Stock, which will be converted into 40,075,167
shares of common stock (a ratio of approximately 9 of our shares for 1 share of
HDSI stock). The HDSI preferred shareholders will exchange a total of 522,487
shares of stock for 25,079 shares of our Series B Preferred Stock which will be
converted into 18,809,574 shares of common stock (a ratio of approximately 36 of
our shares for 1 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 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.
Concurrent with the exchange, our Series A Preferred shareholders agreed to
exchange 512,500 shares of stock for an aggregate of 20,500 shares of our Series
B Preferred Stock, which will be converted into 15,375,000 shares of common
stock (a ratio of approximately 30 of our common shares for 1 share of Series A
preferred stock). As of October 31, 2004, 433,000 shares of Series A Preferred
shares have been exchanged for 17,320 shares of Series B Preferred shares. We
anticipate that the majority of the remaining Series A shareholders will
exchange their shares in the near future.
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 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
21
2,900,000 of these shares were issued to the parties who agreed to cancel their
special warrants. We also incurred additional costs related to the exchange
approximating $48,000. Approximately $328,000 of these 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 shares outstanding as of the exchange date.
In addition to the exchange of shares, all outstanding options/warrants of
HDSI were exchanged for our 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 HDSI options/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 2,736,000 warrants. 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.
Prior to the transaction, we had approximately 4,212,500 options and
warrants outstanding. After giving effect to the transactions above, we will
have approximately 31,483,000 options and warrants outstanding and debt
convertible into approximately 28,551,000 common shares as a result of the
exchange agreement.
As previously stated, in fiscal 2004, we did not conduct any business, but
actively sought new business opportunities, resulting in the consummation of the
share exchange agreement with HDSI.
Overview of Business of HDSI
HDSI was organized to develop, manufacture and market electron beam
cross-linked aqueous polymer sheet hydrogels, hereafter referred to as "gels".
One of two known manufacturers in the world, we specialize in custom gels
capitalizing on proprietary manufacturing technologies. These capabilities allow
us to manufacture gels which meet the rigid specifications of our customers, a
key requirement in gels used for delivery of active ingredients, a rapidly
growing component of the hydrogel industry.
Our 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 medications and non- prescription active ingredients;
-- cosmetic skin care; and
-- components in medical diagnostics.
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
22
the foreseeable future, all of our hydrogel products are electron beam
cross-linked, water and polymer hydrogels, a category in which we have a
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.
Many of the competitive products feature physical characteristics which are
less desirable than those of our gels. These include aggressive skin bonding,
chemical and form instability, lack of uniformity, low water content, and
actives receptivity issues. Some of these products do offer higher absorptive
and adherence characteristics than our gels.
Our hydrogels are manufactured using proprietary mixing, coating and
cross-linking technologies. Together, these proprietary technologies enable us
to produce gels 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. We believe that we have sufficient capacity in our 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 gel, we have the manufacturing technology to
offer broad choices in selection of gel 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.
Business Strategy
Although currently our primary sources of revenues are the development,
manufacture and sale of hydrogel-related products to the original equipment
manufacturer ("OEM") market and developers and distributors of skin care
preparations and other cosmetics as well as prescription and over-the-counter
medication, we have expanded our business to include the sales of finished
product on a private label and branded basis. This includes our branded wound
care products, AQUAMATRIX, which we plan to market to wound care providers and
other potential users. We plan to expand this business by:
-- Increasing the number of distributors who carry AQUAMATRIX
-- Identifying potential private label opportunities;
-- Incorporating active ingredients for wound healing into the gels as
product extensions; and
-- Expanding the AQUAMATRIX product line to include complimentary
products.
We also plan to enhance our core business through the following strategies:
23
Continued Focus on High Quality Custom Hydrogels for Transdermal Drug Delivery
and Topical Application of Cosmetics.
These products have high margins, may produce significant revenues which
would enable us to become a leader in development and manufacture of quality
hydrogel products for transdermal drug delivery and topical application of
cosmetics.
Diversifying our OEM Business.
We plan to expand our hydrogel component manufacturing businesses by:
-- Aggressively marketing our core competencies of developing gels to
customer specifications with a high degree of consistency of
properties and publicizing our core competencies through development
of an aggressive marketing program.
-- Capitalizing on the popularity of patches for consumption of topical
therapeutics, such as pain relief, headache, cosmetics, pore strippers
and moisturizers by
- forming strategic alliances with complementary suppliers, such as
topical application formulators and R&D laboratories specializing
in trans and intradermal technologies;
- aggressively marketing capabilities in this area to complementary
suppliers; and
- emphasizing HDSI's reputation for providing quality products.
Provide Value-Added Services to OEM Customers by:
-- Enhancing HDSI's converting capabilities and establish packaging
capability by investing in improvements to our converting
capabilities;
-- Dedicating resources to the development of OTC and cosmetic products
with short lead times from development to market;
-- Aggressively pursuing co-branding and other marketing opportunities
for finished products such as the sale of hydrogel patches containing
OTC drugs and cosmetic products to mass retailers, including drug and
variety store chains;
-- Aggressively pursuing opportunities to market OTC products to medical
professionals and skin care patches to them;
-- Forming strategic alliances with medical professionals and for the
development of co- branded products for these markets such as hydrogel
patches that reduce the side effects from laser treatments and skin
care masks; and
-- Attendance at trade shows.
24
Capitalizing on Market Developments.
Our plans for expansion into manufacture and distribution of hydrogel
patches as finished products for delivery of OTC therapeutics and topical wound
and skin care, are based on the growth in awareness of diverse applications for
patches among suppliers, retail distributors and consumers, as observed by
management.
Other benefits of diversification include:
-- Increased Gross & Net Revenues due to:
- Reduced dependency on R&D projects which have long lead times to
commercialization;
- Utilization of excess plant production capacity; and
- Addition of products with greater speed to market and higher
margins.
Enhancing Proprietary Protection
We intend to enhance our proprietary protection by pursuing trademarks for
cobranded products and considering patent protection for our proprietary
processes.
Products and Services
We manufacture and market electron-beam cross-linked sheet hydrogels and
hydrogel 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 nonprescription drugs, other
skin care treatments and cosmetics. We market our own brand of moist wound/burn
dressings under the AQUAMATRIX brand name, and are currently developing
additional line extensions of this product. In addition, our hydrogels are
prepared as components for products distributed by our customers under their
brand names. In addition to manufacturing hydrogel we offer our customers
converting services, allowing us to create competitive advantage in pricing
while expediting the production process.
Hydrogels and their Properties
Aqueous polymer hydrogels are created by mixing water and a smaller amount
of polymers (anywhere from 3% to 25%, dependant upon desired physical
characteristics) resulting in a highly viscous (thick and resistant to flow)
gel-like material, which is then exposed to an energy field in an electron beam
accelerator. Hydrogels, such as ours which are cross-linked, have a greater
degree of molecular integrity and by varying the key building blocks water,
polymer content and type, energy - can be crafted to specif1ied physical
characteristics to maximize product benefit. The following is a description of
some of the attributes of the gels we manufacture:
-- Higher Water Content. As compared to other gels in the market, our
hydrogels offer up to 98% water content which enables them to
capitalize on the "high specific heat", or ability to hold heat, of
25
water, which in turn creates a clinically documented environment which
diminishes skin inflammation, encourages healing to traumatized skin,
and provides pain relief. These gels also provide a protective
covering, in their sheet form. In addition, the high concentration of
water in these gels creates an environment of 100% humidity where they
are applied. This encourages rapid aqueous dilation of the stratum
corneum (the outer layer of the skin), making possible faster and
deeper penetration of active ingredients; and simultaneous
moisturizing of the skin.
-- Secure Adhesion Without Bonding to Skin or Hair. Through proprietary
manufacturing techniques controlling the level of cross-linking we can
create a wide range of adhesion - from none to very aggressive, but
never bonding the gel to the skin as do most competitive hydrocolloid
(chemical) gels and traditional adhesives. For most applications our
gels do not require a secondary adhesive and can be removed from the
application site without pulling the hair or skin. This feature makes
aqueous polymer electron beam gels particularly relevant to
applications to traumatized skin and in the cosmetic industry.
-- Precise Dosage Control. Our hydrogels have a high degree of
consistency in dosage of medical, therapeutic or cosmetic ingredients,
due to the high level of homogeneity resulting from proprietary mixing
processes and precise control of the cross-linking process.
-- Uniformity; Less Degradation. Our proprietary manufacturing processes,
in combination with the stability associated with high water content
hydrogels, allow for the manufacture of products which are easily
reproducible from production run to production run and have a multiple
year shelf-life.
-- Flexibility in Shape. Our hydrogels have great flexibility in shape
and draping characteristics which enable them to fit better to skin
providing comfort and reliability.
-- Fluid Absorption. Through the variation of the polymer levels, we can
design hydrogels with a broad range of absorption characteristics.
HDSI Manufacturing Process
Hydrogel is manufactured by introducing a polymer (solid) into water,
creating a feed mix. The feed mix is used to coat a web material (or scrim) and
two outer linings are applied creating sheets of hydrogel. These sheets are then
introduced to a high energy field which cross-links the polymers giving the
hydrogel greater molecular integrity and thereby creating sheets of hydrogel.
Active ingredients such as over-the counter (OTC) medication, and skin care,
wound healing or other materials can be added before or after cross-linking.
Materials that do not survive radiation are added after the cross-linking
process is completed. Once the hydrogels have been mixed and cross-linked, they
form sheets which can be delivered to customers or first cut and shaped
according to customer specifications. We believe that many of the processes
described above are proprietary to our processes and provide competitive
advantages.
26
Proprietary Technologies.
Proprietary Mixing. Our proprietary mixing technology utilizes a
methodology of forced hydration of polymers. We believe that we are able to
manufacture hydrogel feed mixes with far greater homogeneity than those of the
competition. This is critical especially as it relates to the dosing of active
ingredients. In addition, our proprietary mixing technology allows for the
incorporation of sensitive materials which may degrade if subjected to other
types of mixing.
Proprietary Coating. Our proprietary coating technology enables us to
handle the gels properly even though they are extremely viscous (thick and
resistant to flow). We have achieved coating tolerances which have allowed it to
coat materials as thin as 0.005 inches with a margin for error of typically less
than 5%. Thickness controls are critical with respect to the performance of many
of the end products utilizing our hydrogels including medical electrodes,
transdermal delivery patches and cosmetic patches. We have also developed
coating methodology which minimizes imperfections such as wrinkling in the end
product by significantly reducing line tension. This proprietary know-how allows
us to manufacture high quality, consistent product which meet the exacting
standards of our customers.
Proprietary Cross-linking Technology. We cross-link our hydrogels using an
electron beam accelerator. Electron beam cross-linking is achieved through the
introduction of the high energy field, created by the accelerated electrons,
which causes the release of hydrogen atoms thereby causing carbon molecule
covalent bonding. The creation of longer chains of the polymer in the gel
increases its molecular integrity, giving the gel characteristics which make it
useful in a variety of products.
Our electron-beam cross-linking process is one of three types of
cross-linking used in the industry. The other types used are ultra violent
cross-linking and chemical cross-linking. The benefits of electron beam
cross-linking include:
-- precise control of the amount of polymer cross-linking; other types
allow for the continuation of cross-linking over a period of time;
-- no need for chemical cross-linking agents which may complicate or
interfere with other additives or active ingredients; and
-- the ability to manufacture high quality hydrogels on a consistent
basis.
The physical characteristics can be further modified by varying the percent
of polymer cross- linking and the way in which the high energy field is
delivered. There are three variables in the use of an electron beam accelerator
for cross-linking of hydrogels:
-- time of exposure of the target material to the electron stream;
-- voltage (electrical potential); and
-- amperage (strength of the electrical current)
We believe that our methods of managing these three variables make it
possible to produce high quality gels matching customer specifications as to a
wide range of characteristics. These methods are proprietary to us.
27
Applications for Hydrogel Patches
Hydrogel patches are now being marketed in the United States or abroad for
many different applications:
Moist Wound and Burn Dressings. Dressings made from hydrogels have long
been used for the treatment of wounds and burns. The benefits of moist wound
healing versus traditional dressings include immediate anti-inflammatory
effects, keeping the wound bed moist allowing for the freer cell flow and less
scarring, and accelerated healing. The current market for moist wound healing
dressings is estimated to be in excess of $2 billion worldwide and growing at
10% per annum. In addition, "active wound healing" dressings, those with
ingredients which further provide healing benefits, are estimated to generate
global sales of over $700 million with annual growth of over 20%.
Hydrogels as A Method of Drug Delivery. Hydrogel patches are a relatively
new method of delivering medication that has important advantages over other
more traditional methods of drug delivery. As a system of drug delivery,
hydrogel patches are less intrusive, painless, can medicate for preplanned time
periods, provides the potential for a release of medication more consistent with
the body?s own glandular activity, thereby avoiding dosage spikes and, or,
digestive alteration, and minimizes side effects apparent in more traditional
delivery methodologies of injection or ingestion. The more traditional methods
and their drawbacks are:
-- Ingestion/Oral Delivery. Dosage spikes upon ingestion and declines
over time until the next dosage is ingested. In addition, consumers do
not always remember to take all medication or at the proper intervals.
Dosages vary from consumer to consumer according to differences in
absorption and circulation.
-- Injection. Injections are painful, intrusive and inconvenient and are
subject to dosage spiking.
-- Inhalation. Delivery through inhalation is also subject to dosage
spiking and variation in dosage due to differences in consumer habits.
-- Topical Application without Patches. This form of topical application
is subject to evaporation incidental application and consumer failure
to apply at prescribed intervals.
Other Medical and Applications. Hydrogel patches are being used for
transdermal applications:
-- Hormone replacement therapy and contraception
-- Treatment of acne, shingles, diabetes and motion sickness
-- Treatment of angina with nitroglycerin
-- Treatment of smoking addiction using nicotine
-- Palliatives, i.e., pain relievers, such as lidocaine
Non-Prescription Therapeutic Applications. Hydrogel patches are used in the
medical community, and also directly marketed to consumers for the following
uses:
28
-- Topical application of OTC drugs such as:
- non-prescription acne treatments
- pain relievers, and
- diet preparations
-- Cough suppressants
-- Treatment of warts, calluses and corns
-- Pain relief
Cosmetic Applications. Hydrogel patches are being used to deliver
cosmetics, such as skin care products to consumers and skin care providers for
uses that include:
-- Moisturizers
-- Face masks
-- Anti-aging patches
Customers and Markets for Hydrogel
Moist Wound Healing. We market products under our proprietary brand
AQUAMATRIX as well as supplying hydrogel products to developers and distributors
of prescription and OTC moist wound healing products for redistribution to
healthcare professionals and retailers. The benefits of moist wound healing
products include reduced scarring and pain and greater speed of healing. We
expect the markets for our moist wound healing products to continue to expand
due to the growing recognition by professionals and consumers of the benefits of
moist wound healing.
We recently signed a distribution agreement with a distributor in the home
health care market and are in discussion with several other distributors for a
variety of wound and burn dressings.
Medical Device Manufacturers. We have targeted the high quality, medical
device manufacturers, e.g. monitoring electrodes and devices, defibrillator
pads, as another potential segment of our revenue stream. Using our in-house
staff and outside consultants, we will allocate resources for R & D development.
Transdermal Delivery of Prescription Drugs and OTC Treatments. We actively
participate in new applications for two types of transdermal delivery:
-- Through patches which adhere to the skin and are impregnated with
active ingredients; and
-- Through iontophoresis, which drives the active ingredients through the
skin by use of controlled electrical currents. Iontophoresis allows
for greater control over the delivery of active ingredients.
29
Cosmetics and Other Consumer Products. We manufacture hydrogels and
hydrogel patches for cosmetics companies. These products include OTC skin care
preparations and other products for cosmetic use.
Direct Retailing. We are exploring various opportunities for the
manufacture and distribution of OTC therapeutic, skin care and cosmetic products
using hydrogel through such retailers as chain drug, food and mass merchandise
stores under co-branding arrangements.
Competition
The opportunity for aqueous polymer hydrogels is significant and we believe
our proprietary competitive manufacturing advantages, along with the high
barrier to entry (the substantial cost of acquiring an electron beam as compared
to other cross-linking devices and the cost and extended time required for
installing this beam) and current minimal level of competition for high
performance gels, gives us the opportunity to be a leader in the outlined focus
application categories. These barriers are enhanced by our proprietary mixing,
coating and radiation technologies. We believe these processes remain effective
barriers to entry, although many of our competitor and customers have the
financial resources to establish competitive manufacturing facilities. See Risk
Factors, page 9).
Awareness of our product, low cost, speed to market, and manufacturing
techniques, are going to be achieved through a combination of consumer product
entries, expansion within current OEM base, and institutional reach programs,
e.g. trade magazines, trade shows, senior management connection and contacts.
Protection of Intellectual Property and Proprietary Technology
We currently rely on barriers to entry related to our electron beam and
confidentiality agreements with customers, suppliers and employees to protect
our trade secrets, including our proprietary coating, mixing and radiation
technologies. We cannot provide assurance that such barriers will not be broken
by any of the many competitors with greater financial resources than we have.
Also, we can give no assurance that our confidentiality agreements will not be
breached.
We believe that our activities do not violate the proprietary rights of
third parties and that these proprietary technologies may be eligible for patent
protection, but no assurance can be given that patent applications made by us in
the future, if any, would be granted by the United States or any other country.
There can be no assurance that any patents, if granted, would provide
competitive advantages or would not be challenged, circumvented or rendered
obsolete by our competitors.
Employees
As of December 31, 2004, we had 11 full time employees, including 6
involved in manufacturing and quality control, 5 in finance, administration and
marketing. We also have retained the services of several consultants to assist
in our operations. We believe we have good relations with our employees and have
never incurred a significant work stoppage due to any strike or protest by our
employees.
30
Properties
On October 1, 1998, we entered into a ten-year lease through September 30,
2008 for rental of office facilities. The lease provides for annual rent of
$178,710 and escalations for scheduled rent increases and for our proportionate
share of increases in real estate taxes and maintenance costs. On March 4, 2000,
we entered into a sublease agreement for the October 1998 lease with a company
in which one of our major stockholders is a stockholder. The sublease expires on
September 30, 2008. The sublease rent is being paid directly to the landlord by
the sublease tenant.
HDSI entered into a seven-year sub-lease agreement for a manufacturing
facility in Langhorne, PA with an affiliated entity, effective February 14,
1997, which provided for minimum monthly rental payments of $9,625 and expired
in 2004. On January 25, 2002, this manufacturing facility was purchased by an
entity owned by a related party of HDSI and HDSI entered into a lease with the
related party, 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 to the related party, 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.
On December 1, 2001, HDSI, along with other co-tenants, entered into a
month-to-month lease for office space at 305 Madison Avenue, New York, NY with
an entity owned by a related party, which provided for a monthly lease payment
of $3,735. This lease payment was reduced to $2,500 per month effective November
1, 2003 due to reallocation of the space with other tenants.
We believe our offices and other facilities are adequate for our current
needs.
Legal Proceedings
We are not currently involved in any material legal proceedings.
The NAC entities 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 the Exchange Agreement, between Nesco
and NAC Calabria Acquisition Corporation, NAC Calabria Acquisition Corporation
became responsible for all liabilities of our previous business conducted by the
NAC Entities. In consideration for the indemnity, the transferee received
3,000,000 shares of our common stock and certain related registration rights. In
support of the value of the common stock delivered, we agreed that the
transferee, at its election, may demand we repurchase from the transferee up to
2,400,000 of the common shares upon written notice from the transferee 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.
31
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Since April 1998, our common stock, par value $0.001 ("Common Stock"), has
been quoted on the Electronic Bulletin Board operated by the National
Association of Securities Dealers (OTCBB: NESK) . For the period between January
2000 and March 2002, our Common Stock was quoted on an inter-dealer quotation
system published by the Pink Sheets LLC.
The following table sets forth the high and low closing bid prices per
fiscal quarter quoted for our Common Stock in the last two fiscal years and most
recent quarters;
Closing Bid
High Low
---- ---
Year ended 4/30/2005
--------------------
First Quarter (ended 7/31/04) $0.25 $0.15
Second Quarter (ended 10/31/04) $0.30 $0.17
Third quarter (through 1/26/05) $0.33 $0.15
Year ended 4/30/2004
--------------------
First Quarter (ended 7/31/03) $ 0.12 $ 0.10
Second Quarter (ended 10/31/03) $ 0.45 $ 0.45
Third Quarter (ended 1/31/04) $ 0.45 $ 0.05
Fourth Quarter (ended 4/30/04) $ 0.35 $ 0.10
Year ended 4/30/2003
--------------------
First Quarter (ended 7/31/02) $0.75 $0.30
Second Quarter (ended 10/31/02) $0.25 $0.10
Third Quarter (ended 1/31/03) $0.12 $0.10
Fourth Quarter (ended 4/30/03) $0.12 $0.10
The above quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions. Actual
trading in our shares has been very sporadic.
Holders
As of January 26, 2005, there were 90 record holders of our common stock.
32
Dividends
We have never declared or paid any cash dividends on our common stock. We
currently anticipate that future earnings will be retained to support our
business. Accordingly, we do not anticipate paying cash dividends on our common
stock in the foreseeable future.
Equity Compensation Plan Information
We maintain various stock plans under which options vest and shares are
awarded at the discretion of our board of directors or its compensation
committee. The purchase price of the shares under the plans and the shares
subject to each option granted is not less than the fair market value on the
date of grant. The term of each option is generally five to ten years and is
determined at the time of grant by our board of directors or its compensation
committee. The participants in these plans are officers, directors, employees
and consultants of the company and its subsidiaries or affiliates. The following
table summarizes our equity compensation plans as of December 31, 2004.
- ------------------------------ ---------------------------- --------------------------- ----------------------------
(a) (b) (c)
- ------------------------------ ---------------------------- --------------------------- ----------------------------
- ------------------------------ ---------------------------- --------------------------- ----------------------------
Plan category Number of Weighted- Number of securities
Securities to be average exercise remaining available for
issued upon price of future issuance under
exercise of outstanding outstanding equity compensation
options, warrants options, warrants plans (excluding
and rights and rights securities reflected in
column (a))
- ------------------------------ ---------------------------- --------------------------- ----------------------------
- ------------------------------ ---------------------------- --------------------------- ----------------------------
Equity
compensation -- -- 1,000,000
plans approved
by security
holders
- ------------------------------ ---------------------------- --------------------------- ----------------------------
- ------------------------------ ---------------------------- --------------------------- ----------------------------
Equity
compensation 3,460,000 $0.05 --
plans not
approved by
security holders
- ------------------------------ ---------------------------- --------------------------- ----------------------------
- ------------------------------ ---------------------------- --------------------------- ----------------------------
Total 3,460,000 $0.05 1,000,000
- ------------------------------ ---------------------------- --------------------------- ----------------------------
33
BENEFICIAL OWNERSHIP
On January 26, 2005 our authorized voting stock consisted of 25,000,000
shares of common stock, par value $0.001, 850,000 shares of Series A preferred
stock and 150,000 shares of Series B preferred stock. Each share of common stock
is entitled to one vote; each share of Series A Stock is entitled to 30 votes
and each share of Series B Stock is entitled to 750 votes. On January 26, 2005
there were 19,517,410 shares of common stock, 67,000 shares of Series A Stock
and 115,006.84 shares of Series B Stock issued, outstanding and entitled to
vote. For this purpose, each outstanding share of Series A 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. We are in the process of increasing our authorized shares of
common stock to 400,000,000 shares in which event Series A and Series B stock
will be exchanged for common stock.
The following table sets forth the beneficial ownership as of January 26,
2005 with respect to the beneficial ownership of our common stock by officer and
directors, individually and as a group, and all holders of more than 5% of the
common stock. 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.
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, NY 10165 (2) 19,741,667 18.10%
Matthew Harriton
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, NY 10165 (3) 4,479,597 4.07%
Cornell Capital Partners L.P.
101 Hudson Street
Jersey City, New Jersey 07302 (4) 7,269,334 6.46%
Karen Nazzareno
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, NY 10165 180,000 *
Richard Selinfreund
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, New York 10165 -0- *
Geoffrey Donaldson
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, New York 10165 (5) 1,038,615 *
34
Gene E. Burelson
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, New York 10165 -0- *
Wayne M. Celia
c/o Nesco Industries, Inc.
305 Madison Avenue -0- *
New York, New York 10165
Joel S. Kanter
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, New York 10165 -0- *
Arlen Reynolds
c/o Nesco Industries, Inc.
305 Madison Avenue
New York, New York 10165 -0- *
Richard Harriton
305 Madison Avenue, Suite 4510
New York, NY 10165 (6) 12,144,007 10.15%
KSH Strategic Investments
575 Jericho Turnpike
Jericho, NY 11753 (7) 6,416,500 5.82%
Directors and Officers
as a Group (8 persons) 5,698,212 5.12%
<FN>
* 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) 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 Stock, Series B
Stock, warrants and vested options.
(2) Mr. Petrocelli was the Chairman and a director until June 22, 2004. The
above number of shares beneficially owned includes 2,900,000 shares owned
of record 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.
35
(3) Mr. Matthew Harriton is our President, Chief Executive Officer and a
director. Prior to the share exchange agreement with HDSI and currently,
Mr. Harriton remains as CEO and a director of HDSI. Mr. Harriton is also
CEO of Embryo Development Corp., a public company traded under the symbol
"EMBR" which holds a 4.49% beneficial interest in us. The above number of
shares beneficially owned does not include 2,430,647 shares issuable upon
the conversion of debt. It does include 364,597 shares issuable upon
exercise of a warrant granted for the extension of debt, and 2,000,000
shares 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. The
remaining 3,000,000 shares are not exercisable until a minimum of one year
after the closing date of the share exchange agreement.
(4) The above number of shares beneficially owned by Cornell Capital does not
include 4,666,669 shares issuable upon the conversion of a debenture. It
does include 4,666,669 shares issuable upon the exercise of warrants
granted in conjunction with a convertible debenture.
(5) Mr. Donaldson, a director, is also a director and the Chief Operating
Officer of Hydrogel Design Systems, Inc., our majority owned subsidiary.
The above number of shares beneficially owned does not include 2,924,100
shares issuable upon the conversion of debt. It does include 438,615 shares
issuable upon exercise of a warrant granted for the extension of debt, and
600,000 shares issuable upon exercise of a warrant granted as part of Mr.
Donaldson's employment agreement with Hydrogel Design Systems, Inc. in
January 2000 which has been converted to a warrant.
(6) The above number of shares beneficially owned by Mr. Richard Harriton does
not include 15,696,000 shares issuable upon the conversion of debentures.
It does include 11,874,007 shares issuable upon the exercise of warrants
granted in conjunction with convertible debentures and for the extensions
of debenture debt of Hydrogel Design Systems, Inc. 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).
(7) The above number of shares beneficially owned by KSH Strategic Investment
Fund does not include 3,900,000 shares issuable upon the conversion of a
debenture. It does include 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 Hydrogel Design Systems, Inc. Both the
convertible debenture and the related warrants have been converted to our
debt and warrants.
</FN>
36
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Relationships and related transactions prior to the HDSI exchange agreement.
In fiscal 2004 and 2003, we paid PEC Realty Corp., a company controlled by
our former Chairman Santo Petrocelli, Sr., rents totaling $2,108 and $79,729,
respectively.
On April 1, 2002,we issued interest-free, unsecured promissory notes in
favor of Mr. Petrocelli, Petrocelli Industries, Inc., a private company
controlled by Mr. Petrocelli and then Chief Financial Officer Lawrence S. Polan
in the aggregate amount of $1,032,501 in exchange for and in full satisfaction
of all outstanding balances due on demand loans, management fees, and consulting
fees. In fiscal 2004, we began to impute interest on the stockholder loans at 6%
per annum with an equivalent offset to additional paid in capital. Repayment on
the stockholder loans was scheduled to commence in February and May 2003,
however, the lenders agreed to defer the commencement dates indefinitely. We
made sporadic payments on stockholder loans totaling $80,000 in the year ended
April 30, 2004. At April 30, 2004, the stockholder loans totaled $952,501. Upon
the completion of the transaction with HDSI on May 25, 2004, the stockholder
loans were exchanged for an equity interest in the Company in the aggregate of
15,000,000 common shares. Accordingly, such liabilities have been classified as
long-term at April 30, 2004.
During the fiscal year ended April 30, 2004, we issued 500,000 warrants to
Jeffrey Powell, former President and CEO, 275,000 warrants to Petrocelli
Industries, Inc., a private company controlled by Mr. Petrocelli, and 285,000
warrants to Richard Cohen, a former officer, all such warrants immediately
exercisable at a price of $.05 per share. During the fiscal year ended April 30,
2003, we issued 500,000 fully vested warrants to then interim President and
Principal Executive Officer Michael Caputo, exercisable at a price of $0.55 per
share. Such issuances were free-standing grants, outside of the 1999 plan. The
fair value per warrant was estimated at approximately $0.35 and $0.07 for the
fiscal years ended April 30, 2004 and 2003, respectively. This transaction
resulted in a charge to operations of $370,295 in the fiscal year ended April
30, 2004.
In December 2003, the exercise price for previously issued warrants to
purchase 3,440,000 shares of common stock, of which 3,400,000 were granted to
officers, employees and consultants, was repriced from $.55 to $.05 per share.
These warrants were issued to the parties as described under Item. 10, Report on
Repricing for an aggregate of 2,500,000 shares and to former Chief Financial
Officer Lawrence S. Polan in the aggregate of 900,000 warrants. The fair value
per warrant was estimated at approximately $0.35 on the date of the repricing.
This transaction resulted in a charge to operations of $1,193,665 in the current
year.
In March 2004, Mr. Ronald Kuzon, an interim officer and consultant and
officer exercised 1,000,000 warrants for $.05 in a cashless exercise. An
aggregate of 857,142 shares were received as the excess of the fair value $(.35)
of the stock purchased over the exercise price was used to pay for the shares in
the aggregate of 142,858 shares. The cashless exercise of these warrants in
March, 2004 subsequently resulted in the issuance of 857,412 common shares. Such
shares were issued as free-trading without restrictive legend under Rule 144K of
the Securities Act of 1933 pursuant to an opinion provided by counsel, based in
part on representations made that the purchaser had not been our affiliate for
the preceding three months.
On April 29, 2004, we entered into a share exchange agreement with HDSI,
whereby HDSI would become a majority-owned subsidiary and upon completion of the
share exchange agreement, the holders of HDSI common stock and debt would hold a
majority interest of Nesco. This exchange was completed on May 25, 2004. On
January 12, 2004, we entered into an agreement to make term loans of up to
$125,000 to HDSI, which was subsequently increased prior to the closing. The
37
term loans were to mature January 1, 2005 and bear interest at 8% per annum if
the closing did not take place. If we did not enter into an agreement with HDSI
stockholders to purchase a minimum of 50.1 % and up to all of the capital stock
of HDSI in exchange for our securities by July 1, 2004, or failed to purchase
such securities by July 1, 2004, at election we could convert the term loans
into HDSI Series B Convertible Preferred Stock or accelerate the maturity of the
term loan to August 1, 2004.We advanced an aggregate of $208,500 to HDSI as of
April 30, 2004. On May 25, 2004, the exchange was completed and the outstanding
amount of the term loan was included as part of the minimum cash requirement as
per the agreement to be provided to HDSI.
As part of this transaction, we transferred our wholly owned subsidiaries
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 with respect to 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. In support of the value of the common stock delivered, we
agreed that the transferee, at its election, may demand we repurchase from the
transferee up to 2,400,000 of the common shares upon written notice from the
transferee 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.
In connection with the share exchange agreement, we also issued an
aggregate of 6,500,000 common shares to an advisor, a limited liability
corporation owned by an affiliate of Ronald Kuzon 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.
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 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.
Relationships and related transactions related to the operations of HDSI prior
to and as a result of the exchange agreement.
In the prior two fiscal years, HDSI 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 $69,000 at April 30, 2003, and $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 exchange agreement and currently holds approximately
4.49% of the common stock of Nesco as a result of the exchange.
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 CEO and President of HDSI and currently the CEO and President
of HDSI and Nesco (subsequent to the exchange agreement). In addition, Mr. R.
Harriton has a beneficial ownership of approximately 10.15% upon conversion of
38
all outstanding warrants issued to him in Nesco and holds debt in the amount of
$1,308,000 convertible to 15,696,000 shares of Nesco common stock as a result of
the exchange agreement. On January 25, 2002, HDSI entered into a lease with 2150
Cabot, LLC, and 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 $229,000 and $69,000 were due to
Mr. R. Harriton on these leases as of April 30, 2004 and April 30, 2003,
respectively.
On September 30, 2002, HDSI issued a promissory note in the aggregate of
$550,000, which consolidated all balances due under prior notes, to Mr. Richard
Harriton. The note was to bear interest at the same rates as the original notes
and was due on December 31, 2002. In addition, he was granted warrants to
purchase 17,500 shares of the Company's Series B Preferred stock at an exercise
price of $3.00 per share for a period of ten (10) years. On December 24, 2002,
Mr. R. Harriton loaned the Company an additional $160,000. On December 31, 2002
all of the above outstanding debt due to him was consolidated into one
convertible debenture in the amount of $710,000. The 8% debenture was due on
April 30, 2003. The debenture was convertible to Series B Preferred stock at a
price of $3.00 per share. He was also granted warrants to purchase Series B
Preferred Stock in an amount equal to 50% of the debenture amount ($355,000) at
$3.00 per share or 118,333 shares, which expire on April 30, 2012.
On June 21, 2002, we issued a series of convertible debentures in the
aggregate of $500,000 of which $200,000 were issued to Mr. R. Harriton. The 8 %
debentures were due on April 30, 2003. Each debenture was convertible to Series
B Preferred Stock at a price of $3.00 per share. He was also granted warrants to
purchase Series B Preferred Stock in an amount equal to 50% of the debenture
amount ($100,000) or 33,333 shares at an exercise price of $3.00 per share,
which expire on April 30, 2012.
On May 1, 2003, Mr. R. Harriton agreed to extend the due date for the above
two debentures in the aggregate of $910,000 to October 31, 2003. In
consideration for the extension, the party was granted warrants to purchase
Series B Preferred Stock in an amount equal in shares of 5% of the debenture
amount (45,500 shares) at an exercise price of $3.00 per share, which expire on
April 30, 2012.
On March 7, 2003, Mr. R. Harriton loaned HDSI an additional $200,000 under
the terms of a convertible debenture. The 8% debenture was due on October 31,
2003. The debenture was convertible to Series B Preferred stock at a price of
$3.00 per share. He was also granted warrants to purchase Series B Preferred
Stock in an amount equal to 50% of the debenture amount ($100,000) at $3.00 per
share or 33,333 shares, which expire on April 30, 2012.
On August 7, 2003, Mr. R. Harriton loaned HDSI an additional $198,000 under
the terms of a convertible debenture. The 8% debenture due on October 31, 2003.
The debenture was convertible to Series B Preferred stock at a price of $3.00
per share. He was also granted warrants to purchase Series B Preferred Stock in
an amount equal to 50% of the debenture amount ($99,000) at $3.00 per share or
33,000 shares, which expire on April 30, 2012.
On April 19, 2004, Mr. R. Harriton agreed to exchange the debentures and
related warrants for Nesco debentures and warrants and to extend the due dates
of the four outstanding debentures in the aggregate of $1,308,000 and accrued
interest in the amount of $135,000 until December 31, 2005 upon the closing of
39
the exchange agreement. This transaction was completed on May 25, 2004. Mr. R.
Harriton was also granted approximately 1,308,000 warrants in connection with
this conversion. As a result of the exchange agreement, Mr. R. Harriton
currently holds convertible debentures in the aggregate of $1,308,000
convertible into 15,696,000 shares of common stock and an aggregate of
11,874,007 warrants. These conversion amounts were based on the same ratios as
described in the exchange agreement.
At April 30, 2004 and 2003 we had notes payable, including interest, of
approximately $370,000 and $270,000 respectively, due to Mr. Matthew Harriton,
the President and CEO of HDSI. The notes were at an interest rate of 10% per
annum and collateralized by the accounts receivable of the Company. 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 $.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 approximately $365,000 due to Mr. M. Harriton on that date
was exchanged for convertible 8% debentures which mature in December 2005. Mr.
M. Harriton was also granted approximately 365,000 warrants in connection with
this conversion.
At April 30, 2004, HDSI owed Mr. Geoffrey Donaldson, the COO of HDSI
approximately $439,000 in accrued payroll. On May 25, 2004, this obligation due
to Mr. G. Donaldson was exchanged for a convertible 8% debenture which matures
in December 2005. Mr. Donaldson was also granted approximately 439,000 warrants
in connection with this conversion.
40
Disclosure of Commission Position of Indemnification for Securities Act
Liabilities.
Our Articles of Incorporation contain a provision permitted by the Nevada
General Corporation Law (the "NGCL") which eliminates the personal liability of
directors for monetary damages for breach of their fiduciary duty of care which
arises under state law. Although this does not change the directors' duty of
care, it limits legal remedies which are available for breach of that duty to
equitable remedies, such as an injunction or rescission. This provision has no
effect on directors' liability for: (1) breach of the directors' duty of
loyalty; (2) acts or omissions not in good faith or involving intentional
misconduct or known violations of law; and (3) approval of any transactions from
which the directors derive an improper personal benefit.
The NGCL empowers us to indemnify officers, directors, employees and others
from liability in certain circumstances such as where the person successfully
defended himself on the merits or acted in good faith in a manner reasonably
believed to be in the best interests of the corporation. Our Bylaws require
indemnification, to the fullest extent permitted by the NGCL, of any person who
is or was involved in any manner in any investigation, claim or other proceeding
by reason of the fact that such person is or was a director or officer of [the
Company], or of another corporation serving at management's request, against all
expenses and liability actually and reasonably incurred by such person in
connection with the investigation, claim or other proceeding.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers, and controlling persons of our pursuant
to the foregoing provisions or otherwise, we are advised that in the opinion of
the Securities and Exchange Commission, such indemnifications against public
policy as expressed in the Act and is, therefore, unenforceable.
SELLING SECURITY HOLDERS
The following table sets forth information concerning the resale of the
shares of common stock by the selling stockholders. We will not receive any
proceeds from the resale of the common stock by the selling stockholders. We
will receive proceeds from the exercise of warrants. Assuming all the shares
registered below are sold by the selling stockholders, none of the selling
stockholders will continue to own any shares of our common stock.
The following table sets forth the name of each person who is offering the
resale of shares of common stock by this prospectus, the number of shares of
common stock beneficially owned by each person, the number of shares of common
stock that may be sold in this offering and the number of shares of common stock
each person will own after the offering, assuming they sell all of the shares
they own. Unless otherwise indicated, each of the following persons has sole
voting and investment power with respect to the shares of common stock set forth
opposite their respective names.
Number of Shares Owned
---------------------------------
Selling Shareholder Before Offering After Offering
- ------------------- --------------- --------------
ABBE, COLEMAN TTEE OF THE NANCY ABBE TR 50,000 0
ABIOUNESS, ALFRED 900,000 0
ACREE, MARIAN 843,000 0
41
ALTMAN, LAWRENCE 450,000 0
ANDERSON, DIANA (2) 360,000 0
ARMEN, GARO (2) 1,125,000 0
ARMEN, PARTNERS 450,000 0
BARKER, DARIN (2) 2,232 0
BARTOSH, ROBIN & TOBY BARTOSH 900,000 0
BASS, THOMAS 180,000 0
BECKER, LILLIAN (1)(2) 273,808 0
BEECHWOOD VENTURES (1)(2) 1,379,409 0
BELZA DEVELOPMENT CORP PROFIT SHARE (1)(2) 1,377,630 0
BERGMAN, JOHN 75,000 0
BERGUM, RICHARD 240,000 0
BERKMAN, PAUL 663,000 0
BERLAND, SUE REVOCABLE LIVING TRUST 300,000 0
BERMAN, MYER (1)(2) 1,040,000 0
BEYCHOK, MARK (1)(2) 171,130 0
BOND, EDWARD 252,000 0
BRANDON TRUST (1)(2) 171,130 0
BRAVER, DAVID (1)(2) 1,040,000 0
BRODSKY TRUST, DAVID CRAIG 150,000 0
BRODSKY TRUST, JEFFERY HOLDEN 300,000 0
BRODSKY TRUST, JESSICA HEATHER 150,000 0
BRT PARTNERSHIP 1,427,364 0
BULMAN, WARREN 432,000 0
CAREY, JC (1)(2) 688,815 0
CARUSO, SALVATORE AND ROSARIO (1)(2) 206,200 0
CHICCA, LOUIS & MARIA (1)(2) 1,379,409 0
CHRISTOPHER BROTHERS (2) 2,232 0
CINQUEMANI, SALVATORE AND ANNA (1)(2) 412,400 0
CIPOLLONE, EMILIA AND DEANGELIS, MIRELLA (1)(2) 206,645 0
COHEN, ALAN 39,650 0
COHEN, BOB 1,125,000 0
COHEN, BRIAN (1)(2) 687,334 0
COHEN, MARK 108,000 0
CONNER, FRANK 40,000 0
CONSTANTINE, BARRY (2) 40,000 0
CORNELL CAPITAL (1)(2)(3) 42,122,667 0
CRANCH, EDMUND 180,000 0
CROWLEY, JOHN 186,210 0
CUNNNGHAM, FREDERICK 600,000 0
DEANGELIS, JOHN (1)(2) 344,408 0
DELUCA, LENORE (2) 36,000 0
DEVONSHIRE PARTNERS LLC 122,223 0
42
DICK, GEORGE 300,000 0
DIPAOLO, LORRAINE (1)(2) 1,040,000 0
DONALDSON, GEOFFREY (1)(2) 3,962,715 0
DRAX HOLDINGS, LP 2,495,393 0
EIGHTH DAY PRODUCTIONS 666,666 0
EMBRYO DEVELOPMENT CORP 4,837,500 0
ERB, JAMES 375,000 0
ETRA, RICHARD (1)(2) 275,364 0
FABRIKANT, ANDREW 810,000 0
FELDMAN, RICHARD 450,000 0
FISERV SECURITIES INC A/L/F HARVEY KOHN SEP IRA 135,000 0
FISHMAN, HOWARD (1)(2) 273,808 0
FORMAN, MURRAY 360,000 0
FRANBAR ASSOCIATES INC. 11,650 0
FRANK, MATTHEW 225,000 0
FREDRICKS, HENRY 750,000 0
FRIEDMAN, RICHARD 450,000 0
GAITANARIS, GEORGE 75,000 0
GAMBINO, CALOGERO & MARIA (1)(2) 206,645 0
GARDNER, JOEL 100,000 0
GERVIS, BERNARD 270,000 0
GERVIS, MITCH 225,000 0
GERZOFF, RICHARD 22,500 0
GIAMANCO, JOSEPH 750,000 0
GIANNETTI, VICKEY LANZERI (1)(2) 205,356 0
GIRARDS, ROBERT 300,000 0
GOLDENBAUM, CAROL 45,000 0
GOLEMBRE, EDWARD 600,000 0
GORDON, PETER 1,000 0
GORDON, ROBERT 300,000 0
GRAY, MICHAEL 67,500 0
GREENFIELD, ALEXA 45,000 0
GREENFIELD, HARVEY (1)(2) 1,570,000 0
GREENFIELD, JESSICA 45,000 0
GRGAS, TOMISAVLA (1)(2) 1,380,298 0
HALL, JACK (2) 450,000 0
HARRITON, ARLENE 90,000 0
HARRITON, MATTHEW (1)(2) 9,820,244 0
HARRITON, RICHARD (1)(2) 27,840,000 0
HARTO FAMILY PARTNERS 3,370,500 0
HATSOPOULOS, JOHN (2) 8,640 0
HAUSER, MARK 100,000 0
43
HERNANDEZ, ALEX 40,000 0
HOLDING COMPANY, THE 855,570 0
IAP INC. 364,963 0
INGRASIA, FRANK (1)(2) 688,815 0
JEF LTD PARTNERSHIP 2,141,379 0
JMK ASSOCIATES 1,000,000 0
JOHNSON, JAMES W 360,000 0
K&A TRUST 3,370,500 0
KAHN, RICHARD (2) 67,500 0
KAHN, RICHARD A IRA/SEP 138,750 0
KAHN, RICHARD AND ARLENE KAHN JWTROS 38,574 0
KAPLAN, EILEEN 225,000 0
KAPLAN, HELAINE 513,000 0
KAY, DEBRA ANN 50,003 0
KEATES, RICHARD 360,000 0
KIDS ASSOCIATES 600,000 0
KING, NORMAN 13,500 0
KOHN, HARVEY 180,000 0
KOHN, HELEN (2) 4,953,130 0
KOUSOULOU, CHRISTAKIS (1)(2) 206,645 0
KRASNOW, ELLIOT 49,995 0
KRASNOW, JOSHUA 49,995 0
KRASNOW, KIRA 49,995 0
KRASNOW, MAURICE 49,995 0
KRASNOW, ROSS 50,003 0
KREGAR, NICOLE (2) 36,000 0
KSH STRATEGIC INVESTMENT FUND (1)(2) 10,316,800 0
KUZON, ARIEL 250,000 0
KUZON, JOSHUA 250,000 0
LANSMAN, JEFF 50,003 0
LANSMAN, ROBIN 50,003 0
LANSMAN, SUSAN RODIN 50,003 0
LAWLER, TIMOTHY (1)(2) 1,374,667 0
LEFKOWITZ, STANLEY 186,210 0
LEHIGH UNIVERSITY 300,000 0
LPS CONSULTANTS INC. 566,666 0
LUCEY, JAMES (1)(2) 1,040,000 0
LW MARJAC LLC 509,976 0
MARK, JOHNATHAN 9,900 0
MARKOWITZ, JEFF 450,000 0
MARLIN FINANCIAL GROUP 681,668 0
MASON, LEWIS (2) 12,168 0
MATTHEWS, PAUL 735,000 0
44
MATTINA, GUISEPPE (1)(2) 206,912 0
MAY, BETH 10,000 0
McCLENON, JOHN R. 1,200,000 0
McGILLICUDDY, CLEM 1,200,000 0
McNABNEY, JOHN 450,000 0
MECOX BAY CONSULTANTS INC 666,667 0
MELISSARATOS, ARIS 585,000 0
MERIDOR, DAVID 387,000 0
MG LEWIS ED TRUST 90,000 0
MICHAELS, EVAN (1)(2) 688,815 0
MILGARD, JAMES 3,300,000 0
MILLENIUM CAPITAL CORP 16,640 0
MILLER, GARY (1)(2) 1,377,630 0
MILLER, MICHAEL 765,000 0
MJH TRUST 270,000 0
MOSTOFSKY, M (1)(2) 137,763 0
MUFFET, DAVID 240,000 0
NAC CALABRIA ACQUISITION CORP 2,700,000 0
NAFTOL, JEFFREY (1)(2) 343,667 0
NAGER, RICHARD 360,000 0
NASSERI, MORISE 150,000 0
NAZZARENO, KAREN 180,000 0
NEIL V. MOODY TRUST (1)(2) 1,026,741 0
NICHOLSON, DONALD (1)(2) 136,904 0
NORTHERN FINANCIAL ASSOCIATES 1,629,848 0
NOVAC, JEROLD 288,000 0
NYBOR GROUP 270,000 0
PETROCELLI INDUSTRIES INC. 2,900,000 0
PETROCELLI, SANTO 15,000,000 0
PETTERSON, DAVID S. 330,000 0
PMF 1,260,000 0
POST, AMY TEPLIN 180,000 0
ROBB, GREG 90,000 0
RONA, JEFFREY (2) 225,000 0
ROUSH, DAVID 306,000 0
RUBIN, ALAN T. (1)(2) 2,188,815 0
RUSSIN, LEONARD 375,000 0
SAFRAM, EDWARD 1,000,000 0
SALTZSTEIN, STEPHEN E (1)(2) 688,815 0
SAPPER, WAYNE (1)(2) 344,408 0
SCHARMAN, CARLTON 90,000 0
SCHARMAN, JULIAN 90,000 0
SCHOENFELD, JOEL 987,000 0
45
SCHREIBER, WARREN (FORMALLY SKYES.CORP) 900,000 0
SIEGEL, IRA (2) 204,000 0
SIMON, JOEL 38,573 0
SIMON, JOHNATHAN 51,428 0
SIMONYI, CHARLES 3,000,000 0
SLOAN SECURITIES (2) 5,052,600 0
SMFS CORP 566,667 0
SMITH, ROBIN 100,000 0
SOLOMON SCHECHTER SCHOOL OF WESTCHESTER 200,000 0
SPEDALE, MARYELLEN (2) 36,000 0
SPENCER, JOHNATHAN 155,250 0
SPIEGELMAN, HOWARD (2) 180,000 0
SPINELLO, REGINALD 540,000 0
STAR SPORTS PS PLAN 600,000 0
STEDNICK, TOM 45,000 0
STEEL, MORGAN 450,000 0
STEINBERG, ERIC (1)(2) 345,075 0
STEVENSON, ANTHONY PATRICK 136,800 0
STRATEGIC INITIATIVES CORPORATION (4) 646,155 0
SUCOFF, RONIT (2) 5,268,130 0
SUCOFF, SCOTT (2) 51,300 0
SULCIS, ANTONIO (1)(2) 2,760,594 0
SUNDERLAND, RON (1)(2) 520,000 0
SUNSET CONSULTING SOLUTIONS INC. 666,667 0
TAYLOR, TRUDE 600,000 0
TEMPLE ISRAEL CENTER 200,000 0
THE FALCONWOOD CORP 30,960 0
TOLL, ROBERT 19,800 0
TOMS, CAROLINE & NICHOLAS (1)(2) 689,703 0
TSAI, CYNTHIA 150,000 0
UNITED JEWISH APPEAL 150,000 0
VALKYRIE LEASING LLC 2,880,000 0
VICARIO, MICHAEL 45,000 0
VIGILAN INVESTMENT (1)(2) 1,026,741 0
WARSHAFSKY, JORDAN (2) 40,000 0
WATKINS, BRUCE 900,000 0
WATSON, GEORGE (1)(2) 273,808 0
WILLIAMSON, MICHAEL 244,444 0
WYSE, ROBERT 50,000 0
ZAGON, MATTHEW (2) 7,488 0
ZORN, RICHARD (1)(2) 1,040,000 0
46
<FN>
___________
1. Includes Common Stock issuable to holders of convertible debt.
2. Includes shares issuable upon exercise of Common Stock Purchase Warrants
and Options.
3. Includes shares issuable, at our discretion, pursuant to the Standby Equity
Distribution Agreement
4. Includes shares issuable, at our discretion, for future consulting
services.
</FN>
Investment Banking Agreement
On July 1, 2004, we entered into an investment banking agreement with Sloan
Securities Corp. for the sale of up to $3,000,000 principal amount of our 8%
senior 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 $.15 per share. Each note was issued with a five-year warrant to
purchase shares of our common stock at $.25 per share or 666,667 warrants for
each $100,000 of principal amount of notes purchased. As a result of the
agreement, which terminated on September 30, 2004, we received $2,295,000 in
gross proceeds in connection with this agreement and issued warrants to purchase
15,300,000 shares. Under the terms of the private placement we agreed to
undertake to register the common stock issuable upon the conversion of the notes
and the exercise of the warrants.
In connection with this agreement, we issued the broker warrants to acquire
5,052,600 shares of common stock at an exercise price of $.15 per share.
Standby Equity Distribution Agreement
On August 23, 2004, we entered into a Standby Equity Distribution Agreement
with Cornell Capital Partners, L.P. Under the terms of the agreement, the
investment firm has committed to purchase up to $10,000,000 of our common stock
at a purchase price equal to 98% of the market price at the time of purchase.
Cornell Capital is entitled to a 5% commission per transaction. Cornell Capital
has been provided with certain registration rights for the common stock
issuable, at our discretion, under the equity line; and the equity line can only
be drawn down, in whole or from time to time in part, upon the effectiveness of
a registration statement covering such shares. As consideration for entering
into this agreement, we granted the investment firm 3,333.33 shares of Series B
Preferred shares (convertible into 2,500,000 common shares). The investment firm
concurrently received $70,000 cash consideration for consulting services.
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be offered
and sold from time to time by certain selling stockholders. There will be no
proceeds to us from the sale of shares of common stock in this offering. The
bulk of the shares being registered under this filing relates to stockholders
who hold convertible notes and by employees and consultants who have received
shares as compensation for services rendered.
To the extent all the warrants are exercised, we will receive approximately
$8.8 million dollars from such exercise which we intend to use for general
corporate purposes.
PLAN OF DISTRIBUTION
We are registering the common stock, including the common stock underlying
convertible debentures and the warrants on behalf of the selling stockholders.
47
The common stock may be sold in one or more transactions at fixed prices, at
prevailing market prices at the time of sale, at prices related to the
prevailing market prices, at varying prices determined at the time of sale, or
at negotiated prices. These sales may be effected at various times in one or
more of the following transactions, or in other kinds of transactions:
- in the over-the-counter market;
- in private transactions and transactions otherwise than on these
exchanges or systems or in the over-the-counter market;
- in connection with short sales of the shares;
- by pledge to secure or in payment of debt and other obligations;
- through the writing of options, whether the options are listed on an
options exchange or otherwise;
- in connection with the writing of non-traded and exchange-traded call
options, in hedge transactions and in settlement of other transactions
in standardized or over-the-counter options; or
- through a combination of any of the above transactions.
The selling stockholders and their successors, including their transferees,
pledgees or donees or their successors, may sell the common stock directly to
the purchasers or through underwriters, broker- dealers or agents, who may
receive compensation in the form of discounts, concessions or commissions from
the selling stockholders or the purchasers. These discounts, concessions or
commissions as to any particular underwriter, broker-dealer or agent may be in
excess of those customary in the types of transactions involved.
We entered into registration rights agreements for the benefit of certain
of the selling stockholders to register the common stock under applicable
federal and state securities laws. The registration rights agreements provide
for cross-indemnification of the selling stockholders and us and our respective
directors, officers and controlling persons against specific liabilities in
connection with the offer and sale of the common stock, including liabilities
under the Securities Act. We will pay substantially all of the expenses incurred
by the selling stockholders incident to the registration of the offering and
sale of the common stock.
The selling stockholders should be aware that the anti-manipulation
provisions of Regulation M under the Exchange Act will apply to purchases and
sales of shares of common stock by the selling stockholders, and that there are
restrictions on market-making activities by persons engaged in the distribution
of the shares. Under Registration M, the selling stockholders or their agents
may not bid for, purchase, or attempt to induce any person to bid for or
purchase, shares of our common stock while such selling stockholders are
distributing shares covered by this prospectus. Accordingly, except as noted
below, the selling stockholders are not permitted to cover short sales by
purchase shares while the distribution is taking place. The selling stockholders
are advised that if a particular offer of common stock is to be made on items
constituting a material change from the information set forth above with respect
to the Plan of Distribution, then, to the extent required, a post-effective
amendment to the accompanying registration statement must be filed with the
Securities and Exchange Commission.
48
DESCRIPTION OF SECURITIES
Our authorized capital consists of 25,000,000 shares of common stock $0.001
par value, of which 19,517,410 shares were outstanding as of January 26, 2005.
In addition, we are authorized to issue 850,000 shares and 150,000 shares of our
Series A Convertible Preferred Stock ("Series A Preferred") and Series B
Convertible Preferred Stock ("Series B Preferred") respectively. As of January
26, 2005, there were 67,000 shares of our Series A Preferred outstanding and
115,006.84 shares of our Series B 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 Nevada Revised Statutes.
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 he declared from time to time by the Board of Directors, in its
discretion, from funds legally available therefor.
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
The board of directors has designated and authorized the issuance of
850,000 shares of Series A Convertible Preferred Stock ("Series A Preferred") of
which 67,000 shares are outstanding.
Conversion
Each share of Series A Preferred shall be automatically converted into 30
shares of our common stock upon the filing of an amendment to our Certificate of
Incorporation to increase the number of shares of common stock we are authorized
to issue.
Voting Rights
Series A Preferred shares shall vote together with all other classes on all
actions to be taken by our stockholders. Each share of Series A Preferred shall
entitle the holder to such number of votes as shall equal the number of shares
of common stock into which each share of Series A Preferred is then convertible.
49
Liquidation
Upon any liquidation or dissolution, Holders of Series A Preferred shall
be entitled to receive $2 per share plus an amount equal to all dividends
accrued but unpaid.
Series B Preferred
The board of directors has designated and authorized the issuance of
150,000 shares of Series B Convertible Preferred Stock ("Series B Preferred") of
which 115,000.84 shares are outstanding.
Conversion
Each share of Series B Preferred shall be automatically converted into 750
shares of our common stock upon the filing of an amendment to our Certificate of
Incorporation to increase the number of shares of common stock we are authorized
to issue sufficient to convert the then outstanding Series B Preferred shares.
Voting Rights
At a meeting of our stockholders, each share of common stock shall have one
vote per share and shares of our Series B Preferred 750 votes per share. Each
share of Series B Preferred when voting as a class shall be entitled to one vote
per share.
Rank
Series B Preferred shares shall rank junior to shares of Series A
Preferred.
MANAGEMENT
Directors and Officers
Our directors and executive officers are as follows:
Name Age Position
---- --- ---------
Matthew L. Harriton 40 Chairman of the Board of Directors,
President and Chief Executive Officer
Karen Nazzareno 47 Chief Financial Officer
Richard Selinfreund 47 Director
Geoffrey Donaldson 61 Director
Gene E. Burelson 64 Director
Wayne M. Celia 50 Director
Joel S. Kanter 48 Director
Arlen Reynolds 63 Director
Matthew L. Harriton became our Chairman of the Board of Directors, Chief
Executive Officer and President in May 2004. He has served as Chief Executive
Officer of HDSI since October 1996, and also serves as Chief Executive Officer,
50
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.
Karen Nazzareno became our Chief Financial Officer in May, 2004. She has
served as Chief Financial Officer of HDSI since January 1999 and Controller
since October 1996. Prior to joining HDSI Ms. Nazzareno's professional
experience included positions as Assistant Controller at Fischbach Corporation,
and audit supervisor at Holtz Rubenstein, a public accounting firm. She is a
graduate of Dowling College and a licensed CPA in the State of New York.
Richard Selinfreund became a Director in October 2004. From May 1997 to the
present, he has been president and Chief Technology Officer of Verification
Technology, Inc., a biotech company specializing in developing brand equity
protection technology; specifically, technology to detect
counterfeiting/adulteration of pharmaceuticals, beverages and CDs. From August
1994 to May 1997, he was president of Lion Laboratories Inc., a testing
laboratory for consumer products. From September 1993 to June 1994, he was a
research scientist with the department of pharmacology of Yale University school
of medicine.
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 CEO. 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., all of which have 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 has also been President of Chicago Advisory Group Inc., a privately held
equity financing and consulting company. Since its inception in November 1999,
Mr. Kanter serves on the boards of directors of several public companies as well
as a number of private concerns.
Arlen Reynolds became a director in December 2004. 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 CEO 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.
Geoffrey Donaldson became a Director in December 2004. He is currently and
has been since January 2000 Chief Operating Officer of HDSI. He is also Chief
Executive Officer of Sea Change Group, LLC, a consulting firm which provides
capitalization and management skills to start-up companies. Prior to that, Mr.
51
Donaldson was President of the Revlon Department Store Group and Chief Executive
Officer of Asian American Partners. He is a graduate of L.I. University and has
performed graduate work at both Harvard Business School and Wharton School Of
Business, University of Pennsylvania.
Summary Compensation
The following table sets forth, for our last three fiscal years, all
compensation awarded to, earned by or paid to all persons serving as our chief
executive officer ("CEO") or interim CEO in fiscal 2004 and the most highly
compensated executives officer of our other than the CEO or interim CEO whose
salary and bonus payments exceeded $100,000 in fiscal 2004. Summary Compensation
Table
The following table sets forth, for our last three fiscal years, all
compensation awarded to, earned by or paid to all persons serving as our chief
executive officer ("CEO") or interim CEO in fiscal 2004 and the most highly
compensated executives officer of our other than the CEO or interim CEO whose
salary and bonus payments exceeded $100,000 in fiscal 2004.
- -------------------------------------------------------------------------------------------------------------------------------
Long Term Compensation
- -------------------------------------------------------------------------------------------------------------------------------
Annual Compensation Awards Payouts
- -------------------------------------------------------------------------------------------------------------------------------
Other Restricted Securities
Name and Annual Stock Underlying LTIP All Other
Principal Salary Bonus Compen- Award(s) Options/ Payouts Compensation
Position Year ($) ($) sation) ($) SARS(#) ($) ($)
- -------------------------------------------------------------------------------------------------------------------------------
Santo 2004 12,750 -0- * -0- 1,275,000 -0- -0-
Petrocelli, ----------------------------------------------------------------------------------------------------------------
Sr., Chairman 2003 4,500 -0- * -0- -0- -0- -0-
of the Board, ---------------------------------------------------------------------------------------------------------------
and former 2002 3,300 -0- * -0- -0- -0- -0-
President and
CEO (1)
- -------------------------------------------------------------------------------------------------------------------------------
Jeffrey L. 2004 -0- -0- * -0- 500,000 -0- -0-
Powell, former ----------------------------------------------------------------------------------------------------------------
President, 2003 57,000 -0- * -0- -0- -0- -0-
CEO and ----------------------------------------------------------------------------------------------------------------
Director (2) 2002 -0- -0- 108,500 -0- -0- -0- -0-
- -------------------------------------------------------------------------------------------------------------------------------
Michael J. 2004 -0- -0- * -0- 500,000 -0- -0-
Caputo, ----------------------------------------------------------------------------------------------------------------
President, 2003 135,000 -0- * -0- -0- -0- -0-
Principal ----------------------------------------------------------------------------------------------------------------
Executive and 2002 135,000 -0- * -0- -0- -0- -0-
Financial
Officer (3)
- -------------------------------------------------------------------------------------------------------------------------------
Ronald 2004 -0- -0- 300,000 -0- 1,000,000 -0- -0-
Kuzon -----------------------------------------------------------------------------------------------------------------
Treasurer (4) 2003 -0- -0- * -0- -0- -0- -0-
- -------------------------------------------------------------------------------------------------------------------------------
2002 -0- -0- * -0- -0- -0- -0-
- -------
<FN>
* Less than $50,000
</FN>
52
(1) Mr. Petrocelli was succeeded by Jeffrey L. Powell as President and CEO,
effective July 10, 2002. Mr. Petrocelli was compensated through Petrocelli
Industries, Inc. Payments to this company may be referred to as "management
fees" and "consulting fees" in the Annual Report on Form 10-KSB for the
fiscal year ended April 30, 2003 and other reports filed by us with the
SEC. In March 2002, we issued to Mr. Petrocelli a warrant exercisable for
1,000,000 shares of common stock at an exercise price of $0.55 per share.
On December 11, 2003, this warrant was repriced at an exercise price of
$.05 per share. In addition, on December 11, 2003, Petrocelli Industries
was issued a warrant exercisable for 275,000 shares of common stock at an
exercise price of $.05 per share.
(2) Succeeded by Michael J. Caputo as President and Principal Executive Officer
(interim), effective October 25, 2002. Mr. Powell served as our President,
CEO and Director from July 10, 2002 to October 25, 2002. In fiscal 2002 and
prior to his election as President, CEO and Director in fiscal 2003, Mr.
Powell served as our consultant. Mr. Powell received a total of $108,500 in
compensation for his consulting services in fiscal 2002. In addition, on
December 11, 2003, we issued to Mr. Powell a warrant exercisable for
500,000 shares of common stock at an exercise price of $.05 per share.
(3) In fiscal 2003, Mr. Caputo served as Chief Operating Officer until October
25, 2002, and as interim President, Principal Executive and Financial
Officer from October 25, 2002 to April 29, 2003. On June 25, 2003, we
engaged Mr. Caputo, on a limited basis, to serve as interim President,
Principal Executive and Financial Officer. Mr. Caputo's engagement
terminated on May 25, 2004. In December 2002, Nesco issued to Mr. Caputo a
warrant exercisable for 500,000 shares of common stock at an exercise price
of $0.55 per share. On December 11, 2003, this warrant was repriced at an
exercise price of $.05 per share.
(4) In fiscal 2004, Mr. Kuzon, a former consultant served as interim Treasurer
from February 26th until May 25th, 2004. In March 2002, Nesco issued to Mr.
Kuzon a warrant exercisable for 1,000,000 shares of common stock at an
exercise price of $0.55 per share. On December 11, 2003, this warrant was
repriced at an exercise price of $.05 per share and in March 2004 this
warrant was exercised in a cashless exercise. An aggregate of 857,142
shares were received as the excess of the fair value $(.35) of the stock
purchased over the exercise price ($.05) was used to pay for the shares in
the aggregate of 142,858 shares.
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
Our 1999 Stock Option Plan ("1999 Plan") provides that key employees are
eligible to receive incentive stock options or non-qualified and that directors
and advisors shall be eligible to receive non- qualified options. Under the 1999
Plan, management may grant options to purchase up to a total of 1,000,000 shares
of common stock. As of April 30, 2004 and 2003, there were 850,000 and 780,000
options available for future grants, respectively. 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.
During fiscal 2004 the following option grants were made to the named
executive officers:
53
% of Total
Options
Number of Granted Hypothetical
Options Officers/Employees Exercise Expiration Value at
Name Granted in Fiscal Year Price(1) Date Grant Date
Santo Petrocelli Sr. 1,000,000 22.2% $.05 3/13/07 $346,995
275,000 6.1% .05 12/11/07 96,067
Jeffrey L. Powell 500,000 11.1% .05 12/11/07 174,667
Michael J. Caputo 500,000 11.1% .05 12/26/07 173,497
Ronald Kuzon 1,000,000 22.2% .05 3/13/07 346,995
(1) The market price underlying all of these options at the time of
repricing was $.35. See repricing report.
The hypothetical value of the options as of their date of grant has been
calculated using the Black-Scholes option-pricing model, as permitted by SEC
rules, based upon various assumptions, which include: no dividend yield,
expected volatility of 249%, risk free interest rate of .95% and expected lives
of 3 to 5 years. The fair value per warrant was estimated at approximately $0.35
on the date of the issuance of the warrants granted in the fiscal year 2004 and
on the repriced warrants .The approach used in developing the assumptions upon
which the Black-Scholes valuations were calculated is consistent with the
requirements of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock- Based Compensation." It should be noted that this model is only one
method of valuing options, and our company's use of the model should not be
interpreted as an endorsement of its accuracy. The actual value of the options
may be significantly different, and the value actually realized, if any, will
depend upon the excess of the market value of the common stock over the option
exercise price at the time of exercise.
Aggregated Option/SAR Exercises and Fiscal Year-End Option/SAR Value
Information relating to the number and value of options exercised during
the year and held at year end by such officers is set forth in the following
table:
Number of Securities Value of Unexercised
Underlying Unexercised In-the -Money Options/SAR
Options/SAR at 4/30/04 at
(#)(1) 4/3/04 ($)(2)
------------------------- ----------------------------
Shares Acquired Value
Name on Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
---- ---------------- ------------ ----------- ------------- ----------- -------------
Santo Petrocelli, Sr -0- -0- 1,425,000 -0- $ 127,500 -0-
Jeffrey L. Powell -0- -0- 500,000 -0- 50,000 -0-
Michael J. Caputo -0- -0- 500,000 -0- 50,000 -0-
Ronald Kuzon (3) 1,000,000 300,000 -0- -0- -0- -0-
<FN>
(1) Shares of common stock.
(2) Based on the high "bid" price of shares quoted on April 30, 2004.
(3) Upon cashless exercise, Mr. Kuzon actually received 857,142 shares.
</FN>
Long-Term Incentive Plans
Not Applicable.
54
Compensation of Directors
During the fiscal year ended April 30, 2004, no director received any
compensation for services provided in such capacity. Directors are reimbursed
for any expenses incurred by them in connection with their activities on our
behalf.
Employment Contracts and Termination of Employment and Change in Control
Arrangements
At April 30, 2004, we had no employment contracts or compensatory plans or
arrangements. However, in May 2004 in connection with our acquisition of HDSI 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, the officer was granted
nonqualified options, 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 optionee remains an employee. The options are exercisable at the
"Applicable Trading Price" in the Share Exchange Agreement which is the lesser
of (i) the average closing bid price per share of our common stock for 30
consecutive trading days prior to the closing date and (ii) the average closing
bid price per share of our 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 30 consecutive trading days prior to the
closing was $.15. On December 3, 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.
Report on Repricing of Options/SARS
In December 2003, we repriced 3,440,000 outstanding warrants, of which
3,400,000 were granted to officers, employees and consultants, with exercise
prices lower than the terms of the original grants. These actions were taken in
order to provide an incentive to these individuals to engage in transactions on
our behalf. The following table sets forth certain information concerning the
repricing of options to the named executive officers within the previous ten
years.
Ten-Year Options Repricings
Length of Original
Market Price of Exercise Price Option Term
Number of Securities Stock at Time at Time of New Remaining at Date
Underlying of Repricing Repricing or Exercise of Repricing or
Name Date Repriced or Awarded or Amendment Amendment Price Amendment (Yrs.)
- ---- ---- -------------------- ----------------- -------------- --------- --------------------
Ronald Kuzon (1) 12/11/03 1,000,000 $.35 $.55 $.05 3.25
Santo Petrocelli, Sr. 12/11/03 1,000,000 $.35 $.55 $.05 3.25
Michael Caputo 12/11/03 500,000 $.35 $.55 $.05 4.00
<FN>
(1) These options were exercised by Mr. Kuzon in March 2004.
</FN>
55
EXPERTS
The financial statements of the Company reflect the historical results of
the predecessor entity, HDSI, prior to May 25, 2004 and the consolidated results
of operations of the Company subsequent to the acquisition date of May 25, 2004.
The financial statements of HDSI for the year ended April 30, 2004 and for the
year ended April 30, 2003 have been audited by Rothstein Kass & Company, P.C.
Such financial statements are incorporated herein by reference in reliance upon
such reports given upon the authority of such firms as experts in accounting and
auditing.
WHERE YOU CAN FIND MORE INFORMATION
The effectiveness of this registration statement will render us subject to
the informational requirements of the Exchange Act, and, we will file reports,
proxy statements and other information with the Securities and Exchange
Commission as required by federal law. These reports, proxy statements and other
information can be inspected and copied at the public reference facilities
maintained by the Securities Exchange Commission Investors may read and copy any
of these reports, statements, and other information at the SEC's public
reference room located at 450 5th Street, N.W., Washington, D.C., 20549, or any
of the SEC's other public reference rooms. Investors should call the SEC at
l-800-SEC- 0330 for further information on these public reference rooms upon
payment of the fees prescribed by the Securities Exchange Commission. These SEC
filings are also available free at the SEC's web site at www.sec.gov.
This prospectus does not contain all of the information set forth in the
registration statement, parts of which are omitted to comply with the rules and
regulations of the Securities Exchange Commission. For further information,
please see the registration statement in its entirety.
56
FINANCIAL INFORMATION
NESCO INDUSTRIES, INC.
For the Six Months Ended October 31, 2004
(Unaudited)
Consolidated Balance sheet.................................... F- 1- F-2
Consolidated Statements of operations......................... F -3
Consolidated Statements of cash flows......................... F-4- F-5
Notes to consolidated financial statements.................... F- 6- F-12
For the Years Ended April 30, 2004 and April 30, 2003*
Independent Auditors' Report.................................. F-13
Consolidated Balance sheets................................... F-14-F-15
Consolidated Statements of operations......................... F-16
Consolidated Statements of Stockholders' Deficit.............. F-17
Consolidated Statements of cash flows......................... F-18
Notes to consolidated financial statements.................... F-19-F-33
* Historical results of the predecessor entity HDSI.
57
Item 1. Financial Statements
NESCO INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEET
- --------------------------------------------------------------------------------------------------------------------
October 31,
2004
(unaudited)
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash $ 513,738
Accounts receivable 83,018
Inventories 91,333
Prepaid expenses and other current assets 117,730
------------------
Total current assets 805,819
------------------
Property and equipment, net of accumulated depreciation of $1,584,410 496,265
------------------
Other assets
Purchased technology, net of accumulated amortization of $768,698 28,470
Deferred financing costs 542,402
Stock issuance costs 712,500
Investments 6,000
Other 16,491
------------------
Total other assets 1,305,863
------------------
$ 2,607,947
=================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Interest payable, convertible debentures $ 42,667
Customer deposits 839,653
Accounts payable and accrued expenses 265,997
Due to affiliate 74,710
------------------
Total current liabilities 1,223,027
------------------
Long-term liabilities
Note and interest payable 621,339
Deferred sublease income 140,400
Convertible debentures and interest payable, related party, net of debt discount of $870,818 625,039
Convertible debentures and interest payable, other, net of debt discount of $2,173,117 878,310
Convertible debentures and interest payable, officers, net of debt discount of $66,821 764,382
------------------
Total long-term liabilities 3,029,470
------------------
F-1
NESCO INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEET (CONTINUED)
- --------------------------------------------------------------------------------------------------------------------
October 31,
2004
(unaudited)
- --------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' deficit
Series A convertible preferred stock, $.001 par value, authorized
850,000 shares, 79,500 issued and outstanding 79
Series B convertible preferred stock, $.001 par value, authorized
150,000 shares, 113,118 issued and outstanding 113
Common stock, $.001 par value, authorized 25,000,000 shares,
19,127,105 issued and outstanding 19,127
Additional paid-in-capital 14,046,854
Accumulated other comprehensive loss (69,000)
Accumulated deficit (15,641,723)
------------------
Total stockholders' deficit (1,644,550)
------------------
$ 2,607,947
=================
F-2
NESCO INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended October 31, Three Months Ended October 31,
---------------------------- ------------------------------
2004 2004 2003 2003
(unaudited) (unaudited) (unaudited) (unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 332,086 $ 396,713 $ 143,972 $ 304,207
Cost of revenues 421,413 447,328 210,947 244,801
-------------------------------------------------------------------------
Gross margin (89,327) (50,615) (66,975) 59,406
-------------------------------------------------------------------------
Operating expenses
General and administrative 656,509 343,598 424,606 188,253
Amortization and other expenses 107,435 58,289 76,325 29,139
-------------------------------------------------------------------------
-
763,944 401,887 500,931 217,392
-------------------------------------------------------------------------
Loss from operations (853,271) (452,502) (567,906) (157,986)
-------------------------------------------------------------------------
Other income (expenses)
Sublease income 23,400 - 11,700 -
Amortization of debt discount (900,743) (158,526) (636,075) (96,053)
Non-cash stock compensation (2,892,608) - - -
Interest expense (103,767) (72,238) (65,790) (37,971)
Interest expense, related parties (80,743) (50,140) (42,572) (23,379)
Amortization of financing costs (149,121) - (116,816) -
-------------------------------------------------------------------------
(4,103,582) (280,904) (849,553) (157,403)
-------------------------------------------------------------------------
Net loss $ (4,956,853) $ (733,406)$ (1,417,459) $ (315,389)
=========================================================================
Weighted average common shares outstanding
Basic and diluted 102,612,104 58,884,741 110,289,021 58,884,741
-------------------------------------------------------------------------
Loss per common share
Basic and diluted $ (0.05) $ (0.01)$ (0.01) $ (0.01)
=========================================================================
F-3
NESCO INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------------------
Six Months Ended October 31,
----------------------------
2004 2003
(unaudited) (unaudited)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net loss $ (4,956,853) $ (733,406)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash stock compensation 2,892,608 -
Depreciation and amortization 139,664 171,474
Amortization of debt discount 900,743 158,526
Amortization of financing costs 149,121 -
Gain on sale of equipment - (950)
Changes in operating assets and liabilities:
Accounts receivable (9,326) (33,948)
Inventories (2,995) (62,623)
Prepaid expenses and other assets (59,711) (4,247)
Other assets (6,585) (2,093)
Customer deposits (8,000) 320,500
Accounts payable and accrued expenses (190,485) (25,262)
Deferred sublease income (23,400) -
Due to affiliates (153,968) 50,156
Interest payable 98,618 107,378
----------------------------------------
Net cash used in operating activities (1,230,569) (54,495)
----------------------------------------
Cash flows from investing activities
Net cash acquired from merger 86,183 -
Purchase of equipment (3,948) -
Proceeds from sale of equipment - 2,000
----------------------------------------
Net cash provided by investing activities 82,235 2,000
----------------------------------------
Cash flows from financing activities
Proceeds from issuance of convertible debentures, other 2,008,620 -
Proceeds from issuance of convertible debentures, related party - 198,000
Payments on notes payable (238,000) (180,140)
Payments of stock issuance costs (87,500) -
Proceeds from loan from officer - 55,000
Payments on loan from officer (7,000) -
Payments to affiliate (14,876) (50,138)
----------------------------------------
Net cash provided by financing activities 1,661,244 22,722
----------------------------------------
Net increase (decrease) in cash 512,910 (29,773)
Cash
Beginning of period 828 44,854
----------------------------------------
End of period $ 513,738 $ 15,081
========================================
Supplemental disclosure of cash flow information,
cash paid during the period for interest $ 86,748 $ 18,227
========================================
F-4
NESCO INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------------------
Six Months Ended October 31,
2004 2003
(unaudited) (unaudited)
- --------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash investing and financing,
activities:
Stock issued in connection with Equity Distribution Agreement $ 625,000 $ -
=====================================
Fair value of warrants issued to brokers $ 405,143 $ -
=====================================
Debt discount related to convertible debentures $ 3,971,073 $ -
=====================================
F-5
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
six and three month periods ended October 31, 2004 and 2003. The results of of
operations for the six month periods ended October 31, 2004 and 2003 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.
F-6
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. On November 16, 2004
NEWCO filed an information statement with the Securities and Exchange Commission
("SEC"), and is currently awaiting any comments from the SEC. 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 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 94% of
the common and 88% of the preferred shareholders have exchanged their shares as
of October 31, 2004 which has resulted in approximately 51.1% of NEWCO's voting
securities outstanding at the time of the exchange owned by HDS stockholders.
The Company anticipates that the remaining shareholders will exchange their
shares in the near future, which will result in 55.3% of NEWCO's voting
securities outstanding at the time of the exchange being owned by HDS
stockholders. 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). 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, 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.
F-7
Concurrent with the exchange, 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 of October 31, 2004, 433,000 shares of Series A
Preferred shares have been exchanged for 17,320 shares of Series B Preferred
shares. The Company anticipates that the majority of the remaining Series A
shareholders will exchange their shares in the near future.
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 costs related to the exchange
approximating $48,000. Approximately $328,000 of these costs, 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 quarter 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 as of the exchange date.
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 exchange.
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 six months ended October 31,
2004 the amortization of debt discount approximated $505,000.
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 as a result of the exchange
agreement.
F-8
The following supplemental pro forma information is presented to illustrate the
effects of the acquisition of HDS on the historical operating results for the
six and three months ended October 31, 2004 and 2003 as if the acquisition had
occurred at the beginning of the respective period:
Six Months Ended Three Months Ended
---------------- ------------------
October, 31 October, 31
----------- -----------
2004 2003 2004 2003
---- ---- ---- ----
Revenues $ 332,086 $ 396,713 $ 143,972 $ 304,207
Net loss $ (5,051,311) $ (4,431,462) $ (1,417,459) $ (689,837)
Net loss per share $ (0.05) $ (0.04) $ (0.01) $ (0.01)
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 six months ended October 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 October 31, 2004, the Company had an accumulated deficit of approximately
$15,642,000, a working capital deficit of approximately $417,000 and incurred a
net loss of approximately $4,957,000 for the six 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 has additional financing available as
described in Note 5. 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 October 31, 2004 related to these debentures was approximately
$347,000.
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
quarter ended July 31, 2004.
F-9
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, either in cash or common stock, and
convertible into common stock at $.15 per share. Each note was 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 a result of the agreement, which terminated on September 30, 2004,
the Company received $2,295,000 in gross proceeds in connection with this
agreement and issued warrants to purchase 15,300,000 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 $1,108,000 of the proceeds as of October 31, 2004 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. These
amounts were recorded as equity components. The remaining balance of $183,000
was recorded as long-term debt. For the six months ended October 31, 2004 the
amortization of debt discount was approximately $355,000. Interest expense for
the six months ended October 31, 2004 was approximately $43,000.
Financing fees in connection with this agreement approximated $286,000 at
October 31, 2004 which are being amortized over the term of the convertible
notes. For the six months ended October 31, 2004, the amortization of financing
costs approximated $52,000.
In connection with this agreement, the Company issued the broker warrants to
acquire 5,052,600 shares of NEWCO common stock at an exercise price of $.15 per
share. The fair value of the warrants ($405,000) will be charged to operations
over the life of the underlying debt. For the six months ended October 31, 2004,
approximately $96,000 was charged to operations as financing costs for these
warrants.
Note 5. Standby Equity Distribution 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.
The equity line can be drawn down upon a registration statement covering the
shares being declared effective by the SEC. As of October 31, 2004, a
registration statement has not been filed. 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. The fair value of the shares ($625,000) as well as $17,500 in fees
associated with this agreement were recorded on the balance sheet as stock
issuance costs in the quarter ended October 31, 2004.
Note 6. 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.
F-10
On December 3, 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. Bonuses are to be paid as determined by the Board of
Directors. The agreement was also extended to December 31, 2009. All other terms
remained the same as defined in the original agreement.
Consulting Agreements
On May 25, 2004, the Company entered into a two-year consulting agreement with
an affiliate of an interim officer and consultant of 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. As of October 31,
2004, the Company has prepaid approximately $60,000 in consulting fees
associated with this agreement.
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 October 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 six months ended October
31, 2004.
Note 7. 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 six months ended
October 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, 113,118 shares of Series B preferred shares
which will be converted into 84,838,435 common shares, 79,500 shares of Series A
preferred shares which will be converted into 2,385,000 common shares, and
4,536,307 common shares for the prior HDS common and preferred holders who have
not yet exchanged their shares. In the aggregate, 110,886,847 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 56,152,304 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-11
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 six and three months ended October 31, 2004 and 2003 as if the Company had
applied the fair value recognition provisions of FASB Statement 123, "Accounting
for Stock-Based Compensation".
Six Months Ended Three Months Ended
----------------- ------------------
October, 31 October, 31
----------- -----------
2004 2003 2004 2003
---- ----- ---- ----
Net loss, as reported $ (4,956,853) $ (733,406) $ (1,417,459) $ (315,389)
Add: Total stock-based employee
compensation expense determined
under fair value based method,
net of related tax effects 181,457 - 30,146 -
---------------- ---------------- --------------- ----------------
Pro forma net loss $ (5,138,310) $ (733,406) $ (1,447,605) $ (315,389)
================ ================ =============== ================
Net loss as reported $ (0.05) $ (0.01) $ (0.01) $ (0.01)
================ ================ =============== ================
Pro-forma net loss per share $ (0.05) $ (0.01) $ (0.01) $ (0.01)
================ ================ =============== ================
Note 8. Subsequent Events
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
shall by payable in cash and $8,200 shall be payable, at the Company's
discretion, in cash or in common stock of the Company. The common stock payment
shall be based each month on the closing bid price of the Company's common stock
on the first day of the month for which payment is due. The consultant shall
have customary piggyback registration rights with respect to any shares issued
under this agreement
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.
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. The warrants vest at the rate of 10,000 shares per month.
F-12
85 Livingston Avenue ROTHSTEIN, KASS & COMPANY, P.C.
Roseland, NJ 07068-1785 Certified Public Accountants
973-994-6666/Fax 973-994-0337
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Hydrogel Design Systems, Inc.
We have audited the accompanying consolidated balance sheets of Hydrogel Design
Systems, Inc. and Subsidiary as of April 30, 2004 and 2003, and the related
consolidated statements of operations, stockholders' deficit and cash flows for
the years then ended. 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. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
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 Hydrogel Design
Systems, Inc. and Subsidiary, as of April 30, 2004 and 2003, and the results of
their operations and their cash flows for the years then ended, 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's ability to continue in the normal course of business is dependent upon
the success of future operations. The Company has incurred cumulative losses of
approximately $10,685,000 since inception and utilized cash of approximately
$569,000 for operating activities during the two years ended April 30, 2004. The
Company has a working capital deficit of approximately $1,369,000 and a
stockholders' deficit of approximately $4,558,000 as of April 30, 2004. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans regarding these matters are also described in
Note 2. The 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
July 2, 2004
F-13
HYDROGEL DESIGN SYSTMS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
April 30, 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash $ 828 $ 44,854
Accounts receivable 73,692 59,872
Inventories 88,338 85,660
Prepaid expenses and other current assets 58,019 12,060
-------------------------------------------
Total current assets 220,877 202,446
-------------------------------------------
Property and equipment, net 570,101 789,380
-------------------------------------------
Other assets
Purchased technology, net of accumulated amortiza
of $711,757 in 2004 and $597,876 in 2003
85,411 199,292
Investments 6,000 6,000
Other 41,906 37,556
-------------------------------------------
Total other asset 133,317 242,848
-------------------------------------------
$ 924,295 $ 1,234,674
-------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Notes and interest payable
$ 104,500 $ 1,006,028
Convertible debentures and interest payable, related pa
net of debt discount of $27,646 in 2003 1,117,119
Convertible debentures and interest payable, other 681,220
Bridge loan, merger candidate 208,500
Customer deposits 847,653 531,948
Accounts payable and accrued expenses 185,214 200,530
Accrued payroll 479,907
Due to affiliates 243,554 137,575
Due to officer 270,356
-------------------------------------------
Total current liabilitie 1,589,421 4,424,683
-------------------------------------------
Long-term liabilities
Note and interest payable
804,868
Convertible debentures and interest payable, related p 1,443,108
Convertible debentures and interest payable, other 731,220
Accrued payroll 544,002
Due to officer 369,846
-------------------------------------------
Total long-term liabilities 3,893,044
-------------------------------------------
See accompanying notes to consolidated financial statements.
F-14
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDARY
CONSOLIDATED BALANCE SHEETS (CONTINUED)
April 30, 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' deficit
Series A preferred stock, $.0001 par value, authorized 13,000,000 shares, none
issued or outstanding
Series B convertible preferred stock, $.0001 par value, authorized
2,000,000 shares, 522,487 issued and outstanding (aggregate
liquidation preference: $1,567,461) 52 52
Preferred stock, $.0001 par value, authorized 5,000,000 shares,
none issued or outstanding
Common stock, $.0001 par value, authorized 20,000,000 shares,
4,702,806 issued and outstanding
470 470
Additional paid-in-capital 6,317,678 6,186,798
Accumulated other comprehensive loss (69,000) (69, 000)
Accumulated deficit (10,684,870) (9,185,829)
Note receivable, officer (80,000) (80, 000)
-------------------------------------------
(4,515,670) (3,147,509)
Less treasury stock, 250,000 common shares, at cost (42,500) (42,500)
-------------------------------------------
Total stockholders' deficit (4,558,170) (3,190,009)
-------------------------------------------
$ 924,295 $ 1,234,674
-------------------------------------------
See accompanying notes to consolidated financial statements.
F-15
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended April 30, 2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 623,349 $ 1,130,995
Cost of revenues 912,082 1,029,044
--------------------------------------------
Gross margin (288,733) 101,951
--------------------------------------------
Operating expenses
General and administrative
661,737 1,056,648
Amortization and other expens 116,213 118,863
--------------------------------------------
777,950 1,175,511
--------------------------------------------
Loss from operations (1,066,683) (1,073,560)
--------------------------------------------
Other expenses
Amortization of debt discount
(158,526) (320,445)
Interest expense (152,398) (195,476)
Interest expense, related partie (121,434) (67,189)
Financing costs (6,250)
--------------------------------------------
(432,358) (589,360)
--------------------------------------------
Net loss $ (1,499,041) $ (1,662,920)
--------------------------------------------
Weighted average common shares outstanding
Basic 4,452,806 4,452,806
Diluted 4,452,806 4,452,806
--------------------------------------------
Loss per common share
Basic $ (0.34) $ (0.37)
Diluted $ (0.34) $ (0.37)
--------------------------------------------
See accompanying notes to consolidated financial statements.
F-16
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
Years Ended April 30, 2004 and 2003
- -----------------------------------------------------------------------------------------------------------------------------------
Accumu-
lated
Addi- Other Note
Series B Convertible ional Compre- Accumu- Receiv-
Preferred Stock Common Stock Paid-in hensive lated able, Treasury Stock
Shares Amount Shares Amount Capital Loss Deficit Officer Shares Amount Total
------ ------ ------ ------ ---------- --------- ----------- ------- ------- ------ ------
Balances,
April 30,
2002 522,487 $ 52 4,702,806 $ 407 $5,856,064 $(69,000) $(7,522,909)$(80,000) 250,000 $(42,500) $(1,857,823)
Issuance of
warrants in
connection
with
convertible
debentures 330,734 330,734
Net loss/
comprehensive
loss (1,662,920) (1,662,920)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances,
April 30,
2003 522,487 52 4,702,806 470 6,186,798 (69,000) (9,185,829)$(80,000) 250,000 (42,500) (3,190,009)
Issuance of
warrants in
connection
with
convertible
debentures 130,880 130,880
Net loss/
comprehensive
loss (1,499,041) (1,499,041)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances,
April 30,
2004 522,487 $ 52 4,702,806 $ 470 $6,317,678 $(69,000) $(10,684,870)$(80,000) 250,000 S(42,500) S(4,558,170)
- -----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-17
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended April 30, 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net loss $ (1,499,041) $ (1,662,920)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization
334,160 345,744
Amortization of debt discount 158,526 320,445
Gain on sale of equipment (950)
Changes in operating assets and liabilities:
Accounts receivable (13,820) 11,032
Inventories (2,678) (29,296)
Prepaid expenses and other current assets (45,959) (1,459)
Other assets (6,400) (6,400)
Customer deposits 315,705 531,948
Accounts payable and accrued expenses 48,779 (11,463)
Due to affiliates 195,329 112,302
Interest payable 273,000 64,617
-------------------------------------------
Net cash used in operating activities (243,349) (325,450)
-------------------------------------------
Cash flows from investing activities,
proceeds from sale of equipment 2,000
-------------------------------------------
Cash flows from financing activities
Proceeds from bridge loan, merger candidate
208,500
Proceeds from issuance of convertible debentures, related p 198,000 560,002
Payment on note payable, related party (30, 000)
Proceeds from issuance of convertible debentures, other 299,998
Payments on notes payable (191,827) (317,641)
Proceeds from loan from officer 72,000 80,000
Payments to affiliate (89,350) (231,150)
-------------------------------------------
Net cash provided by financing activities 197,323 361,209
-------------------------------------------
Net decrease in cash (44,026) (235,512)
Cash
Beginning of yea 44,854 9,095
-------------------------------------------
End of year $ 828 $ 44,854
-------------------------------------------
Supplemental disclosure of cash flow information,
cash paid during the year for interest $ 24,827 $ 180,847
-------------------------------------------
See accompanying notes to consolidated financial statements.
F-18
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and nature of operations
Hydrogel Design Systems, Inc. (the "Company") is a Delaware Corporation which
was formed on October 3, 1996. Subsequent to formation, the Company entered into
an asset acquisition agreement for the purchase of certain assets and the
ongoing business of a group of medical products companies. These companies were
engaged in the manufacture, marketing, selling and distribution of hydrogel, an
aqueous polymer-based radiation ionized medical/consumer product. Substantially
all of the Company's revenues come from wholesale sales and its customers are
located in the continental United States.
The Company's affiliate, Embryo Development Corporation ("Embryo"), a
publicly-traded entity, which previously owned 33.3% of the Company's
outstanding common stock reduced its ownership to 13.1 % as a result of the sale
of a portion of its shares held in the Company to third parties in January 1999
and the additional issuance of stock by the Company. At April 30, 2004, Embryo
owned approximately 11.4% of the Company's common stock. In August 1999, the
Company acquired a majority interest in Converting Sciences, Inc. ("CSI"). CSI
is engaged in the converting of hydrogels into finished products which are
primarily manufactured for use in the cosmetic and medical sectors. At April 30,
2004, the Company held a 60% majority interest in CSI.
On April 29, 2004, the Company entered into a Share Exchange Agreement with
Nesco Industries, Inc. ("Nesco"), a Nevada publicly held corporation, whereby
the Company would become a majority-owned subsidiary of Nesco and upon
completion of the Share Exchange Agreement, the holders of the Company's common
stock and debt would hold a majority interest of Nesco. This exchange was
completed on May 25, 2004 as more fully described in Note 19.
2. Going concern and liquidity
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. The Company has
incurred cumulative losses of approximately $10,685,000 since inception and
utilized cash of approximately $569,000 for operating activities during the two
years ended April 30, 2004. The Company has a working capital deficit of
approximately $1,369,000 and a stockholders' deficit of approximately $4,558,000
as of April 30, 2004.
Management recognizes that the Company must generate additional revenue to
achieve profitable operations. Management's plans to increase revenues include
the continued building of its customer base, especially in the medical and
cosmetic industries, through its ability to manufacture goods on a custom basis
or to the exacting standards required by medical customers. Management also will
seek to increase revenues through the development of alternative uses of its
equipment, such as irradiation and sterilization services.
As a result of the completion of the Share Exchange Agreement with Nesco on May
25, 2004, the Company was effectively able to obtain debt extensions on a
significant portion of its current debt obligations to December 31, 2005 (see
Note 7 and Note 19). In addition, the Company received net cash of approximately
$328,000 as part of the terms of the agreement, of which approximately $208,000
was received as a bridge loan prior to April 30, 2004 and is included in current
liabilities at April 30, 2004 (see Note 8). Management believes that this
transaction will enable the Company to seek additional debt or equity financing.
In June 2004, Nesco entered into an Investment Banking Agreement with a third
party whereby Nesco would issue 8% Senior Convertible Notes to private investors
for an aggregate of a minimum of $250,000 and a maximum of $1,700,000. In June
and July 2004, the Company received approximately $705,000 in connection with
this transaction.
F-19
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Going concern and liquidity (continued)
There can be no assurance that the Company will be able to obtain sufficient
debt or equity financing on favorable terms if at all, or that it will be
successful in building its customer base or developing alternative uses for its
equipment. If the Company is unsuccessful in building its customer base and
developing alternative uses for its equipment or is unable to obtain additional
financing on terms favorable to the Company there could be a material adverse
effect on the financial position, results of operations and cash flows of the
Company. The accompanying financial statements do not include any adjustments
that might be necessary if the Company is 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 majority-owned subsidiary, CSI. Upon consolidation, all
significant intercompany accounts and transactions are eliminated.
Accounts Receivable
The Company carries its accounts receivable at cost less an allowance for
doubtful accounts. On a periodic basis, the Company evaluates its accounts
receivable and establishes an allowance for doubtful accounts, based on a
history of past write-offs and collections and current credit 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.
Depreciation and Amortization
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.
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 5-7 Years
Purchased technology 7 years
Loss Per Share
Basic loss per common share is 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,
2004 and 2003.
F-20
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Summary of significant accounting policies (continued)
Income Taxes
The Company complies with Statement of Financial Accounting Standards ("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.
Investments
Available-for-sale securities are recorded at fair value, with the change in
fair value during the year excluded from earnings and recorded net of tax as a
component of other comprehensive income.
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.
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.
Concentrations of Credit Risk
Financial instruments which 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. As of April 30,
2004 and 2003, the Company was not subject to credit risk with any financial
institution beyond the insured amount. The Company does not require collateral
or other security to support financial instruments subject to credit risk.
F-21
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Summary of significant accounting policies (continued)
Impairment of Long-Lived Assets
Certain long-lived assets (including purchased technology) 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 impairment is deemed to exist, the assets will be written
down to fair value. Management also reevaluates the periods of amortization to
determine whether subsequent events and circumstances warrant revised estimates
of useful lives. As of April 30, 2004 and 2003, management expects these assets
to be fully recoverable.
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 APB 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:
2004 2003
---- ----
Net loss, as reported $ (1,499,041) $ (1,662,920)
Stock-based compensation determined under the
fair value-based method, net of related tax effects (25,625)
------------------------------------
Net loss, pro forma $ (1,499,041) $ (1,688,545)
------------------------------------
Loss per common share, basic and diluted
As reported
$ (0.34) $ (0.37)
Pro forma $ (0.34) $ (0.38)
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 years ended April 30, 2004 and 2003: risk
free interest rate 6%; no dividend yield; expected lives of 3-10 years; and zero
volatility.
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 shareholder'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.
F-22
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Property and equipment
Property and equipment, at cost, consist of the following at April 30, 2004 and
2003:
2004 2003
---- ----
Machinery and equipment $ 1,614,114 $ 1,615,614
Office equipment and fixtures 82,957 82,957
Leasehold improvements 373,856 373,856
-----------------------------------
2,070,927 2,072,427
Less accumulated depreciation
and amortization 1,500,826 1,283,047
-----------------------------------
$ 570,101 $ 789, 380
-----------------------------------
Depreciation expense for the years ended April 30, 2004 and 2003 amounted to
approximately $218,000 and $230,000, respectively.
5. Purchased technology
On February 6, 1997, the Company acquired certain assets from a group of
entities for an aggregate purchase price of $150,000 in cash and 150,000 shares
of Embryo Common Stock (valued at $75,000), which would vest in two years if the
Company met certain revenue levels. At that time, if the shares had a fair value
of less than $900,000, the parties could demand that the Company purchase the
shares at an aggregate price of $900,000 in cash and/or marketable securities.
Assets acquired included property rights and technology, machinery and
equipment, and inventory. This agreement was modified and incorporated into the
Settlement Agreement as discussed below.
On November 6, 1997, the Company brought action in New York State Court against
the former owners of the entities alleging breach of contract, negligence and
other charges. On November 24, 1997, the former owners filed their answer and
counterclaim against the Company. On January 21, 1998, the Company entered into
a Settlement Agreement (the "Agreement") with the former owners settling in all
regards its outstanding litigation. In connection with the Agreement, the former
owners received a cash payment of $450,000 and a promissory note from the
Company in the amount of $950,000 which was due and payable upon the earlier of
the (a) initial public offering of securities of the Company, (b) completion of
a private financing by the Company in the aggregate amount of at least
$4,000,000, (c) the sale or transfer of all, or substantially all of the assets
of the Company, or (d) January 10, 2002. In addition, they surrendered their
rights to the 150,000 shares of Embryo Common Stock formerly granted to them and
one of the former owners surrendered the 250,000 shares of the Company's Common
Stock formerly issued to him under the terms of an employment agreement. The
note was extended numerous times until it was paid in full on August 8, 2003
(see Note 6).
For the years ended April 30, 2004 and 2003, amortization expense related to the
purchased technology, amounted to approximately $114,000. The amortization
expense will approximately be $85,000 for the year ending April 30, 2005.
F-23
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Notes and interest payable Note
Payable, Purchased Technology
At April 30, 2003, notes and interest payable includes $191,827 due to the
parties within the Agreement (see Note 5). The obligation was paid in full in
August 2003.
Note Payable, Manufacturing Equipment
On January 24, 1997, the Company 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 funds were transferred
directly from the lender to the seller of the equipment. The note is
collateralized by the related equipment.
On January 23, 2001, the note was amended and restated in the amount of $793,053
which was the aggregate amount of the original note plus interest through the
date of the restated note. The amended note bears interest at 8%, payable
quarterly, and was due on January 23, 2002. On December 9, 2001, the note was
again amended and restated in the amount of $793,053 which was originally due on
January 23, 2002. The amended note bears interest at 8%, payable quarterly, and
called for a principal payment of $250,000 on January 23, 2002, and the balance
on January 23, 2003. At April 30, 2003, the Company was in default for the
non-payment of the $250,000 payment due on January 23, 2002 and for the $543,053
payment due on January 23, 2003.
On April 21, 2004, the lender agreed to amend and restate the note in the amount
of $793,053 upon the Company's entering into a Share Exchange Agreement with
Nesco (see Note 19) which occurred on April 29, 2004. The amended note bears
interest at 11% (the default rate) until such time that an aggregate interest
payment of $84,000 is made, which was due July 3, 2004 but which was extended to
August 16, 2004, interest from such date forward until the maturity date shall
be at the interest rate of 8% payable at maturity. The Company has paid interest
through December 31, 2002 and has accrued interest at 11% through April 30,
2004. The Company is required to repay the principal in the amount of ten (10)
percent of any equity funding in excess of $500,000. Accordingly, after the
Company collected $705,000 from the issuance of Senior Convertible Notes in July
2004 (see Note 2), the Company repaid $20,500 in principal. The Company also
made an interest payment of $84,000. The balance of the note and additional
accrued interest at April 30, 2004 and 2003 is $909,368 and $814,201 and is due
on December 31, 2005. Accrued interest was $116,315 and $21,148 as of April 30,
2004 and 2003, respectively.
7. Convertible debentures
Convertible Debentures - Related Party
On October 12, 1999, a related party loaned CSI $200,000 under the terms of a
promissory note. The note bears interest at 8%, is collateralized by the assets
of CSI, and was due with interest on October 12, 2002.
On November 3, 2000, this related party loaned the Company an additional
$200,000 under the terms of a promissory note. The note bears interest at 10%
and was due on September 30, 2002. In addition, the related party was granted
options to purchase 50,000 shares of the Company's common stock at an exercise
price of $3.50 per share for a period of ten (10) years. The fair value of the
options ($78,958) was amortized over the life of the loan.
F-24
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Convertible debentures (continued)
On August 31, 2001, this related party loaned the Company an additional $180,000
under the terms of a promissory note. The note bears interest at 10% and was due
on September 30, 2002. On June 19, 2002, the Company repaid $30,000 to this
related party.
On September 30, 2002, the above notes in the aggregate of $550,000 were
consolidated into one promissory note. The note bears interest at the same rates
as the original notes and was due on December 31, 2002. In addition, the related
party was granted warrants to purchase 17,500 shares of the Company's Series B
Preferred stock at an exercise price of $3.00 per share for a period of ten (10)
years. The fair value of the warrants ($22,033) was amortized over the life of
the loan.
On December 24, 2002, this related party loaned the Company an additional
$160,000. On December 31, 2002 all of the above outstanding debt due to the
related party was consolidated into one convertible debenture in the amount of
$710,000. The debenture bears interest at 8% and was due on April 30, 2003. The
debenture is convertible to Series B Preferred stock at a price of $3.00 per
share. The related party was also granted warrants to purchase Series B
Preferred Stock in an amount equal to 50% of the debenture amount ($355,000) at
$3.00 per share or 118,333 shares, which expire on April 30, 2012. The fair
value of the warrants ($125,344) was amortized over the life of the loan.
On June 21, 2002, the Company issued a series of convertible debentures in the
aggregate of $500,000 of which $200,002 were issued to this related party. The
debentures bear interest at 8% and were due on April 30, 2003. Each debenture is
convertible to Series B Preferred Stock at a price of $3.00 per share. The
related party was also granted warrants to purchase Series B Preferred Stock in
an amount equal to 50% of the debenture amount ($100,000) or 33,333 shares at an
exercise price of $3.00 per share, which expire on April 30, 2012. The fair
value of the warrants ($36,814) was amortized over the life of the debentures.
On May 1, 2003, the related party agreed to extend the due date for the above
two debentures in the aggregate of $910,002 to October 31, 2003. In
consideration for the extension, the party was granted warrants to purchase
Series B Preferred Stock in an amount equal in shares of 5% of the debenture
amount (45,500 shares) at an exercise price of $3.00 per share, which expire on
April 30, 2012. The fair value of the warrants ($57,684) was amortized over the
life of the loan extension.
On March 7, 2003, this related party loaned the Company an additional $200,000
under the terms of a convertible debenture. The debenture bears interest at 8%
and was due on October 31, 2003. The debenture is convertible to Series B
Preferred stock at a price of $3.00 per share. The related party was also
granted warrants to purchase Series B Preferred Stock in an amount equal to 50%
of the debenture amount ($100,000) at $3.00 per share or 33,333 shares, which
expire on April 30, 2012. The fair value of the warrants ($35,308) was amortized
over the life of the loan. As of April 30, 2003, the unamortized portion of the
fair value of the warrants was $27,646.
On August 7, 2003, this related party loaned the Company an additional $198,000
under the terms of a convertible debenture. The debenture bears interest at 8%
and was due on October 31, 2003. The debenture is convertible to Series B
Preferred stock at a price of $3.00 per share. The related party was also
granted warrants to purchase Series B Preferred Stock in an amount equal to 50%
of the debenture amount ($99,000) at $3.00 per share or 33,000 shares, which
expire on April 30, 2012. The fair value of the warrants ($33,579) was amortized
over the life of the loan.
On April 19, 2004, the related party agreed to extend the due dates of the four
outstanding debentures in the aggregate of $1,308,002 and accrued interest in
the amount of $135,106 until December 31, 2005 upon the closing of the Share
Exchange Agreement with Nesco. This transaction was completed on May 25, 2004
(see Note 19).
F-25
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Convertible debentures (continued)
Convertible Debentures - Other
On January 10, 2002, the Company received a bridge loan in connection with a
private placement. The aggregate loan in the amount of $475,000, which bears
interest at 8%, was due upon the earlier of April 15, 2002, or immediately upon
the closing of any additional private placement subsequent to the date of the
note of a minimum of $650,000. The lender, as consideration for the loan, was
also paid a 5% fee of $23,750, granted 40,000 shares of common stock which were
valued at $3 per share, and issued warrants to purchase 50,000 shares of the
Company's common stock at an exercise price of $3 per share for a period of ten
(10) years. The pro rata fair value of the stock issued ($86,015), the warrants
granted ($48,511) and the lenders fee ($23,750) were amortized over the loan
term which expired on April 15, 2002. The Company repaid $150,000 of the
principal balance on February 28, 2002. On May 1, 2002, a restated promissory
note was issued for the $325,000 outstanding balance. The restated loan, which
bears interest at 8%, was due on April 30, 2003. The lender was also granted
warrants to purchase 50,000 shares of the Company's common stock at an exercise
price of $3 per share which expire on April 1, 2012. The fair value of the
warrants ($56,014) was amortized over the life of the loan. The loan is
collateralized, under the terms of a security agreement, by the assets of the
Company. On May 1, 2003, the lender agreed to exchange the restated promissory
note for a convertible debenture of the same amount ($325,000) and to extend the
due date to October 31, 2003. The debenture is convertible to Series B Preferred
stock at a price of $3.00 per share and bears interest at 8%. In consideration
for the exchange and extension, the lender was granted warrants to purchase
Series B Preferred Stock in an amount equal in shares of 5% of the debenture
amount (16,250 shares) at an exercise price of $3.00 per share, which expire on
April 30, 2012. The fair value of the warrants ($20,601) was amortized over the
life of the loan extension.
On June 21, 2002, the Company issued a series of convertible debentures in the
aggregate of $500,000, of which $200,002 were issued to a related party. The
debentures bear interest at 8% and were due on April 30, 2003. Each debenture is
convertible to Series B Preferred Stock at a price of $3.00 per share. Each
purchaser was also granted warrants to purchase Series B Preferred Stock in an
amount equal to 50% of the debenture amount ($150,000) or 50,000 shares at an
exercise price of $3.00 per share, which expire on April 30, 2012. The fair
value of the warrants ($55,221) was amortized over the life of the debentures.
On May 1, 2003, the parties agreed to extend the due date for the series of
debentures in the aggregate of $300,000 to October 31, 2003. In consideration
for the extension, each party was granted warrants to purchase Series B
Preferred Stock in an amount equal in shares of 5% of the debenture amount
(15,000 shares) at an exercise price of $3.00 per share, which expire on April
30, 2012. The fair value of the warrants ($19,016) was amortized over the life
of the loan extension.
On April 19, 2004, the lenders agreed to extend the due dates of all debentures
in the aggregate amount of $624,998 and accrued interest in the amount of
$106,222 until December 31, 2005 upon the closing of the Share Exchange
Agreement with Nesco. This transaction was completed on May 25, 2004 (see Note
19).
8. Bridge loan, merger candidate
On April 29, 2004, the Company entered into a Share Exchange Agreement with
Nesco Industries, Inc. ("Nesco"), a Nevada publicly held Corporation, whereby
the Company would become a majority owned subsidiary of Nesco and upon
completion of the Share Exchange Agreement, the holders of the Company's common
stock and debt would hold a majority interest of Nesco. This exchange was
completed on May 25, 2004 as more fully described in Note 19. The Company
received net cash of approximately $328,000 as part of the terms of the
agreement, of which approximately $208,000 was received as a bridge loan prior
to April 30, 2004 and is included in current liabilities at April 30, 2004.
F-26
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Customer deposits
At April 30, 2004 and 2003, approximately $831,000 and $508,000, respectively,
of customer deposits represents deposits from a customer to be applied against
future purchase orders. The deposits are non-refundable but applicable to future
purchases from the Company until December 31, 2008. To the extent that any
portion of the deposits is not used for purchases by the end of calendar year
2008, the deposits will be forfeited.
10. Due to affiliates
Due to affiliates at April 30, 2004 and 2003 of approximately $244,000 and
$138,000, respectively, consists of unpaid rents of approximately $229,000 and
$69,000 at April 30, 2004 and 2003, respectively and the aggregate due under a
revolving line of credit. The line, which bears interest at 8% per annum,
provided for maximum borrowing of $850,000. The original line of credit, which
expired on January 31, 1999, was extended to January 31, 2001. On February 1,
2001, the affiliate agreed to extend the maturity date by an additional twenty
(20) months to September 30, 2002. The terms of the extension prohibited any
future cash advances on the credit line and provided for repayment of an amount
equal to 50% of any cash flow from operations in excess of $500,000 annually to
be paid within 45 days of the fiscal year end of the Company, with any remaining
outstanding balance due on September 30, 2002. On September 30, 2002 the Company
was unable to repay the outstanding balance in full but has continued to make
monthly payments. The outstanding balance at April 30, 2004 was $15,000.
11. Due to officer
At April 30, 2004 and 2003 the Company has notes payable, including interest, of
approximately $370,000 and $270,000 respectively, to an officer of the Company.
The notes bear interest at 10% per annum and are collateralized by the accounts
receivable of the Company. Interest expense pertaining to these notes was
approximately $27,500 and $16,800 for the years ended April 30, 2004 and 2003,
respectively.
On May 1, 1999, 200,000 options, which were previously granted to this officer
under the terms of an employment agreement, were exercised at a price of $.40
and 200,000 shares of common stock were issued. The Company received a
promissory note dated May 1, 1999 from the officer in the amount of $80,000 for
payment of the shares. The note matures on May 1, 2004, bears interest at 8% and
is 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.
On May 25, 2004, the net amount of these notes was exchanged for Nesco
convertible 8% debentures which mature in December 2005 (see Note 19).
12. Stockholders' deficit
Capitalization
The Company's initial authorized capitalization consists of 20,000,000 shares of
common stock, 15,000,000 shares of Series A preferred stock and 5,000,000 shares
of preferred stock. In October 2001, the Company designated 2,000,000 of the
20,000,000 shares of preferred stock to be issued as Series B Convertible
Preferred Stock. All stock has a $.0001 par value. Each share of common, Series
A preferred, Series B preferred convertible, and preferred has one vote in all
matters.
F-27
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Stockholders' deficit (continued)
The Series B preferred shares rank senior to all common and preferred stock. The
Series A preferred stock has been retired and will not be reissued. The Series B
convertible preferred stockholders are entitled to a cumulative dividend,
payable in shares of common stock calculated at a rate of 7% of the purchase
price, issuable only upon conversion to common shares. Each share of Series B
convertible preferred stock is convertible to one share of common stock, subject
to certain anti-dilution provision adjustments. The Series B convertible
preferred shares have liquidation preference over all other shares of the
capital stock of the Company. The liquidation preference is $3.00 per share
before any distributions of assets or surplus funds to common stockholders.
Private Placement
During the year ended April 30, 2000, the Company issued 155,019 shares of
common stock at $3.50 per share for an aggregate of $542,566 in conjunction with
a private placement. During the year ended April 30, 2001, the Company issued an
additional 64,287 shares of common stock at $3.50 per share for an aggregate of
$225,005 in conjunction with this same offering.
During the year ended April 30, 2002, the Company issued 522,487 shares of
Series B convertible preferred stock at $3.00 per share in conjunction with a
private placement. The Company received net proceeds of $1,303,226 after private
placement fees and related costs. As an additional placement fee, the agent was
granted warrants to purchase 182,870 shares of the Company's common stock at an
exercise price of $3.00 per share for a period of ten years.
13. Income taxes
Income taxes have been recorded under SFAS No. 109, "Accounting for Income
Taxes." Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and (b)
operating loss carryforwards.
The tax effects of significant items comprising the Company's net deferred tax
asset as of April 30, 2004 and 2003 are as follows:
2004 2003
---- ----
Deferred tax asset
Net operating loss carryforward $3,435,000 $2,984,000
Tax basis of intangible assets in
excess of book basis 150,000 126,000
---------- ----------
Deferred tax asset 3,585,000 3,110,000
Valuation allowance (3,585,000) (3,110,000)
---------- ----------
Net deferred tax asset $ - $ -
========== ==========
The increase in valuation allowance of $475,000 and $523,000 for the years ended
April 30, 2004 and 2003 respectively is primarily attributable to the Company's
additional net operating losses. At April 30, 2004, the Company has federal and
state net operating loss carryforwards of approximately $8,590,000, which expire
beginning in 2012.
F-28
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Income taxes (continued)
Ownership changes resulting from the Company's issuance of capital stock (see
Note 19) may limit the amount of net operating loss carryforwards that can be
utilized annually to offset future taxable income. The amount of the annual
limitation is determined based upon the Company's value immediately prior to the
ownership change. Subsequent significant changes in ownership could further
affect the limitation in future years.
The following table presents the principal reasons for the differences between
the effective tax rate and the U.S. Federal statutory income tax rate
attributable to continuing operations for the years ended April 30, 2004 and
2003:
2004 2003
------ -----
U.S. federal statutory income tax rate -34.0% -34.0%
State and local statutory income tax rate
(net of Federal benefit) -7.3% -7.3%
Change in the valuation allowance 31.7% 31.5%
Other 9.6% 9.8%
------ ------
0.0% 0.0%
====== ======
14. Commitments and contingencies
Employment Agreements
In September 1997, the Company entered into five-year employment agreement with
an executive. The agreement, which took effect January 1, 1998, provides for
minimum annual compensation of $30,000, which may increase to $150,000 based
upon earnings and other contingencies, and minimum bonuses. Further, the
executive was granted options to purchase 200,000 shares of the Company's common
stock at an exercise price of $.40 per share, which were exercised in May 1999
(see Note 11). No compensation expense was recorded in the granting of options
as the exercise price approximates the fair value of the stock at the date of
grant. At April 30, 2004 and 2003, this executive is owed approximately $105,000
and $30,000, respectively under the terms of this agreement which expired on
December 31, 2002.
On January 1, 2000, the Company entered into a three-year employment agreement
with an executive, which provides for an aggregate minimum annual salary of
$200,000 in the first year with annual increases thereafter. In addition, the
executive will receive a semi-annual bonus of 3% of sales on certain products.
Further, the executive was granted options to purchase 200,000 shares of the
Company's common stock at a price equal to the offering price of the next
private placement ($3.50) (see Note 17). The options vest over a three-year
period and expire three years from the vesting dates. No compensation expense
was recorded in the granting of options as the exercise price approximates the
fair value of the stock at the date of grant. At April 30, 2004 and 2003, this
executive is owed approximately $439,000 under the terms of this agreement which
expired on December 31, 2002.
On May 25, 2004, approximately $544,000 of accrued payroll relating to the above
agreements was exchanged for Nesco convertible 8% debentures which mature in
December 2005 (see Note 19).
F-29
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Commitments and contingencies (continued)
Consulting Agreements
On February 1, 2001, the Company entered into a one-year consulting agreement
which provided for an aggregate annual fee of $200,000 to be payable monthly
commencing with two monthly installments payable on May 31, June 30, and July
31, and the last day of the month thereafter. The agreement also provides for a
sales incentive bonus, a budget incentive bonus and a profit incentive bonus
based on sales and performance. In addition, the consultant was granted options
to purchase 50,000 shares of common stock exercisable for a period of five (5)
years at $3.50 per share (see Note 17). The fair value of the options ($45,357)
was charged to operations over the term of the agreement. At April 30, 2003, the
Company has paid the consultant an aggregate of $157,000. The remaining balance
of $43,000, which is included in current liabilities at April 30, 2003, was paid
during the fiscal year ended April 30, 2004.
15. Related party transactions
The Company entered into a seven-year sub-lease agreement for a manufacturing
facility with Embryo, effective February 14, 1997, which provided for minimum
monthly rental payments of $9,625 and expires in 2004. In February 2000, the
monthly rent was increased to $10,214 per the escalation provision in the
sublease.
On January 25, 2002, this manufacturing facility was purchased by an entity
owned by a related party of the Company and the Company entered into a lease
with the related party, 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 (see Note 7) due to the related party, 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.
On December 1, 2001, the Company, along with other co-tenants, entered into a
month-to-month lease for office space with an entity owned by a related party of
the Company, which provided for a monthly lease payment of $3,735. This lease
payment was reduced to $2,500 per month effective November 1, 2003 due to
reallocation of the space with other tenants.
Minimum annual rentals under the manufacturing facility lease are approximately
as follows:
Year ending April 30,
2005 $ 162,000
2006 164,000
2007 170,000
2008 172,000
2009 179,000
Thereafter 509,000
--------------
$ 1,356,000
Rent expense for the years ended April 30, 2004 and 2003 was approximately
$186,000 and $185,000, respectively.
F-30
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. Major customers
The Company generated revenues from four major customers during fiscal 2004 and
two major customers in 2003 aggregating approximately $420,000 and $674,000,
respectively. Accounts receivable from these customers aggregated approximately
$46,000 and $8,000 at April 30, 2004 and April 30, 2003, respectively.
17. Stock options and warrants
Stock Options
A summary of common stock options are as follows:
Number of Exercise Weighted Average
Options Price Exercise Price
-----------------------------------------------------------------------------------------------------
Balance outstanding 425,000 $1.00-3.50 $2.76
May 1, 2003
Expired (66,666) 3.50 3.50
-----------------------------------------------------------------------------------------------------
Balance outstanding
April 30, 2003 and 2004 358,334 $1.00-3.50 $2.63
======================================================================================================
Exercisable
April 30, 2004
358,334 $1.00-3.50 $2.63
======================================================================================================
Further information about the Company's outstanding stock options at April 30,
2004 is as follows:
Weighted
Average Weighted
Number Remaining Average
Range of of Contractual Exercise
Exercise Prices Shares Life (in Years) Price
- ----------------------------------------------------------------------------------------------------
$1.00 125,000 N/A $ 1.00
$3.50 233,334 2.53 $ 3.50
- ----------------------------------------------------------------------------------------------------
358,334 N/A $ 2.76
======================================================================================================
F-31
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. Stock options and warrants (continued)
Warrants
For the years ended April 30, 2004 and 2003, warrant activity is as follows:
Exercise Price Type of Warrants Balance Warrants Balance, Warrants Balance,
per Share Stock Expiring May 1, 2002 Granted April 30, 2003 Granted April 30, 2004
------------- ------- --------- ----------- -------- ------------- -------- --------------
3.00 Common 01/17/2011 50,000 50,000 50,000
3.00 Common 06/04/2011 17,500 17,500 17,500
3.00 Common 01/10/2012 50,000 50,000 50,000
3.00 Common 04/01/2012 182,870 182,870 182,870
3.00 Common 04/30/2012 50,000 50,000 50,000
3.00 Preferred 04/30/2012 252,500 252,500 109,750 362,250
---------------------------------------------------------------------------
300,370 302,500 602,870 109,750 712,620
===========================================================================
All warrants outstanding at April 30, 2004 are exercisable.
18. Employee benefit plan
The Company maintains a 401(k) plan that allows all full-time employees to
participate immediately in the plan. The plan is funded 100% by employee
contributions as the Company does not make any matching contributions.
19. Subsequent events
Share Exchange Agreement
On April 29, 2004, the Company entered into a Share Exchange Agreement with
Nesco, a Nevada publicly held corporation, whereby the Company would become a
majority owned subsidiary of Nesco and upon completion of the Share Exchange
Agreement, the holders of the Company's common stock and debt would hold a
majority interest of Nesco. This exchange was completed on May 25, 2004. Nesco
was previously engaged in asbestos abatement contracting but had ceased
operations in May 2003.
Nesco had intended to issue shares of its common stock in exchange for the
equity securities of the Company in certain ratios as provided for in the
Exchange Agreement. However, because Nesco 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
("Preferred Stock") for, among others, equity and debt of the Company. Upon
filing of the 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 Preferred Stock will be automatically converted into
shares of Nesco Common Stock.
F-32
HYDROGEL DESIGN SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
19. Subsequent events (continued)
On May 25, 2004, the Company's common shareholders 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 common
shares for every 1 share of the Company's common stock). The Company's preferred
shareholders 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 common stock
(a ratio of approximately 36 Nesco common shares for 1 share of the Company's
preferred stock). Approximately 72% of the common and 57% of the preferred
shareholders exchanged their shares at this time. This resulted in approximately
44.6% of Nesco's voting securities exchanged and owned by the Company's
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 Nesco's voting securities owned by the Company's stockholders upon
exchange of all outstanding the Company's securities. In addition, all
outstanding warrants and options of the Company were exchanged for Nesco
warrants based on the same ratios as the common and preferred share exchange.
In addition, Nesco was required to retain net cash of approximately $350,000 and
to dispose of all of its subsidiaries as part of the terms of the agreement, of
which approximately $208,000 was received as a bridge loan prior to April 30,
2004 and is included in current liabilities at April 30, 2004. This bridge loan
became part of the closing requirements in May 2004.
The accounting of the transaction will differ from its legal form, as the
Company will be considered the accounting acquirer and Nesco the acquired
entity. The transaction will be accounted for as a reverse acquisition under the
purchase method of accounting, whereby the assets of Nesco will be revalued and
the purchase price allocated to those assets acquired and liabilities assumed.
The Company's historical financial statements will be carried forward as those
of the combined entity. The results of operations for Nesco are not reflected in
the accompanying consolidated statements of operations.
Current Debt Exchanges and Extensions
As a result of the Share Exchange Agreement which was completed on May 25, 2004,
the convertible debentures due to related party in the aggregate principal
amount of $1,308,000, the convertible debentures in the aggregate principal
amount of $625,000, the amount due to officer in the aggregate amount of
approximately $258,000 and accrued payroll of approximately $544,000
representing primarily payroll due to current and former officers were all
exchanged for Nesco convertible 8% debentures which mature on December 31, 2005.
Investment Banking Agreement
In June 2004, Nesco entered into an Investment Banking Agreement with a third
party whereby Nesco would issue 8% Senior Convertible Notes to investors for an
aggregate of a minimum of $250,000 and a maximum of $1,700,000. In June and July
2004, the Company received approximately $634,500 in connection with this
transaction, net of expenses of $70,500.
F-33
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 24. Indemnification of Directors
Our Articles of Incorporation contain a provision permitted by the Nevada
General Corporation law (NGCL) which eliminates the personal liability of
directors for monetary damages for breach of their fiduciary duty of care which
arises under state law. Although this does not change the directors? duty of
care, it limits legal remedies which are available for breach of that duty to
equitable remedies, such as an injunction or rescission. This provision has no
effect on directors' liability for: (1) breach of the directors? duty of
loyalty; (2) acts or omissions not in good faith or involving intentional
misconduct or known violations of law; and (3) approval of any transactions from
which the directors derive an improper personal benefit.
The NGCL empowers us to indemnify officers, directors, employees and others
from liability in certain circumstances such as where the person successfully
defended himself on the merits or acted in good faith in a manner reasonably
believed to be in the best interests of the corporation. Our Bylaws require
indemnification, to the fullest extent permitted by the NGCL, of any person who
is or was involved in any manner in any investigation, claim or other proceeding
by reason of the fact that such person is or was a director or officer of us, or
of another corporation serving at our request, against all expenses and
liability actually and reasonably incurred by such person in connection with the
investigation, claim or other proceeding.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to our directors, officers, and controlling persons pursuant to
the foregoing provisions or otherwise, we are advised that in the opinion of the
Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable.
Item 25. Other Expenses of Issuance and Distribution
The estimated expenses of the distribution, all of which are to be borne by
us, are as follows. All amounts are estimates except the Securities and Exchange
Commission registration fee:
Registration Fee $ 4,750
Accounting Fees and Expenses 5,000
Legal Fees and Expenses 55,000
Transfer Agent's Fees and Expenses 5,000
Miscellaneous 5,250
-------
Total $75,000
=======
Item 26. Recent Sale of Unregistered Securities
In January 2002, we issued five-year warrants to purchase a total of
200,000 shares of common stock at an exercise price of $0.50 per share to KSH
Strategic Investment Fund I, LF and Cleveland Overseas, Ltd. in connection with
a January 2002 bridge loan financing of $500,000. These investors also received
secured promissory notes in the aggregate principal amount of $500,000 which
bore interest at 10% per annum. KSH Investment Group, Inc., a registered
II-1
broker-dealer and an affiliate of KSH Strategic Investment Fund I, LP, received
$25,000 and was granted 75,000 shares of common stock (which were issued in June
2002) as a fee for arranging the bridge loan financing. We relied on Section
4(2) of the Securities Act in issuing the warrants and shares of common stock
without registration under the Act. Under the terms of the bridge loan
financing, we have agreed to undertake to register the shares of common stock
issuable upon the exercise of the warrants issued to the bridge investors and
the shares of common stock issued to KSH Investment Group, Inc. These warrants
were cancelled in connection with the Exchange Agreement.
In June 2002, we issued 512,500 shares of our 10% Series A Convertible
Preferred Stock ("Preferred Stock") in connection with the initial closing of a
private placement of a minimum of 500,000 and a maximum of 1,000,000 shares of
our Preferred Stock to accredited investors at $2.00 per share. Each share of
Preferred Stock is convertible into four shares of common stock at a conversion
price of $0.50 per share. KSH Investment Group, Inc. served as placement agent
and received, among other things, a cash commission equal to 7.5% of the
aggregate purchase price of the shares sold, a non- accountable expense
allowance equal to 1.5% of the aggregate purchase price of the shares sold, and
warrants to purchase 402,500 shares of Common Stock as commissions in connection
with the June 2002 private placement. We relied on Section 4(2) of the
Securities Act and Rule 506 of Regulation D promulgated thereunder in issuing
the shares of Preferred Stock and warrants without registration under the Act.
Under the terms of the private placement, we have agreed to undertake to
register the common stock issuable upon the conversion of the Preferred Stock
sold and the Common Stock issuable upon the exercise of warrants issued to the
placement agent. These warrants were cancelled in connection with the Exchange
Agreement.
In May 2004 and through the period ended January 26, 2005, in connection
with the closing of the Exchange Agreement, among us, HDSI and certain
stockholders of these entities, the stockholders exchanged 50,288 shares of our
Series B Convertible Preferred Stock for 4,190,638 shares of HDSI common stock.
They also exchanged 22,657 shares of our Series B Convertible Preferred Stock
for 472,020 shares of HDSI Series B Preferred Stock. The shares of our Series B
Convertible Preferred Stock which was issued to HDSI holders will be
automatically converted into 54,708,750 shares of our common stock upon
completing the recapitalization of our capital structure. In addition, pursuant
to the Agreement, 6,500,000 shares of common stock was issued to advisers;
3,000,000 shares issued in connection with the sale of our subsidiaries and
20,000 shares of our Series B Convertible Preferred Stock issued in the
conversion of certain of our outstanding debt in the amount of $985,000 which
will be automatically converted into 15,000,000 shares of our common stock upon
completing the recapitalization of our capital structure. We relied on the
exemption available under Rule 506 of Regulation D and Section 4(2) of the Act
for the issuance of our Series B Convertible Preferred Stock and common stock.
In March 2004, Mr. Ronald Kuzon, an interim officer and consultant
exercised 1,000 warrants in a cashless exercise. An aggregate of 857,142 shares
of common stock were delivered as the excess of the fair value $0.35% of the
Stock Purchase over the exercise price was used to pay for the shares in the
aggregate of 142,858 shares.
On July 1, 2004, we entered into an investment banking agreement with Sloan
Securities Corp. for the sale of up to $3,000,000 principal amount of our 8%
senior 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 $.15 per share. Each note was issued with a five-year warrant to
purchase shares of our common stock at $.25 per share or 666,667 warrants for
each $100,000 of principal amount of notes purchased. As a result of the
agreement, which terminated on September 30, 2004, we received $2,295,000 in
gross proceeds in connection with this agreement and issued warrants to purchase
15,300,000 shares. Under the terms of the private placement we agreed to
undertake to register the common stock issuable upon the conversion of the notes
and the exercise of the warrants.
II-2
In connection with this agreement, we issued the broker warrants to
acquire 5,052,600 shares of common stock at an exercise price of $.15 per share.
We relied on the exemption available under Rule 506 of Regulation D and Section
4(2) of the Act for the issuance of these securities.
As described elsewhere, pursuant to the Exchange Agreement additional
securities were issued.
II-3
Item 27. Exhibits
Exhibit No. Description
- ----------- -----------
3.1 Articles of Incorporation as amended (a)
3.2 Bylaws as amended (a)
3.3 Certificate of Designation of 10% Series A Convertible Preferred Stock (b)
3.4 Certificate of Designation of Series B Convertible Preferred Stock (e)
3.5 Amendment to Certificate of Designation of 10% Series A Convertible
Preferred Stock(e)
3.6 Amendment to Certificate of Designations Series A Preferred Stock (f)
3.7 Amendment to Certificate of Designations Series B Preferred Stock (f)
4.1 Common Stock Certificate (a)
4.2 Form of Warrant
4.3 1999 Incentive Stock Option Plan (a)
4.4 2001 Stock Option Plan (b)
4.5 Form of Registration Rights Agreement related to the June 2002 private
placement of the Company's 10% Series A Convertible Preferred Stock (c)
4.6 Registration Rights Agreement by and between the Company and Cornell
Capital Partners LP dated August 23, 2004
4.7 Form of 8% Senior Convertible Promissory Note
5.1 Opinion of Beckman, Lieberman & Barandes, LLP *
10.1 Promissory Note issued to Santo Petrocelli, Sr. dated April 1, 2002 (d)
10.2 Promissory Note issued to Lawrence S. Polan dated April 1, 2002 (d)
10.3 Promissory Note issued to Petrocelli Industries Inc. dated April 1, 2002
(d)
10.4 Share Exchange Agreement by and among the Company, Hydrogel Design Systems,
Inc. and certain signatory stockholders of Nesco and HDSI, dated April 29,
2004 (c)
10.5 Employment Agreement between the Company and Matthew Harriton(f)
10.6 Amended and Restated Employment Agreement between the Company and Matthew
Harriton.
10.7 Securities Purchase Agreement by and between the Company and Sloan
Securities Corp., dated as of July 1, 2004.
10.8 Standby Equity Distribution Agreement by and between the Company and
Cornell Capital Partners LP, dated August 23, 2004.
10.9 Stock Purchase and Assumption Agreement dated as of May 13, 2004, as
amended, between Registrant and Nac Calabria Acquisition Corporation (f)
14 Code of Ethics
23.1 Consent of Beckman, Lieberman & Barandes, LLP (included in Exhibit 5.1
hereof)
23.2 Consent of Rothstein Kass
(a) Filed as an Exhibit with the Company's Registration Statement on Form
10-SB filed with the SEC on November 30, 1999, and incorporated by
reference herein.
(b) Filed as an Exhibit with the Company's Annual Report on Form 10-KSB
filed with the SEC on August 13, 2002, and incorporated by reference
herein.
(c) Filed as an Exhibit with the Company's Quarterly Report on Form 10-QSB
filed with the SEC on September 23, 2002, and incorporated by
reference herein.
(d) Filed as an Exhibit with the Company's Current Report on Form 8-K
filed with the SEC on April 18, 2002, and incorporated by reference
herein.
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(e) Filed as an Exhibit with the Company's Current Report on Form 8-K
filed with the SEC on June 9, 2004, and incorporated by reference
herein.
(f) Filed as an Exhibit with the Company's Quarterly Report on Form 10-QSB
filed with the SEC on October 22, 2004.
_______________________
* To be filed by amendment
Item 28. Undertakings
A. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to our directors, officers and controlling persons
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities, other than the payment by us of expenses incurred or paid by
our director, officer or controlling person in the successful defense of any
action, suit or proceeding, is asserted by such director, officer or controlling
person in connection with the securities being registered, we will, unless in
the opinion of our counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
B. We hereby undertake:
(1) To file, during any period in which offers or sales are being made, a
posteffective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a) (3) of the
Securities Act of 1933;
(ii) To specify in the prospectus any facts or events arising after
the effective date of the Registration Statement or most recent
posteffective amendment thereof which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
Registration Statement. Notwithstanding the foregoinq, any increase or
decrease in volume of securities offered, if the total dollar value of
securities offered would not exceed that which was registered, and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Securities and
Exchange Commission pursuant to Rule 424(b), Section 230.424(b) of
Regulation SB, if, in the aggregate, the changes in volume and price
represent no more than a 20% change in the maximum aggregate offering price
set forth in the "Calculation of Registration Fee" table in the effective
Registration Statement; and
(iii) To include any additional or changed material information with
respect to the plan of distribution not previously disclosed in the
Registration Statement or any material change to such information in the
Registration Statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such posteffective amendment shall be deemed to be a new
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Registration Statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a posteffective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
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SIGNATURES
In accordance with the requirements of the Securities Act of 1933, as
amended, the registrant certifies that it has reasonable grounds to believe that
it meets all of the requirements for filing on Form SB2 and has duly caused this
amendment to the registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of New York, State of New
York on the 27th day of January, 2005.
NESCO INDUSTRIES, INC.
By: /s/ Matthew L.Harriton
-----------------------------
Matthew L. Harriton
Chairman of the Board, President
and Chief Executive Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below on January 27, 2005 by the
following persons in the capacities indicated. Each person whose signature
appears below also constitutes and appoints Matthew L. Harriton, his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities to sign any and all amendments (including post-effective amendments)
to this Registration Statement, and to file the same, with all exhibits thereto
and all other documents in connection therewith, with the Commission, granting
unto said attorney-in-fact and agent full power and authority to do and perform
each and every act and thing requisite and necessary to be done, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent or his substitute or
substitutes may lawfully do or cause to be done by virtue hereof.
/s/ Matthew L. Harriton Chairman of the Board,
- ----------------------------------- President and Chief Executive Officer
Matthew L. Harriton
/s/ Karen Nazzareno
- ----------------------------------- Chief Financial and Accounting Officer
Karen Nazzareno
/s/ Richard Selinfreund
- ----------------------------------- Director
Richard Selinfreund
/s/ Geoffrey Donaldson
- ----------------------------------- Director
Geoffrey Donaldson
- ----------------------------------- Director
Gene E. Burelson
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- ----------------------------------- Director
Wayne M. Celia
/s/ Joel S. Kanter
- ----------------------------------- Director
Joel S. Kanter
/s/ Arlen Reynolds
- ----------------------------------- Director
Arlen Reynolds
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