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 the quarterly period ended SEPTEMBER 30, 2002
------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE EXCHANGES ACT
For the transition period from to
--------------------- ---------------
Commission file number 000-14646
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
(Exact name of Small Business Issuer as Specified in Its Charter)
NEW YORK 06-1113228
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
4 Ashlagan Street, P.O. Box 8624,
Kiryat Gat, Israel 82021
------------------ -----
(Address of principal executive offices) (Zip Code)
011 972 8 660 2108 (Issuer's telephone number, including area code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
The number of shares outstanding of the registrant's Common Stock, $0.01 Par
Value, on November 13, 2002 was 42,766,087 shares.
Transitional Small Business Disclosure Format (check one):
Yes X No
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page Number
Item 1. Financial Statements..............................................4-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..........................13-19
Item 3. Controls and Procedures..........................................20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................21
Item 6. Exhibits and Reports on Form 8-K.................................21
Signatures and Certifications....................................22-24
Exhibits.........................................................25
-2-
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-QSB contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. Forward-looking
statements include statements concerning plans, objectives, goals, strategies,
future events or performance and underlying assumptions and other statements,
which are other than statements of historical facts. These statements are
subject to uncertainties and risks including, but not limited to, product and
service demand and acceptance, changes in technology, economic conditions, the
impact of competition and pricing, government regulation, and other risks
defined in this document and in statements filed from time to time with the
Securities and Exchange Commission. These cautionary statements and any other
cautionary statements that may accompany the forward-looking statements
expressly qualify all such forward-looking statements. In addition, Clean
Systems Technology Group, Ltd. disclaims any obligation to update any
forward-looking statements to reflect events or circumstances after the date
hereof.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheet as of September 30, 2002 (Unaudited)..................4
Consolidated Statements of Operations for the three and nine months
ended September 30, 2002 (Unaudited) and 2001 (Unaudited)...................5
Consolidated Statement of Shareholders' Equity for the nine
months ended September 30, 2002 (Unaudited).................................6
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 (Unaudited) and 2001 (Unaudited)..................7-8
Notes to Consolidated Financial Statements (Unaudited)...........................9-12
-3-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 2002.
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents $ 49
Accounts receivable - net 2,539
Inventory 2,274
Costs incurred in excess of billings on
contracts in progress 568
Refundable value added tax 85
Employee advances 23
Other current assets 339
Deferred taxes 33
------
TOTAL CURRENT ASSETS 5,910
PROPERTY AND EQUIPMENT - NET 1,712
OTHER ASSETS 255
------
TOTAL ASSETS $7,877
======
LIABILITIES AND SHAREHOLDERS' EQUITY:
CURRENT LIABILITIES:
Bank line of credit $2,269
Accounts payable 1,934
Accrued compensation 700
Short-term loans 131
Accrued expenses 292
Other liabilities 92
------
TOTAL CURRENT LIABILITIES 5,418
------
CONVERTIBLE NOTES 1,312
------
BANK LOANS 18
------
COMMITMENTS AND CONTINGENCIES --
------
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, 110,000,000 shares authorized,
42,766,087, issued and outstanding 428
Additional paid-in capital 428
Retained earnings 273
------
TOTAL SHAREHOLDERS' EQUITY 1,129
------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $7,877
======
See Notes to Consolidated Financial Statements.
-4-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2 0 0 2 2 0 0 1 2 0 0 2 2 0 0 1
------- ------- ------- -------
REVENUES $ 1,512 $ 2,158 $ 6,189 $ 10,123
COST OF REVENUE 1,196 1,100 4,360 6,391
------------ ------------ ------------ ------------
GROSS PROFIT 316 1,058 1,829 3,732
OPERATING EXPENSES:
Selling, general and administrative 475 739 1,742 1,677
------------ ------------ ------------ ------------
[LOSS] INCOME FROM OPERATIONS (159) 319 87 2,055
INTEREST EXPENSE (164) (29) (317) (104)
OTHER (EXPENSE) INCOME (57) 186 (308) 271
------------ ------------ ------------ ------------
[LOSS] INCOME BEFORE PROVISION FOR
INCOME TAXES (380) 476 (538) 2,222
PROVISION FOR INCOME TAX EXPENSE
[BENEFIT] (17) (57) (5) 97
------------ ------------ ------------ ------------
NET [LOSS] INCOME $ (363) $ 533 $ (533) $ 2,125
============ ============ ============ ============
NET [LOSS] INCOME PER SHARE - BASIC $ (.01) $ .01 $ (.01) $ .05
============ ============ ============ ============
NET [LOSS] INCOME PER SHARE - DILUTED $ (.01) $ .01 $ (.01) $ .05
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES - BASIC 42,766,087 42,766,087 42,766,087 42,766,087
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES - DILUTED 42,766,087 43,809,087 42,766,087 43,809,087
============ ============ ============ ============
See Notes to Consolidated Financial Statements.
-5-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS, EXCEPT NUMBER OF SHARE DATA)
COMMON STOCKADDITIONAL TOTAL
NUMBER PAID-IN RETAINED SHAREHOLDERS'
OF SHARES AMOUNT CAPITAL EARNINGS EQUITY
BALANCE DECEMBER 31, 2001 42,766,087 $ 428 $ 428 $ 806 $ 1,662
Net [Loss] -- -- -- (533) (533)
-------------- --------------- --------------- -------------- ---------------
BALANCE SEPTEMBER 30, 2002 42,766,087 $ 428 $ 428 $ 273 $ 1,129
============== =============== =============== ============== ===============
See Notes to Consolidated Financial Statements.
-6-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NINE MONTHS ENDED
SEPTEMBER 30,
2 0 0 2 2 0 0 1
------- -------
OPERATING ACTIVITIES:
Net [loss] income $ (533) $ 2,125
Adjustments to reconcile net [loss] income to net cash
(used for) operating activities:
Amortization and depreciation 281 133
Loss from the sale of property and equipment 50 1
Change in accrued severance pay - net 20 22
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable - net (1,055) (458)
Accounts receivable - related party 129 --
Inventory 23 (835)
Costs incurred in excess of billings on
contracts in progress (231) (870)
Refundable value added tax (13) 79
Employee advances 7 (19)
Other current assets (309) (58)
Deferred taxes 1 (44)
Increase (decrease) in:
Accounts payable 293 (887)
Accrued compensation 244 69
Accrued expenses (86) 269
Other liabilities 98 205
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NET CASH - OPERATING ACTIVITIES (1,081) (268)
------- -------
INVESTING ACTIVITIES:
Acquisition of property and equipment (573) (746)
Proceeds from sale of property and equipment -- 16
Other assets (6) (192)
Investment in unconsolidated subsidiaries 108 --
------- -------
NET CASH - INVESTING ACTIVITIES (471) (922)
------- -------
FINANCING ACTIVITIES:
Proceeds from convertible notes 1,009 --
Repayment of shareholder loans -- (78)
Changes in short-term bank credit - net 777 259
Changes in short-term loans - net (175) (127)
Deferred loan costs (117) --
------- -------
NET CASH - FINANCING ACTIVITIES 1,494 54
------- -------
NET [DECREASE] IN CASH AND CASH EQUIVALENTS - FORWARD $ (58) $(1,136)
See Notes to Combined Financial Statements.
-7-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NINE MONTHS ENDED
SEPTEMBER 30,
2 0 0 2 2 0 0 1
------- -------
NET [DECREASE] IN CASH AND CASH EQUIVALENTS - FORWARDED $ (58) $ (1,136)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIODS 107 1,238
------------------ -----------------
CASH AND CASH EQUIVALENTS - END OF PERIODS $ 49 $ 102
================== =================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 184,000 $ 104,000
Income taxes $ 12,000 $ 83,000
See Notes to Consolidated Financial Statements.
-8-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE AND
PER SHARE DATA OR AS OTHERWISE NOTED)
[1] BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Clean Systems
Technology Group, Ltd. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-QSB and Item 310(b) of Regulation S-B.
Accordingly, they do not include all information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, such statements include, all adjustments [consisting
only of normal recurring items] considered necessary in order to make the
interim financial statements not misleading. Results for the nine months ended
September 30, 2002 are not necessarily indicative of the results that may be
expected for the year ended December 31, 2002. For further information, refer to
the consolidated financial statements and footnotes thereto of the Company and
management's discussion and analysis of financial condition and results of
operations included in the Company's annual report on Form 10-KSB for the year
ended December 31, 2001.
On October 17, 2001, Entertainment International Ltd. ("ENTI"), through its
wholly-owned subsidiary ENTI Acquisition I Corp., closed a transaction (the
"Transaction") providing for the acquisition of CSTI Hi-Tec, Ltd. an Israeli
corporation. All of the issued and outstanding shares of CSTI Hi-Tec, Ltd. were
exchanged for shares of ENTI's unregistered restricted common stock.
Simultaneously with the closing, the Board of Directors authorized a one for
twenty reverse stock split of all ENTI's issued and outstanding common stock.
All references in the accompanying consolidated financial statements to the
number of shares have been restated to reflect the reverse stock split.
For accounting purposes, the Transaction has been treated as a recapitalization
of CSTI Hi-Tec, Ltd., with CSTI Hi-Tec, Ltd. as the acquirer. The shares issued
in the Transaction are treated as being issued for cash and are shown as
outstanding for all periods presented in the same manner as for a stock split.
The consolidated financial statements reflect the results of operations of CSTI
Hi-Tec, Ltd. and its subsidiaries and ENTI as of and for the three and nine
months ended September 30, 2002. The consolidated financial statements for the
three and nine months ended September 30, 2001, reflect the results of
operations and financial position of CSTI Hi-Tec, Ltd. and its subsidiaries. Pro
forma information on the Transaction is not presented as, at the date of the
Transaction, ENTI was considered a public shell and accordingly, the Transaction
was not considered a business combination. On December 27, 2001, ENTI amended
its certificate of incorporation to change its name from Entertainment
International, Ltd. to Clean Systems Technology Group, Ltd. (the "Company" or
"CSTI").
[2] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies followed by the Company are set forth in Note 1 to the
Company's consolidated financial statements included in the Company's Form
10-KSB for the year ended December 31, 2001.
USE OF ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
-9-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE AND
PER SHARE DATA OR AS OTHERWISE NOTED)
[2] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES [CONTINUED]
REVENUE RECOGNITION - The Company follows the percentage-of-completion method of
accounting for contracts that extend for periods in excess of one year.
Accordingly, income is recognized in the ratio that costs incurred bears to
estimated total costs. Where contracts in progress are subject to negotiation
and it is probable that the additional costs will be recovered, none of the
costs are recognized in the income statement until pricing has been approved.
Similarly, the revenue is not recognized until realization is assured beyond a
reasonable doubt. Adjustments to cost estimates are made periodically, and
losses expected to be incurred on contracts in progress are charged to
operations in the period such losses are determined. The aggregate of cost
incurred on contracts in progress in excess of related billings is shown as a
current asset, and the aggregate of billings on contracts in progress in excess
of related costs incurred as shown as a current liability.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In July 2001, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations"
("SFAS No. 141"). SFAS No. 141 changes the accounting for business combinations
initiated after September 30, 2001, requiring that all business combinations be
accounted for using the purchase method and that intangible assets be recognized
as assets apart from goodwill if they arise from contractual or other legal
rights, or if they are separable or capable of being separated from the acquired
entity and sold, transferred, licensed, rented or exchanged. SFAS No. 141 is
effective for all business combinations initiated after September 30, 2001. The
adoption of SFAS No. 141 did not have a material impact on the Company's
financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangibles"
(SFAS No. 142") SFAS No. 142 specifies the financial accounting and reporting
for acquired goodwill and other intangible assets. Goodwill and intangible
assets with indefinite useful lives will not be amortized but rather will be
tested at least annually for impairment. SFAS No. 142 is effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 requires that the useful
lives of intangible assets acquired on or before June 30, 2001 be reassessed and
the remaining amortization periods adjusted accordingly. Previously recognized
intangible assets deemed to have indefinite lives shall be tested for
impairment. Goodwill recognized on or before June 30, 2001, shall be assigned to
one or more reporting units and shall be tested for impairment as of the
beginning of the fiscal year in which SFAS No. 142 is initially applied in its
entirety. As of September 30, 2002, the Company had no recorded goodwill or
indefinite lived intangibles. Therefore, the Company believes that the adoption
of SFAS No. 142 will not have a significant impact on its results of operations
or financial position.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS No. 143"), which is effective October 1, 2003. SFAS No. 143
requires, among other things, the accounting and reporting of legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development, or normal operation of a long-lived
asset. The Company is currently assessing, but has not yet determined, the
effect of SFAS No. 143 on its financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," ("SFAS No. 144"). SFAS No. 144 is effective for
fiscal years beginning after December 15, 2001. SFAS No. 144 addresses
accounting and reporting of all long-lived assets, except goodwill, that are
either held and used or disposed of through sale or other means. The Company is
currently assessing the impact of SFAS No. 144, but believes that its adoption
will not have a material impact on its operating results or financial position.
-10-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE AND
PER SHARE DATA OR AS OTHERWISE NOTED)
[2] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES [CONTINUED]
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS [CONTINUED] - On April 30, 2002, the
Financial Accounting Standards Board (FASB) issued Statement No. 145, Rescission
of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections.
Statement 145 rescinds Statement 4, which required all gains and losses from
extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of any income tax effect. As a result, the criteria in
Opinion No. 30 will now be used to classify those gains and losses. Statement 64
amended Statement 4 and is no longer necessary because Statement 4 has been
rescinded.
Statement 145 amended Statement 13 to require that certain lease modifications
that have economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale-leaseback transactions. This amendment is
consistent with the FASB's goal of requiring similar accounting treatment for
transactions that have similar economic effects.
This Statement also makes technical corrections to existing pronouncements.
While those corrections are not substantive in nature, in some instances, they
may change accounting practice.
In June 2002 the FASB issued Statement No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities."
The Company expects that the adoption of the new statements will not have a
significant impact on its financial statements. It is not possible to quantify
the impact until the newly issued statements have been studied.
[3] INVENTORY
Inventory, which consists of raw materials, is valued at the lower of cost or
market. Cost is determined by the weighted average method.
[4] NET INCOME [LOSS] PER SHARE
Earnings per share are calculated in accordance with the provisions of Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128").
SFAS 128 requires the reporting of both basic earnings per share, which is the
weighted-average number of common shares outstanding, and diluted earnings per
share, which includes the weighted-average number of common shares outstanding
and all dilutive potential common shares outstanding, utilizing the treasury
stock method. For the three and nine months ended September 30, 2002 and 2001,
the shares issued in the Transaction are treated as outstanding for all periods
presented. For the three and nine months ended September 30, 2002 and 2001,
dilutive potential common shares outstanding reflect shares issuable under
convertible notes [See Note 5]. The computation of diluted earnings per share
does not assume conversion, exercise or contingent issuance of securities that
would have an anti-dilutive effect on earnings per share. Share and per share
amounts reflect the effect of the one for twenty reverse stock split in October
2001.
[5] CONVERTIBLE NOTES
During the nine months ended September 30, 2002, the Company issued $1,009 in
principal convertible notes. Principal amounts of the notes may be converted by
the holders into shares of Company common stock, at a conversion price of $0.875
per share, at any time from issuance until May 15, 2003. At May 15, 2003, the
notes automatically convert into shares of Company common stock at a price equal
to $0.875, subject to adjustment. The adjustment entitles the noteholders to
receive consideration at least equal to the original principal amount of the
note plus accrued interest at eight percent from the date of issuance. The
consideration may be paid in cash or common stock at the sole discretion of the
Company.
At September 30, 2002, interest of $63 has been accrued on the outstanding
principal convertible notes.
-11-
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE AND
PER SHARE DATA OR AS OTHERWISE NOTED)
[6] OTHER (EXPENSE) INCOME
Aggregate amounts in other (expense) income are primarily the result of foreign
currency translation adjustments and capital losses on the sale of equipment.
Substantially all of the Company's sales are made in U.S. dollars. In addition,
a substantial portion of the Company's costs are incurred in U.S. dollars. Since
the U.S. dollar is the primary currency in the economic environment in which the
Company operates, the U.S. dollar is its functional currency.
During the nine months ended September 30, 2002 certain assets and liabilities
were denominated in NIS while the payments to suppliers were linked to the U.S.
dollar which caused a substantial translation adjustment due to the relative
strength of the U.S. dollar to the New Israeli shekel in 2002.
[7] GEOGRAPHIC REPORTING
Revenues by geographic classifications are as follows:
[IN U.S. $ THOUSANDS]
-------------------
ISRAEL ITALY INDIA OTHER TOTAL
------ ----- ----- ----- -----
For the period ended September 30, 2002 $ 5,880 $ 284 $ 18 $ 7 $ 6,189
For the period ended September 30, 2001 $ 201 $ 7,765 $ 1,990 $ 167 $ 10,123
[8] INVESTMENT IN UNCONSOLIDATED SUBSIDIARY - AT COST
The Company has a nineteen percent (19%) interest in Altan Systems Ltd., an
entity whose processes and technology may enhance CSTI's product line. The
investment is carried at cost.
. . . . . . . . . .
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Form 10-QSB and in future filings by CSTI with the Securities
and Exchange commission, the words or phrases "will likely result" and "the
company expects," "will continue," "is anticipated," "estimated," "project," or
"outlook" or similar expressions are intended to identify "forward-looking
statements." CSTI wishes to caution readers not to place undue reliance on any
such forward-looking statements, each of which speak only as of the date made.
Such statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. CSTI has no obligation to publicly release the result
of any revisions which may be made to any forward-looking statements to reflect
anticipated or unanticipated events or circumstances occurring after the date of
such statements.
OVERVIEW
CSTI designs, engineers, manufactures, installs and services ultra high purity
systems for transportation of clean gases and liquids from the source, where the
gases and liquids are stored, to the point of use for the following processing
industries:
o Micro-electronics (semi conductors);
o Optical fibers;
o Pharmaceuticals and Bio-technology; and
o Metal Blades.
CSTI product lines provide a total solution for the four major gas and chemical
systems from source to the point of use referenced above. Since the gases and
the chemicals are pure and extremely dangerous, the systems that CSTI
manufactures must have the highest levels of safety and quality.
CSTI products are divided into three main categories:
o Systems for ultra high purity gases from source to point of use; o
Pre-manufactured products sub-systems; and o System upgrades.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This discussion and analysis of the Company's financial condition and results of
operations are based on its consolidated financial statements that have been
prepared under accounting principles generally accepted in the United States of
America. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates. All significant
accounting policies are disclosed in note 1 to the consolidated financial
statements included in Form 10-KSB. The consolidated financial statements and
the related notes thereto should be read in conjunction with the following
discussion of the Company's critical accounting policies. Critical accounting
policies and estimates are:
o Revenue Recognition
o Use of Estimates
-13-
REVENUE RECOGNITION - The Company follows the percentage-of-completion method of
accounting for contracts that extend for periods in excess of one year.
Accordingly, income is recognized in the ratio that costs incurred bears to
estimated total costs. Adjustments to cost estimates are made periodically, and
losses expected to be incurred on contracts in progress are charged to
operations in the period such losses are determined. The aggregate of cost
incurred and income recognized on uncompleted contracts in excess of related
billings is shown as a current asset, and the aggregate of billings on
uncomplete contracts in excess of related costs incurred and income recognized
is shown as a current liability.
USE OF ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In July 2001, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS') No. 141, "Business Combinations" ("SFAS No. 141"). SFAS No.
141 changes the accounting for business combinations initiated after September
30, 2001, requiring that all business combinations be accounted for using the
purchase method and that intangible assets be recognized as assets apart from
goodwill if they arise from contractual or other legal rights, or if they are
separable or capable of being separated from the acquired entity and sold,
transferred, licensed, rented or exchanged. SFAS No. 141 is effective for all
business combinations initiated after September 30, 2001. The adoption of SFAS
No. 141 did not have a material impact on the Company's financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangibles"
(SFAS No. 142") SFAS No. 142 specifies the financial accounting and reporting
for acquired goodwill and other intangible assets. Goodwill and intangible
assets with indefinite useful lives will not be amortized but rather will be
tested at least annually for impairment. SFAS No. 142 is effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 requires that the useful
lives of intangible assets acquired on or before June 30, 2001 be reassessed and
the remaining amortization periods adjusted accordingly. Previously recognized
intangible assets deemed to have indefinite lives shall be tested for
impairment. Goodwill recognized on or before June 30, 2001, shall be assigned to
one or more reporting units and shall be tested for impairment as of the
beginning of the fiscal year in which SFAS No. 142 is initially applied in its
entirety. As of December 31, 2001, the Company had no recorded goodwill or
indefinite lived intangibles. Therefore, the Company believes that the adoption
of SFAS No. 142 will not have a significant impact on its results of operations
or financial position.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS No. 143"), which is effective October 1, 2003. SFAS No. 143
requires, among other things, the accounting and reporting of legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development, or normal operation of a long-lived
asset. The Company is currently assessing, but has not yet determined, the
effect of SFAS No. 143 on its financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," ("SFAS No. 144"). SFAS No. 144 is effective for
fiscal years beginning after December 15, 2001. SFAS No. 144 addresses
accounting and reporting of all long-lived assets, except goodwill, that are
either held and used or disposed of through sale or other means. The Company is
currently assessing the impact of SFAS No. 144, but believes that its adoption
will not have a material impact on its operating results or financial position.
On April 30, 2002, the Financial Accounting Standards Board (FASB) issued
Statement No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections.
-14-
Statement 145 rescinds Statement 4, which required all gains and losses from
extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of any income tax effect. As a result, the criteria in
Opinion No. 30 will now be used to classify those gains and losses. Statement 64
amended Statement 4 and is no longer necessary because Statement 4 has been
rescinded.
Statement 145 amended Statement 13 to require that certain lease modifications
that have economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale-leaseback transactions. This amendment is
consistent with the FASB's goal of requiring similar accounting treatment for
transactions that have similar economic effects.
This Statement also makes technical corrections to existing pronouncements.
While those corrections are not substantive in nature, in some instances, they
may change accounting practice.
In June 2002 the FASB issued Statement No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities."
The Company expects that the adoption of the new statements will not have a
significant impact on its financial statements. It is not possible to quantify
the impact until the newly issued statements have been studied.
The following table sets forth, as a percentage of total revenue, certain
consolidated statements of operations data for the periods indicated. These
operating results are not necessarily indicative of the results for any future
period.
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2001 (AMOUNTS IN THOUSANDS UNLESS OTHERWISE INDICATED)
REVENUES
Revenues in 2002 of $1,512 decreased $.65 million (or 29.9%) from $2,158 in
2001. Management's strategic decision is to continue to be a premier industry
leader in Israel as well as to continue to gain market share in the European and
Central Asian markets, especially Italy and India, respectively. During the
three months ended September 30, 2002 and 2001, revenues to customers in Israel
amounted to $1,474 and $57, respectively. Revenues to Italian, Indian, and other
non-domestic customers amounted to $38 and $2,101 for the three months ended
September 30, 2002 and 2001, respectively. In general, the Company is not
dependent upon any single customer or group of customers. The nature of the
Company's business is such that it works on several large contracts at any one
time. Therefore, several customers may comprise a significant portion of CSTI's
revenues during any fiscal period. Once the Company installs a system for its
customer, the customer is generally dependent on the Company for future upgrades
of that system.
COST OF REVENUES
The following table sets forth a comparison of the costs of revenues for the
periods indicated:
THREE MONTHS ENDED
SEPTEMBER 30,
2 0 0 2 2 0 0 1
------- -------
Cost of materials and inventory $ 436 $ 55
Salaries and related expenses 501 370
Subcontractors 67 279
Cost of service abroad 13 59
Rent and taxes 35 50
Vehicles and transportation 51 138
Equipment maintenance and insurance 48 48
Depreciation 45 34
Miscellaneous -- 67
--------------- --------------
Cost of Revenues $ 1,196 $ 1,100
=============== ==============
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Cost of revenues has increased by $0.10 million (or 9%) to $1.20 million in 2002
from $1.10 million in 2001. Costs of revenues increased despite the overall
decline in revenues due to management's strategy to absorb higher job costs
associated with gaining market share. Materials, inventory and subcontractors
costs increased by $0.17 million to $0.50 million in 2002. The average number of
employees during 2002 was 130 as compared to 83 for 2001. Other costs such as
rent and taxes, transportation, equipment maintenance and insurance and
depreciation decreased in relative proportion to the decrease in revenues.
GROSS PROFIT
Gross profit has decreased by $0.74 million to $0.32 million in 2002 from $1.06
million in 2001 due to the lower volume of revenues. Gross margins approximated
21% in 2002 versus 49% in 2001. The lower margins relate to the competitive
pricing environment and the Company's inability to absorb its fixed production
costs at a lower revenue volume. During the three months ended September 30,
2002, a substantial portion of revenues were earned in Israel while revenues
earned in the comparative three month period were earned substantially outside
of Israel.
SELLING, GENERAL AND ADMINISTRATIVE
The following table sets forth details regarding selling, general and
administrative expenses for the periods indicated:
THREE MONTHS ENDED
SEPTEMBER 30,
2 0 0 2 2 0 0 1
------- -------
Salaries and related expenses $ 169 $ 165
Professional fees 111 104
Telephone and office maintenance 27 181
Travel vehicles and transportation 85 57
Depreciation 28 21
Sales and marketing 55 211
--------------- ---------------
$ 475 $ 739
=============== ===============
Selling, general and administrative expenses ("SG&A") have decreased $0.26
million to $0.48 million in 2002 from $0.74 million in 2001. Due to the current
economic environment, management has temporarily instituted certain cost
containment initiatives in the sales and marketing departments.
INTEREST EXPENSE
Interest expense increased by $135 to $164 in 2002 from $29 in 2001. The
increase is primarily attributable to the higher levels of outstanding debt in
2002, and higher interest rates in 2002, as compared to 2001.
-16-
OTHER INCOME (EXPENSE)
The increase in other income (expense) of $(243) to $(57) in 2002 as compared to
$186 in other income in 2001 is primarily the result of foreign currency
translation adjustments and capital losses on the sale of equipment.
Substantially all of the Company's sales are made in U.S. dollars. In addition,
a substantial portion of the Company's costs are incurred in U.S. dollars. Since
the U.S. dollar is the primary currency in the economic environment in which the
Company operates, the U.S. dollar is its functional currency.
During the three months ended September 30, 2002, certain assets and liabilities
were denominated in NIS while the payments to suppliers were linked to the U.S.
dollar which caused a substantial translation adjustment due to the relative
strength of the U.S. dollar to the New Israeli shekel in 2002 .
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 2001 (AMOUNTS IN THOUSANDS UNLESS OTHERWISE INDICATED)
REVENUES
Revenues in 2002 of $6,189 decreased $3.93 million (or 38.9%) from $10,123 in
2001. During the nine months ended September 30, 2002 and 2001, revenues to
customers in Israel amounted to $5,880 and $201, respectively. Revenues to
Italian, Indian, and other non-domestic customers amounted to $309 and $9,922
for the nine months ended September 30, 2002 and 2001, respectively.
COST OF REVENUES
The following table sets forth a comparison of the costs of revenues for the
periods indicated:
NINE MONTHS ENDED
SEPTEMBER 30,
2 0 0 2 2 0 0 1
------- -------
Cost of materials and inventory $ 1,007 $ 2,564
Salaries and related expenses 1,789 1,232
Subcontractors 167 456
Cost of service abroad 69 611
Rent and taxes 77 100
Vehicles and transportation 238 309
Equipment maintenance and insurance 118 68
Depreciation 134 88
Miscellaneous 27 134
Changes in work in process 734 829
---------------- --------------
Cost of Revenues $ 4,360 $ 6,391
================ ==============
GROSS PROFIT
Gross profit has decreased by $1.90 million to $1.83 million in 2002 from $3.73
million in 2001. The decrease in gross profit percentage to 30% in 2002 from 37%
in 2001 is due to the lower margins attained on revenues in Israel due to the
pricing environment. During the nine months ended September 30, 2002, a
substantial portion of revenues were earned in Israel while revenues earned in
the comparative nine month period were earned substantially outside of Israel.
Further, the projects worked on in the first nine months of 2002 were more labor
intensive than the materials intensive projects of the first nine months of
2001.
-17-
SELLING, GENERAL AND ADMINISTRATIVE
The following table sets forth details regarding selling, general and
administrative expenses for the periods indicated:
NINE MONTHS ENDED
SEPTEMBER 30,
2 0 0 2 2 0 0 1
------- -------
Salaries and related expenses $ 754 $ 504
Professional fees 420 345
Telephone and office maintenance 150 273
Travel vehicles and transportation 168 111
Depreciation 71 40
Sales and marketing 179 404
---------------- ---------------
$ 1,742 $ 1,677
================ ===============
Selling, general and administrative expenses ("SG&A") have increased $65 (or 4%)
to $1.74 million in 2002 from $1.68 million in 2001. The increase is primarily
attributable to the addition of three executive management positions in 2002
which were partially offset by cost reduction efforts in the sales and marketing
departments.
INTEREST EXPENSE
Interest expense increased by $213 to $317 in 2002 from $104 in 2001. The
increase is primarily attributable to higher level of outstanding debt in 2002
as compared to 2001.
OTHER INCOME (EXPENSE)
The increase in other expense of $(579) to $308 in 2002 as compared to income of
$271 in 2001 is primarily the result of foreign currency translation adjustments
and capital losses on the sale of equipment.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, the Company had cash and cash equivalents of $49 as
compared to $102 at September 30, 2001.
Net cash used in operating activities was $1,081 for the nine months ended
September 30, 2002 as compared to $268 for the nine months ended September 30,
2001. The increase in net cash used in operating activities is primarily
attributable to increases in net accounts receivables offset by accounts
payables and other liabilities. These net cash outflows were offset by the net
change in operating results.
Net cash used in investing activities was $471 and $922 for the nine months
ended September 30, 2002 and 2001, respectively. The decrease is primarily due
to a decrease in property and equipment acquisitions net of an increase in
equity investment in an unconsolidated subsidiary.
Net cash provided by financing activities was $1,494 versus $54 for the nine
months ended September 30, 2002 and 2001, respectively. The increase was
primarily due to the increased use of the bank-line of credit facility and the
proceeds received from the issuance of convertible notes.
-18-
The following summarizes certain financing outstanding as of September 30, 2002:
[a] Convertible Notes - During the nine months ended September 30, 2002, the
Company issued $1,009 in convertible notes. Principal amounts of the notes may
be converted by the holder into shares of Company common stock, at a conversion
price of $0.875 per shares, at any time from issuance until May 15, 2003. At May
15, 2003, the notes automatically convert into shares of Company common stock at
a price equal to $0.875, subject to adjustment. The adjustment entitles the
noteholders to receive consideration at least equal to the original principal
amount of the note plus accrued interest at eight percent from the date of
issuance. The consideration may be paid in cash or common stock at the sole
discretion of the Company.
[b] Bank Guarantees - Certain customers require the Company to obtain bank
guarantees of a portion of the contract undertaken. The Company has an agreement
with the bank under which such guarantees are available. In the event the
Company is unable to perform all aspects of the contracts, the bank will make
contractual payments to customers and then seek reimbursement from the Company.
As of September 30, 2002, the bank had extended approximately $278 in guarantees
to four customers.
Assuming there is no significant change in the business, the Company believes
that additional funding such as described above and cash flow from operations
and will be sufficient to fund its needs for at least the remainder of year
2002.
-19-
ITEM 3. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer have concluded, based on
their evaluation within 90 days of the filing date of this report, that our
disclosure controls and procedures are effective for gathering, analyzing and
disclosing the information we are required to disclose in our reports filed
under the Securities Exchange Act of 1934. There have been no significant
changes in our internal controls or in other factors that could significantly
affect these controls subsequent to the date of the previously mentioned
evaluation.
-20-
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Other than as previously disclosed in the Company's Form 10-KSB, the Company is
not party to any other material legal proceedings.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
None.
(b) Reports on Form 8-K.
None.
-21-
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on behalf by the undersigned, thereunto duly
authorized.
The undersigned chief executive officer and chief financial officer of Clean
Systems Technology Group, Ltd., certify that this quarterly report on Form
10-QSB for the period ended September 30, 2002, which accompanies this
certification fully complies with the requirements of Section 13(a) or 15(d), as
applicable, of the Securities Exchange Act of 1934 and the information contained
in the periodic report fairly presents, in all material respects, the financial
condition and results of operations of the Registrant at the dates and for the
periods indicated. The foregoing certification is made pursuant to ss. 906 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. ss. 1350) and no purchaser or seller
of securities of any other person shall be entitled to rely upon the foregoing
certification for any purpose. The undersigned expressly disclaims any
obligation to update the foregoing certification except as required by law.
CLEAN SYSTEMS TECHNOLOGY GROUP, LTD.
Dated: November 19, 2002 By:
----------------------------------
Jacob Lustgarten
Chief Executive Officer and
Chairman of the Board
Dated: November 19, 2002 By:
----------------------------------
Yona Leibowitz
Chief Financial Officer
-22-
SARBANES-OXLEY SECTION 302(a) CERTIFICATION
I, Jacob Lustgarten certify that:
1. I have reviewed this quarterly report on Form 10-Q of Clean Systems
Technology Group, Ltd.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared.
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002
-------------------------
Jacob Lustgarten
Chief Executive Officer and Chairman of the Board
-23-
SARBANES-OXLEY SECTION 302(a) CERTIFICATION
I, Yona Leibowitz certify that:
1. I have reviewed this quarterly report on Form 10-Q of Clean Systems
Technology Group, Ltd.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared.
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002
-------------------------
Yona Leibowitz
Chief Financial Officer
-24-