UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For quarterly period ended October 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-28307
NESCO INDUSTRIES, INC.
(Exact name of Registrant as specified in its charter)
Nevada 13-3709558
(State or other jurisdiction of (State or I.R.S. Employer
incorporation of organization) Identification Number)
305 Madison Avenue, Suite 4510
New York, New York
(Address of principal executive offices)
10165
(Zip Code)
(212) 986-0886
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12B-2 of the Exchange Act). Yes [ ] NO [X]
State the number of shares outstanding of each of the Registrant's classes of
common equity as of the latest practicable date:
Class Outstanding at April 10, 2006
----- ------------------------------
Common Stock 20,136,225
Transitional Small Business Disclosure Format: Yes [ ] No [X]
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheet................................ 1-2
Condensed Consolidated Statements of Operations..................... 3
Condensed Consolidated Statements of Cash Flows..................... 4
Notes to Condensed Consolidated Financial Statements................ 5-14
Item 2. Management's Discussion and Analysis or Plan
of Operations.......................................... 15-19
Item 3. Controls and Procedures................................ 20
Part II. - Other Information........................................... 21
Signatures............................................................. 22
Item 1. Financial Statements
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
- --------------------------------------------------------------------------------------------------------------------------
October 31,
2005
(unaudited)
- --------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash $ 16,000
Accounts receivable 118,000
Inventories 72,000
Prepaid expenses and other current assets 24,000
------------------
Total current assets 230,000
------------------
Property and equipment, net of accumulated depreciation and amortization of $1,750,000 330,000
------------------
Other assets
Deferred financing costs 41,000
Investments and other 22,000
------------------
Total other assets 63,000
------------------
$ 623,000
==================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Note and interest payable $ 687,000
Convertible debentures and interest payable, related party, net of debt discount of $125,000 1,476,000
Convertible debentures and interest payable, other, net of debt discount of $193,000 2,986,000
Convertible debentures and interest payable, officers, net of debt discount of $10,000 886,000
Accrued penalties and interest under registration rights agreement 242,000
Customer deposits 840,000
Accounts payable and accrued expenses 422,000
Stock to be issued 237,000
Common stock subject to redemption 330,000
Due to related party and affiliates 421,000
------------------
Total current liabilities 8,527,000
------------------
Long-term liabilities
Deferred sublease income 94,000
------------------
Total non current liabilities 94,000
------------------
Commitments and contingencies
Stockholders' deficit
Series A convertible preferred stock, $.001 par value, authorized
850,000 shares, 67,000 issued and outstanding -
Series B convertible preferred stock, $.001 par value, authorized
150,000 shares, 116,687 issued and outstanding -
Common stock, $.001 par value, authorized 25,000,000 shares,
17,736,225 issued and outstanding 18,000
Additional paid-in-capital 14,004,000
Accumulated other comprehensive loss (69,000)
Accumulated deficit (21,951,000)
------------------
Total stockholders' deficit (7,998,000)
------------------
$ 623,000
==================
See notes to condensed consolidated financial statements
1
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------------------------------------------
Six Months Ended October 31, Three Months Ended October 31,
---------------------------- ------------------------------
2005 2004 2005 2004
(unaudited) (unaudited) (unaudited) (unaudited)
- --------------------------------------------------------------------------------------------------------------------
Revenues $ 633,000 $ 332,000 $ 247,000 $ 144,000
Cost of revenues 527,000 421,000 281,000 211,000
-----------------------------------------------------------------------------
Gross profit (loss) 106,000 (89,000) (34,000) (67,000)
-----------------------------------------------------------------------------
Operating expenses
General and administrative 663,000 657,000 350,000 425,000
Stock compensation charge - 2,892,000 - -
Amortization and other expenses - 107,000 - 76,000
-----------------------------------------------------------------------------
-
663,000 3,656,000 350,000 501,000
-----------------------------------------------------------------------------
Loss from operations (557,000) (3,745,000) (384,000) (568,000)
-----------------------------------------------------------------------------
Other income (expenses)
Sublease income 23,000 23,000 12,000 12,000
Amortization of debt discount (1,403,000) (901,000) (702,000) (636,000)
Interest and other expense (152,000) (104,000) (74,000) (66,000)
Interest expense, related parties (85,000) (81,000) (42,000) (42,000)
Amortization of financing costs (253,000) (149,000) (126,000) (117,000)
Liquidated damages (242,000) - (151,000) -
-----------------------------------------------------------------------------
(2,112,000) (1,212,000) (1,083,000) (849,000)
-----------------------------------------------------------------------------
Net loss $ (2,669,000) $ (4,957,000)$ (1,467,000) $ (1,417,000)
=============================================================================
Weighted average common shares
Basic and diluted 17,600,000 14,700,000 17,700,000 17,100,000
-----------------------------------------------------------------------------
Net loss per common share
Basic and diluted $ (0.15) $ (0.34)$ (0.08) $ (0.08)
=============================================================================
See notes to condensed consolidated financial statements
2
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------------------
Six Months Ended October 31,
----------------------------
2005 2004
(unaudited) (unaudited)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net loss $ (2,669,000) $ (4,957,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash stock compensation - 2,893,000
Depreciation and amortization 88,000 140,000
Amortization of debt discount 1,403,000 901,000
Amortization of financing costs 253,000 149,000
Changes in operating assets and liabilities:
Accounts receivable 6,000 (9,000)
Inventories (7,000) (3,000)
Prepaid expenses and other assets 26,000 (66,000)
Customer deposits - (8,000)
Accounts payable, accrued expenses, stock to be issued and other 535,000 (191,000)
Deferred sublease income (23,000) (23,000)
Due to affiliates 106,000 (154,000)
Interest payable 111,000 98,000
----------------------------------------
Net cash used in operating activities (171,000) (1,230,000)
----------------------------------------
Cash flows from investing activities
Net cash acquired from merger - 86,000
Purchase of equipment - (4,000)
----------------------------------------
Net cash provided by investing activities - 82,000
----------------------------------------
Cash flows from financing activities
Proceeds from issuance of convertible debentures, other - 2,009,000
Payments on notes payable - (238,000)
Payments of stock issuance costs - (88,000)
Payments on loan from officer - (7,000)
Payments from (payments to) affiliate 165,000 (15,000)
----------------------------------------
Net cash provided by financing activities 165,000 1,661,000
----------------------------------------
Net increase (decrease) in cash (6,000) 513,000
Cash
Beginning of period 22,000 1,000
----------------------------------------
End of period $ 16,000 $ 514,000
========================================
Supplemental disclosure of cash flow information,
Cash paid during the periods for interest $ - $ 87,000
========================================
See notes to condensed consolidated financial statements
3
NESCO INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------
Six Months Ended October 31,
----------------------------
2005 2004
(unaudited) (unaudited)
- ----------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash investing and financing,
activities:
Stock issued for interest payment on convertible debentures $ 93,000 $ -
========================================
Stock issued in connection with Equity Distribution Agreement $ - $ 625,000
========================================
Fair value of warrants issued to brokers $ - $ 405,000
========================================
Debt discount related to convertible debentures $ - $ 3,971,000
========================================
Reclassification of note receivable (and interest), officer,
accrued expenses, officer, and due to officer to convertible
debentures and interest payable, officer $ - $ 922,000
----------------------------------------
Balance sheet of Nesco Industries, Inc. at the date of the
Share Exchange (See Note 2):
Property and equipment $ - $ 5,000
----------------------------------------
Accounts payable and accrued expenses 177,000
Deferred sublease income 164,000
Stockholders' equity - 7,000
----------------------------------------
Total liabilities and stockholders' equity - 348,000
----------------------------------------
Elimination of intercompany bridge loan - (209,000)
----------------------------------------
Cash acquired from merger - 134,000
Expenditure of legal fees in connection with merger - (48,000)
----------------------------------------
Net cash acquired from merger $ - $ 86,000
----------------------------------------
See notes to condensed consolidated financial statements
4
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
Organization
NESCO Industries, Inc. (hereinafter referred to as "Nesco" or the "Company") is
a Nevada publicly traded corporation whose principal business is conducted
through its wholly-owned subsidiary, Hydrogel Design Systems, Inc. ("HDS"). HDS
is engaged in the manufacturing, marketing, selling and distribution of
hydrogel, an aqueous polymer-based radiation ionized gel which is used in
various medical and cosmetic consumer products. During October 2005, the Company
entered into an agreement which grants it the exclusive rights to manufacture
patented hydrophilic urethane foam products, polyurethane gels and moisture
managed foam footwear inserts and to distribute, as provided in the agreement,
these products in North America in consideration of a 7-10% royalty based on
sales. Products manufactured under this agreement will be sold for use in
cosmetic, medical, and household markets including the foot-care market under
the brand name DRYZ, a registered trademark. In January 2006, the Company formed
a wholly-owned subsidiary, Foam Manufacturing, Inc., for these manufacturing
operations. See Notes 4 and 5.
Prior to April 29, 2004, Nesco was a "shell company" having ceased business
operations and become inactive in May 2003. Prior to May 2003, Nesco was a
provider of asbestos abatement and indoor air quality testing, monitoring and
remediation services. Nesco provided services through its wholly-owned
subsidiary National Abatement Corporation ("NAC") and other wholly-owned
subsidiaries including NAC/Indoor Air Professionals, Inc. ("IAP") and NAC
Environmental Services, Inc. ("NACE").
On April 29, 2004, Nesco entered into a share exchange agreement with HDS, a
Delaware privately held corporation, whereby HDS became a majority-owned
subsidiary of Nesco and the holders of HDS common stock and debt acquired a
majority interest of Nesco. This exchange (the "Share Exchange") was completed
on May 25, 2004. The accounting for the transaction, commonly called a reverse
acquisition, resulted in a recapitalization of HDS, which was treated as the
accounting acquirer. The acquired assets and assumed liabilities of Nesco were
carried forward at their historical values which 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. See Note 2.
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 the Company 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 condensed consolidated financial statements and the
accompanying notes included herein have been prepared by the Company without
audit, in accordance with the instructions for Form 10-QSB pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC") and therefore
do not include all information and notes normally provided in the annual
financial statements and should be read in conjunction with the audited
consolidated financial statements and the notes thereto of the Company for the
year ended April 30, 2005, as amended. 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, 2005 and 2004. The results of operations for the six
month periods ended October 31, 2005 and 2004 are not necessarily indicative of
the results for the full year.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries on a consolidated basis. All
significant intercompany accounts and transactions have been eliminated.
5
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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.
Estimates
The preparation of consolidated 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 consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain prior period items have been reclassified to conform to the current
period presentation.
Note 2. Exchange of Securities
On May 25, 2004, HDS consummated the Share Exchange with Nesco whereby HDS
became a majority-owned subsidiary of Nesco, and the holders of HDS common stock
and debt acquired a majority interest of Nesco. Because the former HDS
stockholders own a majority of the voting stock of Nesco (common stock and
Series B preferred stock convertible into common stock), HDS is considered for
accounting purposes to be the acquirer in the transaction. The accounting for
the transaction, commonly called a reverse acquisition, resulted in a
recapitalization of HDS.
The Company had intended to issue shares of its common stock in exchange for the
equity securities of HDS in certain ratios as provided for in the exchange
agreement. However, because the Company 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 the Company
is authorized to issue, each share of the Series B Preferred Stock will be
automatically converted into shares of common stock. Such amendment requires
action by, or notification to, shareholders, which notification has been
reflected in a November 16, 2004 preliminary information statement filed with
the SEC. The information statement cannot be completed until all comments from
the SEC are addressed and all required filings are brought up to current
status." Upon completion of this process, the Company will file the Certificate
of Amendment and issue the common stock.
As of October 31, 2005, approximately 97% of the HDS common and 90% of the HDS
preferred shareholders have exchanged their shares. As a result, approximately
54.1% of the Company's voting securities outstanding at the time of the exchange
are now owned by HDS stockholders. The Company anticipates that the remaining
HDS shareholders will exchange their shares in the near future, which will
result in 55.3% of the Company's voting securities outstanding at the time of
the exchange being owned by HDS stockholders. Upon completion of this exchange
and the Certificate of Amendment, HDS common shareholders will exchange their
shares into 40,075,167 shares of the Company's common stock (a ratio of
approximately 9 shares of the Company's common stock for 1 share of HDS stock),
and the HDS preferred shareholders will exchange their shares into 18,809,574
shares of the Company's common stock ( a ratio of approximately 36 shares of the
Company's common stock for 1 share of HDS stock). The total shares issued to HDS
shareholders, 58,884,741 common shares, will represent 55.3% of the total shares
outstanding at the time of the exchange (106,386,847 equivalent common shares on
the May 25, 2004 exchange date).
Concurrent with the exchange, Nesco Series A Preferred shareholders agreed to
exchange 512,500 shares of stock for an aggregate of 20,500 shares of the
Company's Preferred B Stock, which will be converted into 15,375,000 shares of
the Company's common stock (a ratio of approximately 30 common shares for 1
share of Series A preferred stock). As of October 31, 2005, 445,500 shares of
Series A Preferred shares have been exchanged for 17,820 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.
6
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
As part of this transaction, Nesco conditionally transferred its three-wholly
owned subsidiaries, NAC, IAP and NACE, to a consultant and interim officer of
Nesco who resigned his position as officer at the time of the transfer. The
transferee assumed all liabilities and obligations with respect to these
subsidiaries and agreed to indemnify the Company against any claims and, in
exchange therefore, received 3,000,000 shares of common stock of the Company and
certain related registration rights. As additional consideration for the
indemnification by the transferee, the Company agreed that if the transferee
cannot in good faith resell the shares of common stock in an arm's length
transaction during the twelve month period immediately following the closing for
a price equal to the lesser of (i) all liabilities resulting from the agreement
between NAC and its labor union plus legal fees or (ii) $330,000, then the
Company will repurchase from the transferee 2,400,000 of the common shares at
that amount upon written notice from the transferee requesting such. On May 25,
2005, the Company agreed to extend the put right granted to the transferee until
May 25, 2006 subject to the condition that the right may not be exercised until
after January 1, 2006. The repurchase of the 2,400,000 common shares, which are
subject to redemption by the transferee, are included in current liabilities at
an aggregate of $330,000, the maximum amount the Company would be required to
pay in the event of redemption.
Note 3. Liquidity and Going Concern
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going concern.
At October 31, 2005, the Company had cash of approximately $16,000, an
accumulated deficit of approximately $21,951,000, a working capital deficit of
approximately $8,297,000 and, for the six months then ended, incurred a net loss
of approximately $2,669,000 and used approximately $171,000 of cash in
operations. Additionally, $5,031,000 face amount of convertible debt, together
with accrued interest and penalties, which became due in December 2005, was not
paid and is in default at this time. Notes payable of $555,000, together with
accrued interest, also became due in December 2005, was not paid and is in
default at this time. These factors, among others, raise substantial doubt about
the Company's ability to continue as a going concern. 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 continue as
a going concern. The Company's plan to deal with this uncertainty is to raise
capital, attempt to negotiate an extension of the convertible debt and note
payable and improve operations. While the Company obtained a limited amount of
additional financing for its new subsidiary subsequent to October 31, 2005,
there can be no assurance that managements plan to raise capital or improve
operations can result in the Company's continued operation as a going concern.
The 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. Manufacturing agreement and related activities
On October 3, 2005, the Company, on behalf of a wholly-owned subsidiary to be
formed, entered into a manufacturing agreement (the "Agreement") with an entity
affiliated with a Director of the Company. The Agreement grants the Company the
exclusive rights to manufacture patented hydrophilic urethane foam products,
polyurethane gels and moisture managed foam footwear inserts and to distribute,
along with the entity, these products in North America in consideration of a
7-10% royalty based on sales. The Agreement also provides for a supply agreement
between the Company and the entity. Under the Agreement the Company will
purchase certain "first line" equipment from the entity for a purchase price of
$270,000. Products to be manufactured under this Agreement will be sold for use
in cosmetic, medical, and household markets including the foot-care market under
the brand name DRYZ, a registered trademark. In December 2005, the Company
formed Foam Manufacturing, Inc. ("Foam") as a wholly-owned subsidiary of the
Company to control this activity. Foam's activities have been funded by senior
secured notes that mature on April 30, 2006 and are discussed in Note 5.
7
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
On January 18, 2006, the Agreement was amended to permit the Company additional
time to complete the required payments for the purchase of the first line
equipment under the Agreement. In February 2006, Foam executed a six year lease
for approximately 28,000 square feet of space calling for annual rentals ranging
from $159,600 in the initial year to $194,600 in the sixth year. In February
2006, the first line equipment was delivered to the new facility. In April 2006,
upon completion of setup and first production, the Company completed the
required payments to purchase the first line equipment.
The Company also may purchase under the Agreement certain "second line"
equipment on March 31, 2006 for $350,000. Such amount is payable $50,000 in cash
and $300,000 under a 3 year note with interest at prime plus 2% per annum. This
equipment has not been purchased as of April 15, 2006.
Note 5. Subsidiary Senior Secured Notes
Between December 20, 2005 and April 15, 2006, the Company raised approximately
$455,000 by issuing 11% per annum senior secured notes of Foam pursuant to a
note purchase agreement as amended and restated on February 1, 2006. Such senior
secured notes are secured by all the assets of Foam and are due on the earlier
of April 30, 2006 or the completion of a financing of at least $500,000. The
notes were issued to directors and other related parties, an affiliate as well a
third party. $100,000 of the amounts borrowed from the initial investor in the
senior secured notes may be converted into convertible debt and warrants upon
the completion of a proposed financing. Any debt discount associated with such
convertible and warrant features will be recognized once the final terms of the
proposed financing are determined. The Company intends to seek an extension of
the maturity date of these notes.
Note 6. Long-Term Debt
Note and interest payable
On January 24, 1997, HDS entered into a financing agreement with a customer for
the purchase of $600,000 of manufacturing equipment from a third party. The
agreement consisted of a promissory note in the amount of $600,000 bearing
interest at 8% per annum and principal and interest due between three (3) and
six (6) years from the anniversary date, depending upon the amount of product
the customer ordered from the Company. The note has been amended several times,
the most recent of which was on April 21, 2004. In that amendment, the lender
agreed to amend and restate the note in the amount of $793,053 upon the
completion of the Share Exchange with Nesco which occurred on April 29, 2004.
The amended note matures on December 31, 2005 and bears interest at 11%, per
annum (the default rate) until such time that an aggregate interest payment of
$84,000 was made, interest from such date forward until the maturity date
provides for interest rate of 8%, per annum payable at maturity. The Company
made the interest payment of $84,000 on July 27, 2004. In addition, the lender
agreed to release its security position on the collateral 90 days after receipt
of a payment of $200,000 against the principal balance. The Company made this
payment on August 13, 2004. The balance due on the note at October 31, 2005 is
approximately $687,000 consisting of approximately $555,000 in principal and
$132,000 of accrued interest.
This note was not paid on the amended maturity date on December 31, 2005 and is
in default at that time. The Company intends to attempt to negotiate an
extension of the term of the debt.
Interest expenses for the three and six months ended October 31, 2005
approximated $11,000 and $22,000, respectively, and for the three and six months
ended October 31, 2004 approximated 11,000 and $33,000, respectively.
Convertible debentures
The Company has the following convertible debentures outstanding at October 31,
2005:
8
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Debt Accrued
Description Due date Face amount discount interest Total
----------- -------- ----------- -------- -------- -----
Due to related parties December 31, 2005 $ 1,308,000 $125,000 $ 293,000 $1,476,000
Due to others December 1, 2005 2,920,000 193,000 259,000 2,986,000
Due to officers December 31, 2005 803,000 10,000 93,000 886,000
----------- -------- --------- -----------
Total $ 5,031,000 $328,000 $ 645,000 $ 5,348,000
=========== ======== ========= ===========
The original debt discount, quarterly amortization of debt discount and interest
expense on these instruments follows:
Original Debt Quarterly Quarterly
Description Discount Amortization interest
----------- ------------- ------------ ---------
Due to related parties $ 1,195,000 $ 188,000 $26,000
Due to others 2,683,000 499,000 59,000
Due to officers 92,000 14,000 16,000
----------- --------- --------
Total $ 3,970,000 $ 701,000 $101,000
=========== ========= ========
The conversion features and related warrant exercise prices are as follows:
Original Original Total shares Total Shares
conversion Warrant issuable on issuable
Description price Price conversion under warrants
----------- ---------- ------------- ----------- --------------
Due to related parties $0.08 $0.15 15,696,000 1,308,000
Due to others $0.08 - 0.15 $0.08-0.39 22,800,000 15,925,006
Due to officers $0.15 $0.15 5,354,747 803,230
---------- ---------
Total 43,850,747 18,036,230
========== ==========
These convertible secured notes were not paid at maturity dates in December 2005
and are therefore in default at that time. The Company is having discussions
with the holders regarding an extension of the term of the debt.
Additional information about the convertible debentures listed above follows:
Convertible Debentures - Related Party
This debt originates during the period 1999 and 2003, is payable to a related
party and is described in greater detail in Note 4 to the Company's Consolidated
Financial Statements for the year ended April 30, 2005.
In addition to the outstanding debentures, this party exchanged an aggregate of
331,500 options and warrants of HDS for an aggregate of 10,566,000 warrants of
the Company based on the same ratios in the Share Exchange discussed in Note 2.
These options/warrants are currently exercisable at prices that range between
$.08 -$.15 and expire between six and seven years. Compensation expense
approximating $889,000 was recorded on May 25, 2004 for the increase in the fair
value of these vested HDS options/warrants as a result of the Share Exchange.
The increase in the fair value was estimated on the date of the Share Exchange
using the Black-Scholes option pricing model with the following assumptions: no
dividend yield, expected volatility of 59%, risk-free interest rate of 1.38% and
two to three-year expected lives.
Convertible Debentures -- Other
These convertible debentures relate to $2,295,000 raised under an investment
banking agreement with Sloan Securities Corp. in September 2005 and $625,000
($325,000 were issued to a broker and $300,000 were issued to a series of
investors) that was originally due in 2003 and was rescheduled with the Share
Exchange discussed in Note 2. These convertible debentures are described in
greater detail in Note 4 to the consolidated financial statements for the year
ended April 30, 2005.
9
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
In addition, the parties whose debt was originally due in 2003, inclusive of
broker warrants, exchanged an aggregate of 431,619 options and warrants of HDS
for an aggregate of 11,015,820 warrants of the Company based on the same ratios
in the Share Exchange. These options/warrants are currently exercisable at
prices that range between $.08 -$.39 and expire between six and seven years.
Compensation expense approximating $872,000 was recorded on May 25, 2004 for the
increase in the fair value of these vested HDS options/warrants as a result of
the Share Exchange.
In addition, certain bridge lenders who participated in the financing with Sloan
Securities Corp. were also granted warrants to acquire 666,667 common shares at
$.15 per share. The fair value of these warrants of approximately $40,000 was
charged to debt discount in the quarter ended July 31, 2004.
On December 1, 2004 and June 9, 2005, the Company issued 390,305 and 618,815
shares, respectively, of common stock as payment for the interest due on the
amounts raised under the 2005 investment banking agreement in the aggregate of
approximately $59,000 and $93,000, respectively.
In connection with this agreement, the Company issued the broker warrants to
acquire 5,052,600 shares of common stock at an exercise price of $.15 per share.
The fair value of the warrants, $405,000, was recorded as deferred finance cost.
Additionally, financing fees in connection with this agreement approximated
$286,000 and were recorded as deferred financing cost. The aggregate deferred
financing costs of $691,000 are being charged to operations over the life of the
underlying debt at the rate of $126,000 per quarter. Amortization in the first
quarter of the agreement (July 31, 2004) was approximately $32,000 and
amortization will be approximately $41,000 in the last quarter (January 31,
2006). At October 31, 2005, the unamortized balance approximated $41,000.
In connection with this agreement, under the terms of a related registration
rights agreement, the Company was required to file a registration statement to
effectively register the common stock issuable upon the conversion of the notes
and exercise of the warrants no later than 60 days after the termination of the
offering. As the Company did not file the required registration statement until
January 27, 2005, liquidated damages in the amount of 2% per month of the
aggregate purchase price were required to be paid in cash under the terms of the
agreement. The holders of the notes agreed to accept this payment in the
aggregate of $91,800 in common stock of the Company. The fair value of the
shares due ($91,800) was charged to operations in the April 30, 2005 fiscal year
and this amount is included in current liabilities as these shares have not been
issued as of October 31, 2005. In addition, the Company was required to have the
registration statement declared effective no later than June 27, 2005. As the
registration statement has not been declared effective, liquidated damages in
the amount of 2% per month of the aggregate purchase price are required to be
paid in cash under the terms of the agreement. Interest accrues on the unpaid
penalties at the rate of 18% per annum for each month that they are unpaid.
Liquidated damages and interest of $151,000 and $242,000 have been charged to
operations in the three and six months ended October 31, 2005, respectively.
Note 7. Customer Deposits
At October 31, 2005, approximately $831,000 of the $840,000 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, 2009. To the extent that any portion of the
deposits is not used for purchases by the end of calendar year 2009, the
deposits will be forfeited.
Note 8. Due to Affiliates
Due to affiliates at October 31, 2005 of approximately $421,000 consists
primarily of temporary advances ($240,000) due to an entity owned by related
party and unpaid rent and real estate taxes ($181,000) due to an entity
majority-owned by a director of the Company.
10
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 9. Commitments and Contingencies
Employment Agreement
On May 19, 2004, as amended on November 22, 2004, the Company entered into a
three-year employment agreement with an officer calling for annual compensation
of $120,000 until December 31, 2004, $200,000 effective January 1, 2005 and 10%
increases each year on December 31, during the term of the agreement. See Note
14 to consolidated financial statements for the year ended April 30, 2005 for a
more complete description of this agreement including bonus and stock option
provisions.
Beginning in October 2005, the Company ceased making payments on this agreement
due to its cash deficiency. Services continue to be provided and accruals
continue to be made for unpaid compensation.
Consulting Agreements
On May 25, 2004, the Company entered into a two-year consulting agreement with
an affiliate of an interim officer and consultant of the Company which provided
for the issuance of 2,000,000 shares of common stock and a minimum monthly
consulting fee of $7,500 to be credited against any other cash fees earned under
the terms of the agreement. The agreement also provides for certain transaction
fees to be paid to the consultant based on sales and contracts with strategic
alliances. The fair value of the 2,000,000 shares of common stock ($300,000) was
charged to operations in the quarter ended July 31, 2004.
On May 25, 2004, the Company entered into a one-year advisory services agreement
which provided for the issuance of 681,667 shares of common stock and a minimum
monthly consulting fee of $6,250 to be credited against any other cash fees
earned under the terms of the agreement. The agreement also provides for certain
transaction fees to be paid to the consultant based on sales and contracts with
strategic alliances. The fair value of the shares (approximately $102,000) was
charged to operations in the quarter ended July 31, 2004. On December 17, 2004,
the Company terminated the agreement which was cancelable by either party after
six months. On January 5, 2005, the Company issued an aggregate of 908.89 shares
of Series B Preferred shares (convertible into 681,667 common shares) as per the
agreement.
On November 1, 2004, the Company entered into a one-year advisory services
agreement which provides for compensation of $10,000 per month, of which $1,800
shall by payable in cash and $8,200 shall be payable, at the Company's
discretion, in cash or in common stock of the Company. The common stock payment
shall be based each month on the closing bid price of the Company's common stock
on the first day of the month for which payment is due. The consultant shall
have customary piggyback registration rights with respect to any shares issued
under this agreement as of October 31, 2005, the Company has paid the monthly
minimum compensation of $1,800. The fair value of the shares due under the
agreement (approximately $98,000) has been charged to operations and this amount
is included in current liabilities as these shares have not been issued at
October 31, 2005.
On November 15, 2004, the Company entered into a one-year consulting agreement
for research and public relations services which provided for the issuance of
276,000 shares of restricted common stock and a one-time consulting fee of $500.
The fair value of the shares due under the agreement (approximately $47,000
based on the market price of $.17 on the date of the agreement) was charged to
operations in the prior fiscal year and this expense is included in current
liabilities as these shares have not been issued at October 31, 2005. In
December 2005, the Company issued 122.67 shares of Series B Preferred shares in
settlement of approximately $47,000 of this common stock to be issued at October
31, 2005. Such shares are convertible into 276,000 shares of common stock of the
Company.
On December 20, 2004, the Company entered into a one-year advisory services
agreement which provides for compensation in the form of a five year warrant to
purchase 204,000 shares of the common stock of the Company at an exercise price
of $.15. The warrants vest at the rate of 1/3 immediately, 1/3 on the six month
anniversary of the agreement and 1/3 one year from the date of the agreement.
The fair value of the warrants vested as of October 31, 2005 (approximately
$20,000) were charged to operations in the aggregate of approximately $10,000 in
the prior fiscal year and approximately $10,000 in the quarter ended July 31,
2005.
11
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Litigation
Except for the claims against former subsidiaries of Nesco, as described in
Nesco's April 30, 2005 10-KSB filing, the Company and its subsidiaries were not
involved in any other material legal proceedings during the six months ended
October 31, 2005.
The NAC entities, formerly subsidiaries of Nesco, are subject to a number of
claims and alleged violations. Pursuant to the stock purchase and assumption
agreement dated as of April 29, 2004, and completed as part of the terms of the
share exchange agreement with HDS on May 25, 2004, between Nesco and NAC
Calabria Acquisition Corporation (the "Purchaser"), the Purchaser became
responsible for all liabilities of our previous business conducted by the NAC
Entities.
Payroll Taxes
Subsequent to April 30, 2005, the Company became delinquent with regard to
certain federal payroll tax obligations. These liabilities approximated
$104,000, exclusive of penalties and interest assessed as of October 12, 2005.
The total amount of the delinquent payroll taxes due were paid on October 13,
2005 with funds advanced from a related party. The penalties and interest
assessed total approximately $10,000 and are being paid over 19 months beginning
in March 2006.
Note 8. Stockholders' Equity
Loss Per Share
Basic loss per share excludes dilution and is calculated by dividing the net
loss attributable to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted loss per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock and resulted in the
issuance of common stock. Because the Company incurred a net loss, diluted net
loss per share was the same as basic net loss per share for the three and six
months ended October 31, 2005 and 2004, since the effect of any potentially
dilutive securities would be antidilutive.
The loss per common share at October 31, 2005 includes the current outstanding
common shares in the aggregate of 20,136,225 shares less the 2,400,000 shares
which are subject to redemption (see Note 2). It does not include 116,687 shares
of Series B preferred shares which will be converted into 87,515,132 common
shares, 67,000 shares of Series A preferred shares which will be converted into
2,010,000 common shares, and 2,916,308 common shares for the prior HDS common
and preferred holders who have not yet exchanged their shares. The loss per
common share at October 31, 2004 includes the outstanding common shares as of
that date in the aggregate of 19,127,106 shares. It does not include any Series
B preferred shares, Series A preferred shares or unexchanged shares as of that
date. Although the Series A and Series B preferred shares will be automatically
exchanged for common shares upon the filing of a Certificate of Amendment to the
Certificate of Incorporation to increase the number of shares of common stock
which the Company is authorized to issue, they have been excluded from loss per
common share, in accordance with the Emerging Issues Task Force ("EITF") 03-6 as
these securities have no contractual obligation to share in the losses of the
Company.
The following supplemental pro forma information is presented to illustrate the
effects of the conversion of Series A and Series B preferred stock to common
stock for the three and six months ended October 31, 2005 and 2004:
Six months ended October 31, Three months ended October 31,
---------------------------- --------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Net Loss $(2,669,000) $(4,957,000) $ (1,467,000) $ (1,417,000)
Weighed average common shares
Outstanding, Basic and diluted 110,200,000 100,600,000 110,200,000 103,800,000
Loss per common share, basic and diluted $ (.02) $ (.05) $ (.01) $ (.01)
12
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The loss per common shares does not include an aggregate of 56,436,304 warrants
and options outstanding and 43,850,747 shares issuable under the terms of
convertible debt. The effect of these securities would be antidilutive.
Stock Based Compensation
The Company has a stock-based employee compensation plan. 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, 2005 and 2004 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
----------- -----------
2005 2004 2005 2004
---- ---- ---- ----
Net loss, as reported $ (2,669,000) $ (4,957,000) $ (1,467,000) $ (1,417,000)
Add: Total stock-based employee
compensation expense determined
under fair value based method,
net of related tax effects 30,000 180,000 15,000 30,000
---------------- ---------------- --------------- ----------------
Pro forma net loss $(2,699,000) $(5,137,000) $ (1,482,000) $(1,447,000)
================ ================ =============== ================
Net loss as reported $ (0.15) $ (0.34) $ (0.0) $ (0.08)
================ ================ =============== ================
Pro-forma net loss per share $ (0.15) $ (0.35) $ (0.0) $ (0.08)
================ ================ =============== ================
Note 10. Major Customers
Customers accounting for 10% or more of revenue for the three and six months
ended October 31, 2005 and 2004 are as follows:
Six Months Three Months
----------------- -----------------
October 31, October 31,
2005 2004 2005 2004
---- ---- ---- ----
Customer A 26% 51% - 47%
Customer B 23% - 20% -
Customer C 10% 11% 12% 13%
Customer D - - 21% -
Customer F - - 22% -
---- ---- ---- ----
59% 62% 75% 60%
==== ==== ==== ====
Accounts receivable from these customers aggregated approximately $39,000 at
October 31, 2005.
13
NESCO INDUSTRIES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 11. Subsequent Events
Convertible debt
In December 2005, $5,031,000 face amount of convertible debentures and $555,000
face amount of notes payables became due and payable together with accrued
interest as discussed further in Note 6. In addition, under a registration
rights agreement with holders of $2,295,000 of the convertible debentures,
penalties of 2% per month, plus interest on the unpaid penalties at 18% per
annum, accrue subsequent to July 27, 2005. The Company was unable to make such
repayment and penalty payments and, as such, was in default of such agreements.
Equity
In December 2005, the Company issued 122.67 shares of Series B Preferred shares
in settlement of $46,920 of Common Stock to be Issued at April 30, 2005. Such
shares are convertible into 276,000 shares of common stock of the Company.
14
Item. 2 Management's Discussion and Analysis or Plan of Operations
Forward Looking Statements
Some of the statements contained in this report discuss our plans and strategies
for our business and information concerning the ability of the Company to
service its obligations and other financial commitments as they become due or
state other forward-looking statements as this term is defined in the Private
Securities Litigation Reform Act of 1995 (the "Act"). Statements that are not
statements of historical facts may be deemed to be forward-looking statements.
The words "anticipate," "believe," "estimate," "expect," "plan," "intend,"
"should," "seek," "will," and similar expressions are intended to identify these
forward-looking statements, but are not the exclusive means of identifying them.
These forward-looking statements reflect the current views of our management.
However, various risks, uncertainties and contingencies could cause our actual
results, performance or achievements to differ materially from those expressed
in, or implied by, these statements. Our business is subject to many risks
including:
Financial Risks
* We have a limited operating history and we anticipate continued
losses.
* Our financial condition raises substantial doubt about our ability to
continue as a going concern.
Risks Related to our Business
* We are dependent on proprietary know-how. We hold limited patents.
* We are dependent on the services of key personnel the loss of which
would have a material adverse effect on us.
* We are dependent on outside suppliers for raw materials.
Risks Related to Our Industry
* We are subject to governmental regulations
* Our products are subject to obsolescence; competition in the medical
products field is intense and we represent a very small presence.
* Our products risk exposure to product liability claims.
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.
* Future sales of shares of our common stock, including sales of shares
which are convertible into common stock may negatively affect our
stock price.
* 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
* Our common stock is deemed to be "Penny Stock" which may make it more
difficult for investors to sell their shares.
For a more complete listing and description of these and other risks that the
Company faces please see our Registration Statement filed on Form SB-2. The
forward looking statements are qualified in their entirety by these cautionary
statements, which are being made pursuant to the provisions of the Act and with
the intention of obtaining the benefits of the "safe harbor" provisions of the
Act. The Company cautions investors that any forward-looking statements it makes
are not guarantees of future performance and that actual results may differ
materially from those in the forward-looking statements. We assume no obligation
to update any forward-looking statements contained in this report, whether as a
result of new information, future events or otherwise. Any investment in our
common stock involves a high degree of risk.
Background and History; Share Exchange Agreement and Acquisition
NESCO Industries, Inc. (hereinafter referred to as "Nesco" or the "Company") is
a Nevada publicly traded corporation whose principal business, since May 2004,
is conducted through its wholly-owned subsidiary, Hydrogel Design Systems, Inc.
("HDS"). HDS is engaged in the manufacturing, marketing, selling and
distribution of hydrogel, an aqueous polymer-based radiation ionized gel which
is used in various medical and cosmetic consumer products. During October 2005,
the Company entered into an agreement which grants it the exclusive rights to
manufacture patented hydrophilic urethane foam products, polyurethane gels and
moisture managed foam footwear inserts and to distribute, as provided in the
agreement, these products in North America in consideration of a 7-10% royalty
based on sales. Products manufactured under this agreement will be sold for use
in cosmetic, medical, and household markets including the foot-care market under
the brand name DRYZ, a registered trademark. In January 2006, the Company formed
a wholly-owned subsidiary, Foam Manufacturing, Inc., for these manufacturing
operations.
15
Prior to April 29, 2004, Nesco was a "shell company" having ceased business
operations and becoming inactive in May 2003. Prior to May 2003, Nesco was a
provider of asbestos abatement and indoor air quality testing, monitoring and
remediation services. Nesco provided services through its wholly-owned
subsidiary National Abatement Corporation ("NAC") and other wholly-owned
subsidiaries including NAC/Indoor Air Professionals, Inc. ("IAP") and NAC
Environmental Services, Inc. ("NACE").
On April 29, 2004, Nesco entered into a share exchange agreement with Hydrogel
Design Systems, Inc. ("HDS"), a Delaware privately held corporation, whereby HDS
became a majority-owned subsidiary of Nesco and the holders of HDS common stock
and debt acquired a majority interest of Nesco. This exchange (the "Share
Exchange") was completed on May 25, 2004. The accounting for the transaction,
commonly called a reverse acquisition, resulted in a recapitalization of HDS,
which was treated as the accounting acquirer. The acquired assets and assumed
liabilities of Nesco were carried forward at their historical values which
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 the "Company"). HDS is engaged in the
manufacturing, marketing, selling and distribution of aqueous polymer-based
radiation ionized gels ("gels" or "hydrogels") used in various medical and
cosmetic consumer products.
The Company had intended to issue shares of its common stock in exchange for the
equity securities of HDS in certain ratios as provided for in the exchange
agreement. However, the Company did not have the required number of authorized
shares of common stock to complete the exchange on this basis. As such, it
agreed to issue shares of its newly designated Series B Preferred Stock instead
of common stock. Upon filing of a Certificate of Amendment to the Certificate of
Incorporation to increase the number of shares of common stock which the Company
is authorized to issue, each share of the Series B Preferred Stock will be
automatically converted into shares of common stock. On November 16, 2004 the
Company filed a preliminary information statement with the SEC. Various comment
letters have been exchanged with the SEC." Upon completion of this process, the
Company will file the Certificate of Amendment and issue the common stock.
As of October 31, 2005, approximately 97% of the HDS common and 90% of the HDS
preferred shareholders have exchanged their shares, which has resulted in
approximately 54.1% of the Company's voting securities outstanding at the time
of the exchange owned by HDS stockholders. The Company anticipates that the
remaining HDS shareholders will exchange their shares in the near future, which
will result in 55.3% of the Company'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 the Company's Preferred B Stock, which will be
converted into 40,075,167 shares of the Company's common stock (a ratio of
approximately 9 shares of the Company's common stock 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 the Company's Preferred B Stock which will be converted
into 18,809,574 shares of the Company's common stock (a ratio of approximately
36 shares of the Company's common stock 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, the exchange date.
Concurrent with the exchange, Nesco Series A Preferred shareholders agreed to
exchange 512,500 shares of stock for an aggregate of 20,500 shares of the
Company's Preferred B Stock, which will be converted into 15,375,000 shares of
the Company's common stock (a ratio of approximately 30 common shares for 1
share of Series A preferred stock). As of October 31, 2005, 445,500 shares of
Series A Preferred shares have been exchanged for 17,820 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, Nesco conditionally transferred its three
wholly-owned subsidiaries, NAC, IAP and NACE, to a consultant and interim
officer of Nesco who resigned his position as officer at the time of the
transfer. The transferee assumed all liabilities and obligations with respect to
these subsidiaries and agreed to indemnify the Company against any claims and,
in exchange therefore, received 3,000,000 shares of common stock of the Company
and certain related registration rights. As additional consideration for the
indemnification by the transferee, the Company agreed that if the transferee
16
cannot in good faith resell the shares of common stock in an arm's length
transaction during the twelve month period immediately following the closing for
a price equal to the lesser of (i) all liabilities resulting from the agreement
between NAC and its labor union plus legal fees or (ii) $330,000, then the
Company will repurchase from the transferee 2,400,000 of the common shares at
that amount upon written notice from the transferee requesting such. On May 25,
2005, the Company agreed to extend the put right granted to the transferee until
May 25, 2006 subject to the condition that the right may not be exercised until
after January 1, 2006. The repurchase of the 2,400,000 common shares, which are
subject to redemption by the transferee, are included in current liabilities at
an aggregate of $330,000, the maximum amount the Company would be required to
pay in the event of redemption.
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 the Company subsequent to the
acquisition date of May 25, 2004.
Results of Operations
Six months ended October 31, 2005 compared to the six months ended October 31,
2004
Results of operations for the six months ended October 31, 2005 reflect the
following changes from the prior period:
October 31,
---------------------------
2005 2004 Change
---- ---- ------
Sales $ 633,000 $332,000 $ 301,000
Gross profit (loss) 106,000 (89,000) 195,000
Stock compensation charge - 2,892,000 2,892,000
Other operating expenses 663,000 764,000 (101,000)
Loss from operations (557,000) (3,656,000) (3,099,000)
Other expense (2,112,000) (1,212,000) 900,000
Net loss ($ 2,669,000) ($ 4,957,000) ($ 2,288,000)
Revenues increased by over 90% due to the stage of development of revenue
projects in the six months ended October 31, 2005 vs. 2004. Gross profit
increased approximately $195,000 due primarily to fixed overhead costs being
utilized over the higher volume of revenues. The reduction in other operating
expenses of approximately $101,000 reflects principally the completion in 2005
of amortization associated with certain licensed technology. The decrease in
other expense reflects principally, (a) an increase in amortization of debt
discount of approximately $500,000, and an increase in amortization of financing
costs of approximately $104,000 and an increase in interest expense of
approximately $48,000, in 2005 all because the related debt was outstanding
during the entire 2005 period and (b) liquidated damages of approximately
$242,000 in the six months ended October 31, 2005 associated with the Company's
failure to perform under an registration rights agreement that did not occur in
the prior period. The stock compensation charge of approximately $2,892,000 in
the six months ended October 31, 2004 is associated with transactions occurring
at that time and did not recur in the same period of 2005
Three months ended October 31, 2005 compared to the three months ended October
31, 2004
Results of operations for the three months ended October 31, 2005 reflect the
following changes from the prior period:
October 31,
--------------------
2005 2004 Change
---- ---- ------
Sales $ 247,000 $144,000 $ 103,000
Gross profit (loss) (34,000) (67,000) (33,000)
Operating expenses 350,000 501,000 (151,000)
Loss from operations (384,000) (568,000) (184,000)
Other expense (1,083,000) (849,000) 234,000
Net loss ($ 1,467,000) ($ 1,417,000) $ 50,000
17
Revenues increased by over 71% due to the stage of development of revenue
projects in 2005 vs. 2004. Gross profit increased approximately $33,000 due
primarily to fixed overhead costs being utilized by the higher volume of
revenues offset somewhat by higher direct costs. The reduction in operating
expenses of approximately $151,000 reflects (a) the completion in the six months
ended October 31, 2005 of amortization associated with certain licensed
technology (approximately $76,000) and lower legal and professional costs
subsequent to the merger and related activity in 2004. The increase in other
expense reflects principally (a) an increase in amortization of debt discount of
approximately $66,000 in 2005 as the related debt was outstanding during the
entire 2005 period and (c) liquidated damages of approximately $151,000
associated with the Company's failure to perform under an registration rights
agreement in the three months ended October 31, 2005.
Trends
The Company's revenue run rate is not yet at a level of profitable operations.
Due to the high fixed costs of maintaining a Good Manufacturing Practices
("GMP") manufacturing facility (including FDA regulated medical device
manufacturing) and trained staff, operations will likely generate operating
losses unless revenue levels increase. Revenue levels are highly dependant on
the stage of development of customer projects. Customers will often order
sporadically or in small production runs of items while they perform testing and
market analysis. It is difficult to assess when large scale production orders
may be received. While losses from operations decreased significantly in the
three and six months ended October 31, 2005, revenue levels would need to
increase significantly for the business to generate operating income.
In October 2005, the Company, on behalf of a wholly owned subsidiary
subsequently formed, entered into a manufacturing agreement (the "Agreeement")
with an entity affiliated with a Director of the Company. The agreement grants
the Company the exclusive rights to manufacture patented hydrophilic urethane
foam products, polyurethane gels and moisture managed foam footwear inserts and
to distribute, along with the entity, these products in North America in
consideration of a 7-10% royalty based on sales. The Agreement also provides for
a supply agreement between the Company and the entity. In February 2006, the
Company purchased certain equipment and in April 2006 it leased a manufacturing
facility to house the operation. Products to be manufactured under this
agreement will be sold for use in cosmetic, medical, and household markets
including the foot-care market under the brand name DRYZ, a registered
trademark. See Notes 4 and 5 to consolidated condensed financial statements for
additional details. The Company completed setup and first production in April
2006 and received its first order for approximately $271,000. This business is
being operated under a wholly-owned subsidiary, Foam Manufacturing, Inc.
("Foam").
The Company believes that there are manufacturing similarities between the Foam
products and the Hydrogel products. The Foam manufacturing facility is located a
short distance from the Company's Hydrogel facility. It is the Company's
intention to attempt to achieve synergies through the operation of Foam as well
as additional revenues. The Company believes that this could represent a
significant trend for 2006 and beyond with first year revenues projected to
exceed the revenues of Hydrogel.
There are new risks and uncertainties associated with Foam including the fact
that financing for the purchase of assets is a bridge loan that matures on April
30, 2006 and is secured by all of the Foam assets.
Liquidity, Capital Resources and Going Concern
The Company's liquidity at October 31, 2005 compared to April 30, 2005 is as
follows:
October 31, April 30,
2005 2005 Change
---------- ---------
Cash $ 16,000 $21,000 ($ 5,000)
---------- ---------- ----------
Deficit in working capital $8,297,000 $6,049,000 ($2,248,000
---------- ---------- ----------
Liabilities in excess of assets $7,998,000 $5,431,000 $2,567,000
---------- ---------- ----------
In December 2005, approximately $5,031,000 face amount of convertible notes and
approximately $555,000 face amount of notes payable became due and were not
paid. These amounts, plus interest and penalties through that date are in
18
default as of December 2005. Additionally, subsidiary senior secured notes
totaling $455,000 at April 15, 2006 come due on April 30, 2006. The Company
intends to attempt to negotiate an extension of the term of these debts.
Net cash used in operating activities in the six months ended October 31, 2005
was approximately $171,000 and that was largely funded by advances of
approximately $165,000 from a related party. The Company continues to experience
losses from operations subsequent to October 31, 2005. These factors, among
others, indicate that the Company may be unable to continue operations as a
going concern.
The Company currently does not have the liquidity or financing available to it
to fund its operations for the next 12 months without additional capital being
raised and/or forbearance from creditors. In the six months ended October 31,
2005, the following items impacted liquidity negatively:
* Losses from operations of approximately $557,000
* Amortization of debt discount of $1,403,000 which increases the
outstanding balance reported as debt
* Penalties and liquidated damages accrued of approximately $242,000
related to certain debt agreements
In the near term, the following developments have occurred subsequent to October
31, 2005 that have impact on liquidity and capital resources on a going forward
basis:
* Between December 2005 and April 15, 2006, the Company raised
approximately $455,000 through the issuance of 11% senior secured
subsidiary notes of its newly formed subsidiary, Foam. Such senior
secured notes are due on April 30, 2006 (earlier if a financing of
$500,000 or more is completed) and are secured by all of the assets of
Foam.
* The Company's Chief Executive Officer deferred payroll starting in
October 2005
The above are short-term measures aimed at providing the Company additional time
to address its significant liquidity shortage over a longer term. Over that
longer term, the Company will attempt to improve its liquidity through a
combination of measures including:
* Renegotiating the term of existing indebtedness if possible
* Increasing revenues at its Hydrogel operation
* Increasing Company wide revenues by the manufacturing agreement
executed by the Foam subsidiary
* Raising a significant amount of capital on a more permanent basis
* Other measures. Commitments for capital expenditures
The Company currently has the option, but not the commitment, to purchase
certain "second line" equipment associated with the Foam operations for
$350,000. Such amount is payable $50,000 in cash and $300,000 under a three year
note with interest at prime plus 2% per annum.
19
Item 3. Controls and Procedures
Disclosure Controls and Procedures. The Company's limited cash resources have
inhibited the Company's efforts to devote the resources necessary to file its
periodic reports with the SEC in a timely fashion during significant periods of
2005 and into 2006. In addition, the Company's Form 10-QSB for the quarter ended
July 31, 2005 and its Form 10-KSB for the year ended April 30, 2005 have been
recently restated to correct errors in the application of accounting principles
with respect to the accounting for deferred stock issuance costs in the original
such filings.
We carried out an evaluation, under the supervision and with the participation
of the our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act of 1934, as amended (the "Exchange Act")). Controls over: (a) the
application of accounting policies and (b) timely preparation and filing of
periodic reports, are within the scope of internal controls. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer concluded in
December 2005 that, as of the end of the period, as a result of the restatement
and the untimely filings, there were material weaknesses in the Company's
internal controls, as defined by the Public Company Accounting Oversight Board.
The material weaknesses related to the issues described above are being
remediated as a result of processes being implemented by the Company and by
raising capital which permits the company to apply additional resources to its
financial reporting and disclosure obligations.
Internal Controls over Financial Reporting. There have not been any changes in
our internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) that during the fiscal quarter to which this
report relates, have materially affected, or are reasonably likely to affect,
our internal control over financial reporting. Subsequent to October 31, 2005,
there were changes to the Company's internal control over financial reporting as
noted above. Additionally, in January 2006, the Company's Chief Financial
Officer resigned.
20
PART II- OTHER INFORMATION
Item 1. - Legal Proceedings
We are not currently involved in any material legal proceedings.
Item 2. - Unregistered Sale of Equity Securities and Use of Proceeds .
Not applicable.
Item 3. - Defaults Upon Senior Securities.
Not applicable.
Item 4. - Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. - Other Information.
Not applicable.
Item 6. - Exhibits
Exhibits:
10.1 Agreement between H.H. Brown Shoe Technologies, Inc. doing business as
Dicon Technologies, Hydrogel Design Systems, Inc. and a wholly owned
subsidiary of Hydrogel Design Systems, Inc. to be formed and dated
October 3, 2006
10.2 Addendum to Agreement between H.H. Brown Shoe Technologies, Inc. doing
business as Dicon Technologies, Hydrogel Design Systems Inc. and a
wholly owned subsidiary of Hydrogel Design Systems, Inc. to be formed
and dated January 18, 2006.
10.3 Amended and Restated Note Purchase Agreement by and Between Foam
Manufacturing, Inc., Chicago Investments, Inc. and The Additional
Investors Party Hereto, dated February 1, 2006
10.4 Commercial lease dated February 1, 2006 between Hamilton Transit
Corporate Center and Foam Manufacturing Inc.
31 Certification of Principal Executive and Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification of Principal Executive and Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
21
Signatures
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned there unto duly authorized.
NESCO INDUSTRIES, INC.
By: /s/ Matthew L. Harriton
Matthew L. Harriton
President and Chief
Executive Officer
Dated: April 28, 2006
22