UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 28, 2004,
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to __________.
Commission File Number: 000-17072
WINDSWEPT ENVIRONMENTAL GROUP, INC.
-----------------------------------
(Exact name of registrant as specified in its charter)
Delaware 11-2844247
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Sweeneydale Avenue, Bay Shore, New York 11706
------------------------------------------- -----
(Address of principal executive offices)
(Zip Code)
(631) 434-1300
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) 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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes No X
--- ---
The number of shares of Common Stock, par value $.0001, outstanding on
January 27, 2005 was 77,936,358.
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
WINDSWEPT ENVIRONMENTAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 28, 2004 AND JUNE 29, 2004
December 28, June 29,
2004 2004
--------------- ---------------
(Unaudited)
ASSETS:
CURRENT ASSETS:
Cash $ 346,331 $ 63,562
Accounts receivable, net of allowance for doubtful accounts of $1,400,734 and $689,140,
respectively 10,116,673 6,652,806
Inventory 119,381 151,270
Costs and estimated earnings in excess of billings on uncompleted contracts 560,044 608,047
Refundable income taxes - 641,795
Prepaid expenses and other current assets 206,657 257,565
--------------- ---------------
Total current assets 11,349,086 8,375,045
PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $6,038,758
and $5,707,705, respectively 2,482,421 2,757,463
OTHER ASSETS 170,657 198,657
--------------- ---------------
TOTAL $ 14,002,164 $ 11,331,165
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
CURRENT LIABILITIES:
Accounts payable $ 2,939,401 $ 2,309,328
Accrued expenses 1,890,122 1,101,701
Short-term notes payable to related party 5,000,000 5,000,000
Billings in excess of cost and estimated earnings on uncompleted contracts 12,081 239,511
Accrued payroll and related fringe benefits 905,399 924,725
Current maturities of long-term debt 252,592 307,224
Other current liabilities 1,210,334 596,527
--------------- ---------------
Total current liabilities 12,209,929 10,479,016
--------------- ---------------
LONG-TERM DEBT 260,228 340,104
--------------- ---------------
COMMITMENTS AND CONTINGENCIES
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK, $.01 par value; 1,300,000 shares
authorized; 1,300,000 shares outstanding at December 28, 2004 and June 29, 2004 1,300,000 1,300,000
--------------- ---------------
STOCKHOLDERS' EQUITY (DEFICIT):
Series B preferred stock, $.01 par value; 50,000 shares authorized; 0 shares outstanding - -
Nondesignated preferred stock, no par value; 8,650,000 shares authorized; 0 shares
outstanding at - -
December 28, 2004 and June 29, 2004
Common stock, $.0001 par value; 150,000,000 shares authorized; 77,936,358 shares
outstanding at December 28, 2004 and June 29, 2004. 7,794 7,794
Additional paid-in-capital 33,883,017 33,922,017
Accumulated deficit (33,658,804) (34,717,766)
--------------- ---------------
Total stockholders' equity (deficit) 232,007 (787,955)
TOTAL $ 14,002,164 $ 11,331,165
=============== ===============
See notes to consolidated financial statements.
2
WINDSWEPT ENVIRONMENTAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Thirteen Weeks Ended Twenty-Six Weeks Ended
------------------------------ --------------------------------
December 28, December 30, December 28, December 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenues $ 7,359,279 $ 6,523,473 $12,837,785 $11,783,399
Cost of revenues 4,369,867 4,909,711 8,731,991 8,839,653
------------ ------------ ------------ ------------
Gross profit 2,989,412 1,613,762 4,105,794 2,943,746
------------ ------------ ------------ ------------
Operating expenses (income):
Selling, general and administrative expenses 1,502,846 1,204,868 2,735,450 2,406,459
Benefit related to variable accounting
treatment for officer options - (189,533) - (348,625)
------------ ------------ ------------ ------------
Total operating expenses 1,502,846 1,015,335 2,735,450 2,057,834
------------ ------------ ------------ ------------
Income from operations 1,486,566 598,427 1,370,344 885,912
------------ ------------ ------------ ------------
Other expense (income):
Interest expense 55,352 31,504 266,456 59,647
Other, net (755) - (1,322) (23,960)
------------ ------------ ------------ ------------
Total other expense 54,597 31,504 265,134 35,687
------------ ------------ ------------ ------------
Income before provision for income taxes 1,431,969 566,923 1,105,210 850,225
Provision for income taxes 43,659 104,486 46,248 178,637
------------ ------------ ------------ ------------
Net income 1,388,310 462,437 1,058,962 671,588
Dividends on preferred stock (19,500) (19,500) (39,000) (39,000)
------------ ------------ ------------ ------------
Net income attributable to common shareholders $ 1,368,810 $ 442,937 $ 1,019,962 $ 632,588
============ ============ ============ ============
Basic and diluted net income per common share:
Basic $.02 $.01 $.01 $.01
===== ===== ===== =====
Diluted $.02 $.01 $.01 $.01
===== ===== ===== =====
Weighted average number of common shares outstanding:
Basic 77,936,358 77,936,358 77,936,358 77,936,358
============ ============ ============ ============
Diluted 77,961,149 79,718,239 77,980,720 80,556,368
============ ============ ============ ============
See notes to consolidated financial statements.
3
WINDSWEPT ENVIRONMENTAL GROUP, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
Common Stock Additional
Number of Par Paid-in Accumulated
Shares Value Capital Deficit Total
------ ----- ------- ------- -----
Balance at June 30, 2004 77,936,358 $7,794 $33,922,017 $(34,717,766) $(787,955)
Dividends on Series A preferred stock (39,000) (39,000)
Net income - - - - 1,058,962
------------ ------- ------------ ------------- ----------
Balance at December 28, 2004 77,936,358 $7,794 $33,883,017 $(33,658,804) $ 232,007
============ ======= ============ ============= ==========
See notes to consolidated financial statements.
4
WINDSWEPT ENVIRONMENTAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Twenty-Six Weeks Ended
-------------------------------------
December 28, December 30,
2004 2003
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,058,962 $ 671,588
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation and amortization 331,053 283,248
Provision for doubtful accounts, net 711,594 56,451
Benefit related to officer options and redeemable common stock - (348,625)
Changes in operating assets and liabilities:
Accounts receivable (4,175,461) (4,371,897)
Inventory 31,889 11,761
Costs and estimated earnings in excess of billings on uncompleted contracts 48,003 337,683
Refundable income taxes 641,795 1,080,186
Prepaid expenses and other current assets 50,908 (6,834)
Other assets 28,000 (1,064)
Accounts payable and accrued expenses 1,379,494 (235,679)
Accrued payroll and related fringe benefits (19,326) 129,090
Other current liabilities 613,807 223,663
Billings in excess of costs and estimated earnings on uncompleted contracts (227,430) (42,544)
---------------- ----------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES 473,288 (2,212,973)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (56,011) (263,678)
---------------- ----------------
NET CASH USED IN INVESTING ACTIVITIES (56,011) (263,678)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments of long-term debt (134,508) (193,027)
Proceeds from long-term debt - 160,098
Payment of preferred stock dividends - (39,000)
Proceeds from short-term notes payable to a related party - 2,525,000
---------------- ----------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (134,508) 2,453,071
---------------- ----------------
NET INCREASE (DECREASE) IN CASH 282,769 (23,580)
CASH - BEGINNING OF PERIOD 63,562 130,096
---------------- ----------------
CASH - END OF PERIOD $ 346,331 $ 106,516
================ ================
Cash paid during the period for:
Interest $ 190,098 $ 19,159
================ ================
Income taxes $ 2,250 $ -
================ ================
See notes to consolidated financial statements.
5
WINDSWEPT ENVIRONMENTAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS FOR PRESENTATION - The accompanying unaudited consolidated
financial statements include the accounts of Windswept Environmental
Group, Inc. (the "Company") and its wholly-owned subsidiaries,
Trade-Winds Environmental Restoration, Inc. ("Trade-Winds") and North
Atlantic Laboratories, Inc. The unaudited consolidated financial
statements have been prepared by the Company in accordance with
accounting principles generally accepted in the United States of
America ("generally accepted accounting principles") for interim
financial statements and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the
opinion of the Company, all adjustments (consisting of only normal
and recurring accruals) considered necessary to present fairly the
financial position of the Company and its subsidiaries on a
consolidated basis as of December 28, 2004, the results of operations
for the thirteen and twenty-six weeks ended December 28, 2004 and
December 30, 2003 and cash flows for the twenty-six weeks ended
December 28, 2004 and December 30, 2003, have been included. Certain
prior period amounts have been reclassified to conform to the
December 28, 2004 presentation.
The results for the thirteen and twenty-six weeks ended December
28, 2004 and December 30, 2003 are not necessarily indicative of
the results for the entire year. These unaudited consolidated
financial statements should be read in conjunction with the
Company's audited consolidated financial statements and notes
thereto included in the Company's Form 10-K for the fiscal year
ended June 29, 2004.
2. STOCK OPTIONS - In December 2002, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS)" No. 148, "Accounting for Stock-Based Compensation-Transition
and Disclosure - an amendment of FASB Statement No. 123 (" SFAS 148").
SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), to provide alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation and does not permit
the use of the original SFAS No. 123 prospective method of transition
in fiscal years beginning after December 15, 2003. In addition, SFAS
No. 148 amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results, regardless of
whether, when, or how an entity adopts the preferable, fair value
based method of accounting. SFAS No. 148 improves the prominence and
clarity of the pro forma disclosures required by SFAS No. 123 by
prescribing a specific tabular format and by requiring disclosure in
the "Summary of Significant Accounting Policies" or its equivalent and
improves the timeliness of those disclosures by requiring their
inclusion in financial reports for interim periods. The Company has
adopted the disclosure requirements of SFAS No. 148. The Company will
continue to account for stock-based employee compensation under APB
Opinion No. 25 and its related interpretations.
6
The following table illustrates the effect on net income and net
income per share if the Company had applied the fair value
recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation
for all periods:
Thirteen Weeks Ended Twenty-Six Weeks Ended
------------------------------------ -----------------------------------
December 28, December 30, December 28, December 30,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Net income attributable to
common shareholders
as reported $ 1,368,810 $ 442,937 $ 1,019,962 $ 632,588
Less: Stock-based
employee compensation
cost determined under
the fair value method,
net of related tax effects 25,935 41,342 51,870 82,683
--------------- --------------- --------------- ---------------
Pro forma net income
attributable to common
shareholders $ 1,342,875 $ 401,595 $ 968,092 $ 549,905
=============== =============== =============== ===============
Net income per share:
Basic - as reported $.02 $.01 $.01 $.01
===== ===== ===== =====
Basic - pro forma $.02 $.01 $.01 $.01
===== ===== ===== =====
Diluted - as reported $.02 $.01 $.01 $.01
===== ===== ===== =====
Diluted - pro forma $.02 $.01 $.01 $.01
===== ===== ===== =====
3. NET INCOME PER COMMON SHARE -The calculation of basic and diluted
net income per common share was calculated for all periods in
accordance with the requirements of Statement of Financial
Accounting Standards No. 128, "Earnings per Share."
The following table sets forth the computation of the basic and
diluted net income per share for the thirteen and twenty-six weeks
ended December 28, 2004 and December 30, 2003, respectively:
Thirteen Weeks Ended Twenty-Six Weeks Ended
------------------------------------ -----------------------------------
December 28, December 30, December 28, December 30,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Numerator:
Net income attributable to
common shareholders $ 1,368,810 $ 442,937 $ 1,019,962 $ 632,588
=============== =============== =============== ===============
Denominator:
Share reconciliation:
Shares used for basic
income per share 77,936,358 77,936,358 77,936,358 77,936,358
Effect of dilutive items:
Stock options 24,791 1,781,881 44,362 2,620,010
--------------- --------------- --------------- ---------------
Shares used for dilutive
income per share 77,961,149 79,718,239 77,980,720 80,556,368
=============== =============== =============== ===============
Net income per share:
Basic $.02 $.01 $.01 $.01
Diluted $.02 $.01 $.01 $.01
7
The dilutive net income per share computation for the thirteen and
twenty-six week periods ended December 28, 2004 excludes 3,910,309
and 3,710,309 shares, respectively, related to stock options because
the effect of including them would be anti-dilutive. The dilutive net
income per share computation for the thirteen week and twenty-six week
periods ended December 30, 2003 excludes 3,910,309 and 3,710,309
shares, respectively, related to stock options and warrants
because the effect of including them would be anti-dilutive. For
all periods presented, 1,300,000 shares of common stock issuable
upon the exercise of the Series A Redeemable Convertible Preferred
Stock were excluded from diluted earnings per share because the
effect of including them would be anti-dilutive.
4. PROVISION FOR INCOME TAXES - The provision for income taxes for
the thirteen and twenty-six weeks ended December 28, 2004 and
December 30, 2003 consists of the following:
Thirteen Weeks Ended Twenty-Six Weeks Ended
-------------------------------- -----------------------------------
December 28, December 30, December 28, December 30,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Federal - current $41,070 $101,061 $41,070 $171,787
State - current 2,589 3,425 5,178 6,850
-------- --------- -------- ---------
Total $43,659 $104,486 $46,248 $178,637
======== ========= ======== =========
The effective rate for income taxes differs from the statutory
rate primarily as a result of the utilization of federal and state
net operating losses. The Company has a 100% valuation allowance
against deferred tax assets because management believes that it is
more likely than not that such deferred tax assets will not be
realized.
5. CONTINGENCIES - On August 5, 2004, Trade-Winds commenced an action
against the New York City Economic Development Corporation (the
"EDC") in the New York State Supreme Court, County of New York,
claiming that Trade-Winds is entitled to approximately $1,255,000
of contractual billings relating to a large roof tar removal
project. On October 15, 2004, the EDC filed an answer, denying
Trade-Winds' claims. The case is currently in pre-trial discovery.
On October 22, 2004, Trade-Winds commenced an action against
Consolidated Edison Company in the New York State Supreme Court,
County of New York, claiming that Trade-Winds is entitled to
approximately $2,000,000 of contractual billings and related
damages with respect to its removal of sediment from an oil
storage tank. On December 6, 2004, Consolidated Edison Company
filed an answer, denying Trade-Winds' claims. The case is
currently in pre-trial discovery.
The Company is a party to litigation matters and claims that are
in the ordinary course of its operations, and while the results of
such litigation and claims cannot be predicted with certainty,
management believes that the final outcome of such matters will
not have a material adverse effect on the Company's consolidated
financial statements.
6. RELATED PARTY TRANSACTIONS - As of December 28, 2004, the Company owed
Spotless Plastics (USA), Inc. ("Spotless"), a company that owns 79% of
the common stock of the Company, $5,000,000, which bears interest at
the rate of LIBOR (2.55% at December 28, 2004) plus 1% per annum and
is payable on demand. As of December 28, 2004, interest of $43,641
was accrued and unpaid on these borrowings. The Company has increased
its liquidity by entering into an Account Receivable Finance Agreement
("ARFA") dated as of February 5, 2004 with Spotless pursuant to which
Spotless may purchase certain of the Company's accounts receivable
without recourse for cash, subject to certain terms and conditions.
The Company accounts for its transfers of accounts receivable to
Spotless as sales under Statement of Financial Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." Under the ARFA, Spotless may, but
is not obligated to, purchase one or more of the Company's accounts
receivable that are approved by Spotless in its sole discretion, in
respect of the particular debtor, invoices and related credit. As
part of the agreement, Spotless may purchase any accounts receivable
at a 15% discount to invoice prices, which the Company believes
is at least as favorable to it as would be available from an
unaffiliated third-party, based upon a good-faith estimate of an
applicable discount negotiated at arm's length, as
8
may be adjusted by Spotless in its sole discretion. In addition, the
Company pays varying monthly discount fees on any purchased accounts
receivable based upon invoice prices. All discounts and fees under the
ARFA are characterized as interest expense in the consolidated
statements of operations. Further, the Company (a) manages any
accounts receivable that it sells to Spotless while remitting to
Spotless any proceeds received and (b) bears any related litigation
costs. For the thirteen and twenty-six weeks ended December 28, 2004,
the Company sold approximately $0 and $972,311, respectively,
of accounts receivable to Spotless and incurred approximately $0 and
$145,846, respectively, of discounts and fees associated with these
sales.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company, through its wholly-owned subsidiaries, provides a full array of
emergency response, remediation and disaster restoration services to a broad
range of clients. The Company has expertise in areas of hazardous materials
remediation, microbial remediation, testing, toxicology, training, wetlands
restoration, wildlife and natural resources rehabilitation, technical advisory,
restoration and site renovation services.
The Company's revenues are derived primarily from providing emergency response,
remediation and disaster restoration services, and its cost of revenues consists
primarily of labor and labor related costs, insurance, benefits and job-related
insurance, repairs, maintenance, equipment rental, materials and supplies,
disposal costs and depreciation of capital equipment. The Company's selling,
general, and administrative expenses primarily consist of expenses related to
provisions for doubtful accounts, legal fees, sales salaries, marketing,
consulting, insurance and travel and entertainment.
In April 2003, the Company commenced a remediation project in New York City for
Consolidate Edison Company to remove sediment from an oil storage tank. During
the course of the project, the sediment in the tank was found to be
substantially different than the sediment that the customer represented to
be in the tank prior to the inception of the project. The Company continued
to work on the project so as not to default on the terms which it understood to
exist with the customer. The additional costs incurred to remove this matter in
the amount of approximately $1,600,000 were billed to the customer. However, the
collectibility of such monies cannot be assured. Accordingly, the Company has
not recognized the revenue associated with this claim. The project has been
substantially completed and the customer has refused to acknowledge its
liability for the additional charges billed by the Company. On October 22, 2004,
Trade-Winds commenced an action against Consolidated Edison Company in the New
York State Supreme Court, County of New York, claiming that Trade-Winds is
entitled to approximately $2,000,000 of contractual billings and related damages
with respect to its removal of sediment from an oil storage tank. On December 6,
2004, Consolidated Edison Company filed an answer, denying Trade-Winds' claims.
The case is currently in pre-trial discovery. As of August 30, 2004, all amounts
due under the original contract had been paid to the Company.
The Company has encountered slow collections of certain of its accounts
receivable, and its liquidity was severely adversely affected by its unrecouped
costs incurred in connection with the aforementioned oil storage tank project.
Accordingly, the Company needed to borrow increased amounts from Spotless. As a
result of the additional borrowings, the amount outstanding from Spotless was
$5,000,000 as of December 28, 2004. The Company has considered various
alternatives to increase its liquidity. In this connection, the Company
increased its liquidity by entering into the ARFA, dated as of February 5, 2004,
with Spotless pursuant to which Spotless has purchased certain of the Company's
accounts receivable without recourse for cash, subject to certain terms and
conditions. Through September 24, 2004, the date of the last accounts receivable
purchase, Spotless had purchased an aggregate amount of our accounts receivable
equaling $4,991,252 for an aggregate purchase price of $4,080,050.
In the opinion of management, the Company expects to have sufficient working
capital to fund its current operations as long as it does not encounter further
difficulty collecting its accounts receivable or experience significant growth.
However, market conditions and their effect on the Company's liquidity may
restrict the Company's use of cash. In the event that sufficient positive cash
flow from operations is not generated, the Company may need to seek additional
financing in addition to the financing contemplated by the ARFA or otherwise.
Spotless is under no contractual obligation to provide any funds. Currently, the
Company has no credit facility for additional borrowing.
9
Spotless has informed the Company in a letter dated September 29, 2004, that, at
that time, it intended to provide only an additional $150,000 in financing to
the Company pursuant to the ARFA. Spotless has also indicated that it does not
intend to provide any additional debt or equity financing to the Company. The
Company is assessing the impact, if any, of this situation. The Company's board
of directors appointed a special committee consisting of independent director
Anthony P. Towell to investigate its financing and strategic alternatives. The
special committee currently is considering available alternatives.
ABILITY TO CONTINUE AS A GOING CONCERN
The Company's accompanying consolidated financial statements have been prepared
assuming that it will continue as a going concern. They do not include any
adjustments that might result should the Company be unable to continue as a
going concern, and no assurance can be given that it will continue as a going
concern.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of its financial position and results of
operations are based upon the Company's unaudited consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
unaudited financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosure of contingent assets and liabilities. Actual
results could differ from those estimates. Management believes that the critical
accounting policies and areas that require the most significant judgments and
estimates to be used in the preparation of the unaudited financial statements
are accounting for contracts, allowance for doubtful accounts and the valuation
allowance against deferred tax assets.
Contract Accounting - Revenue derived from services provided to customers over
periods of less than one month is recognized at the completion of the related
contracts. Revenue from firm fixed price contracts that extend over periods of
one month or more is recognized using the percentage-of-completion method,
measured by the percentage of costs incurred to date compared to estimated total
costs for each contract. Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are determined. Changes in
job performance, job conditions, estimated profitability, the effect of contract
penalty provisions and final contract settlements may result in revisions to
estimates of costs and income and are recognized in the period in which the
revisions are determined. Revenues from time and material contracts that extend
over a period of more than one month are recognized as services are performed.
Allowance for Doubtful Accounts - The Company maintains an allowance for
doubtful trade accounts receivable for estimated losses resulting from the
inability of its customers to make required payments. In determining
collectibility, the Company reviews available customer financial information
including public filings and credit reports and also consults legal counsel to
assist in determining collectibility. When it is deemed probable that a specific
customer account is uncollectible, that balance is included in the reserve
calculation. Actual results could differ from these estimates under different
assumptions.
Deferred Tax Asset Valuation Allowance - The Company records a valuation
allowance to reduce its deferred tax assets to the amount that is more likely
than not to be realized. Due to the Company's prior history of losses, the
Company has recorded a full valuation allowance against its net deferred tax
assets as of December 28, 2004. The Company currently provides for income taxes
only to the extent that it expects to pay cash taxes for current income. Should
the Company be profitable in the future at levels which cause management to
conclude that it is more likely than not that it will realize all or a portion
of the deferred tax assets, the Company would record the estimated net
realizable value of the deferred tax assets at that time and would then provide
for income taxes at its combined federal and state effective rates.
10
RESULTS OF OPERATIONS
THIRTEEN WEEKS ENDED DECEMBER 28, 2004 AND DECEMBER 30, 2003
REVENUE
Total revenues for the thirteen weeks ended December 28, 2004 increased by
$835,806, or 13%, to $7,359,279 from $6,523,473 for the thirteen weeks ended
December 30, 2003. This increase was primarily attributable to increased
emergency response work associated with hurricanes in Florida.
Cost of Revenues
Cost of revenues decreased $539,844 or 11%, to $4,369,867 for the thirteen weeks
ended December 28, 2004 as compared to $4,909,711 for the thirteen weeks
ended December 30, 2003, primarily due to a greater proportion of emergency
response work related to hurricanes in Florida and equipment-intensive projects
with higher gross margins and a corresponding reduction in labor costs. Gross
profit increased $1,375,650 or 85%, to $2,989,412 for the thirteen weeks ended
December 28, 2004 from $1,613,762 for the thirteen weeks ended December 30,
2003.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $297,978, or 25%, to
$1,502,846 for the thirteen weeks ended December 28, 2004 from $1,204,868 for
the thirteen weeks ended December 30, 2003 and constituted approximately 20% and
18%, respectively, of revenues in each period. This increase was primarily
attributable to increases in bad debt expense of approximately $400,000 and
legal expenses of approximately $108,000, offset by decreases in consulting
expenses of approximately $110,000 and sales salaries of approximately $75,000.
All of these decreases were a result of management reductions in staff and
discretionary spending.
Benefit Related to Variable Accounting Treatment for Officer Options
Under the terms of an employment agreement with the Company and a separate
agreement with Spotless, the Company's President and Chief Executive Officer may
sell to the Company, or in certain circumstances to Spotless, all shares of
common stock of the Company held by him and all shares of common stock
underlying vested options to purchase shares of common stock of the Company held
by him upon the occurrence of certain events. The benefit related to variable
accounting treatment for officer options was $189,533 for the thirteen weeks
ended December 30, 2003. There was no benefit or expense required to be recorded
in the thirteen weeks ended December 28, 2004 due to the low market price of the
Company's common stock. The benefit in the thirteen weeks ended December 30,
2003 was due to a decrease in the market price of the Company's common stock
and/or a change in the number of options outstanding that are vested. Due to the
terms of the options, changes in the market price of the Company's common stock,
in either direction, result in a corresponding expense or benefit.
Interest Expense
Interest expense increased by $23,848 to $55,352 for the thirteen weeks ended
December 28, 2004 from $31,504 for the thirteen weeks ended December 30, 2003.
The increase in interest expense was primarily attributable to greater amounts
of debt outstanding resulting from increased borrowings from Spotless for
working capital.
Provision for Income Taxes
The provision for income taxes for the thirteen weeks ended December 28, 2004
was $43,659 compared to $104,486 for the thirteen weeks ended December
30, 2003.
11
Net Income
Net income of $1,388,310 was incurred for the thirteen weeks ended December 28,
2004 as compared to net income of $462,437 incurred for the thirteen weeks ended
December 30, 2003. The change was the result of the factors discussed above.
TWENTY-SIX WEEKS ENDED DECEMBER 28, 2004 AND DECEMBER 30, 2003
Revenue
Total revenues for the twenty-six weeks ended December 28, 2004 increased by
$1,054,386, or 9%, to $12,837,785 from $11,783,399 for the twenty-six weeks
ended December 30, 2003. This increase was primarily attributable to increased
emergency response work associated with hurricanes in Florida.
Cost of Revenues
Cost of revenues decreased $107,662 or 1%, to $8,731,991 for the twenty-six
weeks ended December 28, 2004 as compared to $8,839,653 for the twenty-six weeks
ended December 30, 2003, primarily due to a greater proportion of emergency
response work related to the hurricanes in Florida and equipment-intensive
projects with higher gross margins and a corresponding reduction in labor
costs. Gross profit increased $1,162,048 to $4,105,794 for the twenty-six weeks
ended December 28, 2004 from $2,943,746 for the twenty-six weeks ended
December 30, 2003.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $328,991, or 14%, to
$2,735,450 for the twenty-six weeks ended December 28, 2004 from $2,406,459 for
the twenty-six weeks ended December 30, 2003 and constituted approximately 21%
and 20%, respectively, of revenues in each period. This increase was primarily
attributable to increases in bad debt expense of approximately $475,000 and
legal expenses of approximately $277,000, offset by decreases in sales salaries
and sales travel and entertainment of approximately $222,000, marketing expenses
of approximately $123,000 and consulting expenses of approximately $60,000. All
of these decreases were a result of management reductions in staff and
discretionary spending.
Benefit Related to Variable Accounting Treatment for Officer Options
Under the terms of an employment agreement with the Company and a separate
agreement with Spotless, the Company's President and Chief Executive Officer may
sell to the Company, or in certain circumstances to Spotless, all shares of
common stock of the Company held by him and all shares of common stock
underlying vested options to purchase shares of common stock of the Company held
by him upon the occurrence of certain events. The benefit related to variable
accounting treatment for officer options was $348,625 for the twenty-six weeks
ended December 30, 2003. There was no benefit or expense required to be recorded
in the twenty-six weeks ended December 28, 2004 due to the low market price of
the Company's common stock. The benefit in the twenty-six weeks ended December
30, 2003 was due to a decrease in the market price of the Company's common stock
and/or a change in the number of options outstanding that are vested. Due to the
terms of the options, changes in the market price of the Company's common stock,
in either direction, result in a corresponding expense or benefit.
Interest Expense
Interest expense increased by $206,809 to $266,456 for the twenty-six weeks
ended December 28, 2004 from $59,647 for the twenty-six weeks ended December 30,
2003. The increase in interest expense was primarily attributable to the
discount recorded when Spotless purchased accounts receivable from the Company
under the ARFA and greater amounts of debt outstanding resulting from increased
borrowings from Spotless for working capital. For the twenty-six weeks ended
December 28, 2004, the Company incurred $145,846 of discounts and fees
associated with the sale of accounts receivable under the ARFA.
12
Provision for Income Taxes
The provision for income taxes for the twenty-six weeks ended December 28,
2004 was $46,248 compared to $178,637 for the twenty-six weeks ended December
30, 2003.
Net Income
Net income of $1,058,962 was incurred for the twenty-six weeks ended
December 28, 2004 as compared to net income of $671,588 incurred for the
twenty-six weeks ended December 30, 2003. The change was the result of the
factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
As of December 28, 2004, the Company had a cash balance of $346,331, working
capital deficit of $(860,843) and stockholders' equity of $232,007. As of June
29, 2004, the Company had a cash balance of $63,562, working capital deficit of
$(2,103,971) and stockholders' deficit of $(787,955). Historically, the Company
has financed its operations primarily through issuance of debt and equity
securities, through short-term borrowings from its majority shareholder,
Spotless, and through cash generated from operations.
In the opinion of management, the Company expects to have sufficient working
capital to fund its current operations as long as it does not encounter further
difficulty collecting its accounts receivable or experience significant growth.
However, market conditions and their effect on the Company's liquidity may
restrict the Company's use of cash. In the event that sufficient positive cash
flow from operations is not generated, the Company may need to seek additional
financing in addition to the financing contemplated by the ARFA or otherwise.
Spotless is under no contractual obligation to provide any funds. Currently, the
Company has no credit facility for additional borrowing.
Spotless has informed the Company in a letter dated September 29, 2004, that, at
that time, it intended to provide only an additional $150,000 in financing to
the Company pursuant to the ARFA. Spotless has also indicated that it does not
intend to provide any additional debt or equity financing to the Company. The
Company is assessing the impact, if any, of this situation. The Company's board
of directors appointed a special committee consisting of independent director
Anthony P. Towell to investigate its financing and strategic alternatives. The
special committee currently is considering available alternatives.
Under the ARFA, Spotless may, but is not obligated to, purchase one or more of
the Company's accounts receivable that are approved by Spotless in its sole
discretion, in respect of the particular debtor, invoices and related credit. As
part of the agreement, Spotless may purchase any accounts receivable at a 15%
discount to invoice prices, which the Company believes is at least as favorable
to it as would be available from an unaffiliated third-party, based upon a
good-faith estimate of an applicable discount negotiated at arm's length, as may
be adjusted by Spotless in its sole discretion. In this regards, all of
Spotless' purchases have been made at 15% discount except one made in April 2004
for the amount of $711,450 in relation to an account receivable balance of
$1,028,194, which constituted a 31% discount. In addition, the Company pays
varying monthly discount fees on any purchased accounts receivable based upon
invoice prices. All discounts and fees under the ARFA are characterized as
interest expense. For the twenty-six weeks ended December 28, 2004, the Company
has incurred approximately $168,190 of such discounts and fees. Further, the
Company (a) manages any accounts receivable that it sells to Spotless while
remitting to Spotless any proceeds received and (b) bears any related litigation
costs.
As of December 28, 2004, the Company owed Spotless $5,000,000 in short-term
loans to fund working capital. During the twenty-six weeks ended December 28,
2004, the Company did not make any repayments to Spotless. All current
borrowings from Spotless bear interest at the London Interbank Offering Rate
("LIBOR") plus 1 percent (2.55% at December 28, 2004) and are secured by all of
the Company's assets. On September 10, 2004, the Company paid accrued interest
to Spotless through August 24, 2004 of approximately $151,000. As of
December 28, 2004, interest of $43,641 was accrued and unpaid on these
borrowings.
13
Net cash provided by operating activities was $473,288 for the twenty-six weeks
ended December 28, 2004 as compared to net cash used in operations of $2,212,973
for the twenty-six weeks ended December 30, 2003. Accounts receivable increased
by $4,175,461 for the twenty-six weeks ended December 28, 2004 as a result of
increased revenues related to the hurricanes in Florida. Accounts receivable
increased by $4,371,897 for the twenty-six weeks ended December 30, 2003 due to
hurricane-related work and difficulties with cash collections. Refundable income
taxes decreased by $641,795 and $1,080,186 for the twenty-six weeks ended
December 28, 2004 and December 30, 2003, respectively, due to the receipt of a
federal income tax refunds. Accounts payable and accrued expenses increased by
$1,379,494 for the twenty-six weeks ended December 28, 2004 as a result of an
increased volume of remediation activity. Other current liabilities increased by
$613,807 for the twenty-six weeks ended December 28, 2004 primarily due to
increases in sales taxes payable and increased customer deposits. Other current
liabilities increased by $223,663 for the twenty-six weeks ended December 30,
2003 primarily due to an increase in income taxes payable.
Cash used for capital expenditures was $56,011 during the twenty-six weeks
ended December 28, 2004 as compared to $263,678 for the twenty-six weeks
ended December 30, 2003.
Financing activities for the twenty-six weeks ended December 28, 2004 used net
cash of $134,508 for repayments of long-term debt. Financing activities for the
twenty-six weeks ended December 30, 2003 provided net cash of $2,453,071. This
amount included repayments of long-term debt of $193,027, proceeds from
long-term debt borrowings of $160,098, proceeds from borrowings from Spotless of
$2,525,000 and payments of preferred stock dividends of $39,000.
The Company's liquidity was severely adversely affected by its unrecouped costs
incurred in connection with an oil storage tank project. The Company believes
that it will be successful in collecting for this project, but no assurance can
be given as to the timing or amount of any such recovery. Management believes
the Company will require positive cash flow from operations to meet its working
capital needs over the next twelve months unless the Company increases its
borrowings from Spotless, successfully obtains debt or equity financing from a
third party or is able to sufficiently utilize the ARFA with Spotless. In the
event that positive cash flow from operations is not generated, the Company may
be required to seek additional financing, from Spotless or otherwise, to meet
its working capital needs.
So long as the Company has sufficient working capital, it anticipates continued
revenue growth in new and existing service areas and continues to bid on large
projects, though there can be no assurance that any of the Company's bids will
be accepted or that it will have sufficient working capital. The Company is
striving to improve its gross margin and control its selling, general and
administrative expenses. In this regard, in fiscal 2005 the Company has reduced
its expenses, including those relating to marketing, at an annualized rate of
approximately $2 million. There can be no assurance, however, that changes in
the Company's plans or other events affecting the Company's operations will not
result in accelerated or unexpected cash requirements, or that it will continue
to be successful in achieving positive cash flow from operations or in obtaining
additional financing. The Company's future cash requirements are expected to
depend on numerous factors, including, but not limited to: (a) the ability to
obtain environmental or related construction contracts, (b) the ability to
generate positive cash flow from operations, and the extent thereof, (c) the
ability to raise additional capital or obtain additional financing, and (d)
economic conditions.
14
The table below summarizes contractual obligations and commitments as of
December 28, 2004:
Total 1 Year 2-3 Years 4-5 Years
----- ------ --------- ---------
Operating leases $1,060,481 $ 450,754 $ 609,727 $ -
Long-term debt 512,820 252,592 247,592 12,636
Series A redeemable convertible
preferred stock 1,300,000 - 1,300,000 -
Short-term notes payable to
related party 5,000,000 5,000,000 - -
----------- ----------- ----------- ---------
$7,873,301 $5,703,346 $2,157,319 $ 12,636
=========== =========== =========== =========
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not have any off-balance sheet arrangements.
INFLATION
Inflation has not had a material impact on the Company's operations over
the past three fiscal years or during the twenty-six weeks ended December
28, 2004.
SEASONALITY
Since the Company and its subsidiaries are able to perform their services
throughout the year, the business is not considered seasonal in nature.
However, it is affected by the timing of large contracts in certain of its
service areas, i.e., asbestos and mold abatement and construction, as well
as the timing of catastrophes.
FORWARD-LOOKING STATEMENTS
Statements contained in this Form 10-Q include "forward-looking statements"
within the meaning of Section 27A of the Securities Act and Section 21E of
the Exchange Act. Forward-looking statements involve known and unknown
risks, uncertainties and other factors which could cause the actual
results, performance and achievements, whether expressed or implied by such
forward-looking statements, not to occur or be realized. Such
forward-looking statements generally are based upon the Company's best
estimates of future results, performance or achievement, based upon current
conditions and the most recent results of operations. Forward-looking
statements may be identified by the use of forward-looking terminology such
as "may," "will," "expect," "believe," "estimate," "anticipate," "continue"
or similar terms, variations of those terms or the negative of those terms.
Potential risks and uncertainties include, among other things, such factors
as:
o the market acceptance and amount of sales of the Company's
services,
o the Company's success in increasing revenues and reducing
expenses,
o the frequency and magnitude of environmental disasters or
disruptions resulting in the need for the types of services
the Company provides,
o the extent of the enactment, enforcement and strict
interpretations of laws relating to environmental
remediation,
o the competitive environment within the industries in which
the Company operates,
o the Company's ability to raise additional capital,
o the Company's ability to continue as a going concern,
o the Company's ability to effectively implement and maintain
its internal controls and procedures,
o the Company's ability to attract and retain qualified
personnel, and
o the other factors and information disclosed and discussed in
other sections of this Quarterly Report on
Form 10-Q and in the Company's Report on Form 10-K for the
fiscal year ended June 29, 2004.
15
Investors should carefully consider such risks, uncertainties and other
information, disclosures and discussions which contain cautionary
statements identifying important factors that could cause actual results to
differ materially from those provided in the forward-looking statements.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
The foregoing discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's
results of operations and financial condition. This discussion should be
read in conjunction with the consolidated financial statements and notes
thereto appearing in Item 1 and with the consolidated financial statements
included in the Company's annual report on Form 10-K for the period ended
June 29, 2004.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to potential loss from market risks that may occur
as a result of changes in the market price of the Company's common stock
(with respect to the variable accounting treatment of a put option for
shares of common stock and common stock options held by an officer of the
Company) and as a result of changes in interest rates (primarily with
respect to its debt obligations to Spotless). There have been no material
changes to the nature of Company's market risks since the Company's Annual
Report on Form 10-K for the period ended June 29, 2004.
ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, an
evaluation was performed under the supervision and with the participation
of the Company's principal executive and financial officers of the
effectiveness of the design and operation of the Company's "disclosure
controls and procedures" (as defined under Rule 13a-15(e) and Rule
15d-15(e)) as of the end of the period covered by this quarterly report on
Form 10-Q. During the thirteen week period ended September 28, 2004, in
order to address issues relating to revenue recognition and allocation of
expenses associated with the Company's contract and billing procedures
which include, but are not limited to, direct participation by the
Company's chief executive officer in customer invoice preparation and the
evaluation of the accuracy of vendor invoices, the audit committee
appointed a task force to assist management in addressing these matters,
and the Company has implemented or is in the process of implementing the
following changes to its internal controls and procedures, among others,
under the supervision of the chief executive officer:
o authorizing the Company's in-house attorney to oversee its contract
and billing procedures;
o standardizing and consolidating the Company's form of contracts;
and
o requiring customers to agree in writing with respect to rates,
including cost estimates where appropriate, before the
Company commences projects.
The Company is assigning high priority to the short-term and long-term
correction of its internal control weaknesses, and will continue to
evaluate the effectiveness of its internal controls and procedures on an
on-going basis and will take further action as might be appropriate. Other
than implementing the improvements discussed above, there were no
significant changes in internal controls or other factors that could
significantly affect these internal controls.
In connection with the foregoing, the Company's principal executive and
financial officers have concluded that, except as noted above, and subject
to the inherent limitations in all control systems, the Company's current
disclosure controls and procedures were effective as of the end of the
period covered by this quarterly report to ensure that information that is
required to be disclosed in the reports the Company files or submits under
the Exchange Act is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and include controls
and procedures designed to ensure that information the Company is required
to disclose in such reports is accumulated and communicated to management,
including its principal executive and financial officers, as appropriate to
allow timely decisions regarding required disclosure.
16
PART 2 - OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
On August 5, 2004, Trade-Winds commenced an action against the
New York City Economic Development Corporation (the "EDC") in
the New York State Supreme Court, County of New York, claiming
that Trade-Winds is entitled to approximately $1,255,000 of
contractual billings relating to a large roof tar removal
project. On October 15, 2004, the EDC filed an answer, denying
Trade-Winds' claims. The case is currently in pre-trial
discovery.
On October 22, 2004, Trade-Winds commenced an action against
Consolidated Edison Company in the New York State Supreme
Court, County of New York, claiming that Trade-Winds is
entitled to approximately $2,000,000 of contractual billings
and related damages with respect to its removal of sediment
from an oil storage tank. On December 6, 2004, Consolidated
Edison Company filed an answer, denying Trade-Winds' claims.
The case is currently in pre-trial discovery.
The Company is a party to other litigation matters and claims
that are normal in the course of its operations, and while the
results of such litigation and claims cannot be predicted with
certainty, management believes that the final outcome of such
matters will not have a materially adverse effect on the
Company's consolidated financial statements.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
The Company is required to pay quarterly dividends on its
Series A Convertible Preferred Stock, par value $.01 per share
(the "Series A Preferred"), which dividends accrue from the
initial date of issuance of the Series A Preferred, are
cumulative and, if not paid when due, bear interest on the
unpaid amount of the past due dividends at the prime rate
published in The Wall Street Journal on the date the dividend
was payable, plus 3%. The Company is currently in arrears on
its Series A Preferred dividend payments and interest thereon
in the aggregate amount of approximately $81,000 due to a lack
of available cash. Under the terms of the Company's
Certificate of Designations of the Series A Preferred, if the
Company fails to make any four consecutive quarterly dividend
payments on the Series A Preferred, the majority in interest
of the holders of the Series A Preferred have the right to
elect a second director to the Company's board of directors,
to serve as a director until such accrued and unpaid dividends
have been paid in full. The Company failed to pay its fourth
consecutive quarterly dividend payment on December 15, 2004 to
the holders of the Series A Preferred. The majority in
interest of the holders of the Series A Preferred has not
exercised the right to elect a second director to the
Company's board of directors. There can be no assurance when
or if the Company will make any Series A Preferred dividend
payments.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
The 2004 Annual Meeting of Stockholders of the Company was
held on December 6, 2004, at which the following matter was
voted upon and adopted by the votes indicated:
To elect eight directors to the board of directors to serve
until the next annual meeting of stockholders, unless any such
director shall resign, become disqualified, disabled or
otherwise removed from office. The names of the directors and
votes cast in favor of their election and votes withheld are
as follows:
17
Nominee For Withheld
------- --- --------
Peter A. Wilson 72,311,838 4,158,605
Michael O'Reilly 72,313,138 4,157,305
Charles L. Kelly, Jr. 72,311,838 4,158,605
Brian S. Blythe 72,311,838 4,158,605
John J. Bongiorno 72,311,838 4,158,605
Ronald B. Evans 72,311,838 4,158,605
Anthony P. Towell 72,313,338 4,157,105
Dr. Kevin Phillips 72,313,288 4,157,155
ITEM 5. OTHER INFORMATION
-----------------
Not applicable.
ITEM 6. EXHIBITS
--------
The following exhibits are included as part of this report:
31.1 Certification of Chief Executive Officer pursuant to
Sarbanes-Oxley Section 302(a)
31.2 Certification of Chief Financial Officer pursuant to
Section 302(a)
32.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350.
18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly authorized.
WINDSWEPT ENVIRONMENTAL GROUP, INC.
Date: February 10, 2005 By: /s/ Michael O'Reilly
---------------------------------
MICHAEL O'REILLY,
President and Chief Executive Officer
(Principal Executive Officer)
Date: February 10, 2005 By: /s/ Charles Kelly, Jr.
----------------------------------
CHARLES L. KELLY, JR.
Chief Financial Officer
(Principal Financial Officer)
19