U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
COMMISSION FILE NO. 000-21325
SYSTEMONE TECHNOLOGIES INC.
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(Exact Name of Small Business Issuer as Specified in its Charter)
FLORIDA 65-0226813
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
8305 N.W. 27TH STREET, SUITE 107
MIAMI, FLORIDA 33122
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(Address of Principal Executive Offices)
(305) 593-8015
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(Issuer's Telephone Number, Including Area Code)
The registrant had an aggregate of 4,960,087 shares of its common stock, par
value $.001 per share, outstanding as of the close of business on November 10,
2003.
Transitional Small Business Disclosure Format (check one): YES [ ] NO [X]
SYSTEMONE TECHNOLOGIES INC.
INDEX TO FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2003
PART I FINANCIAL INFORMATION
Item 1. Condensed Financial Statements (unaudited)
Condensed Balance Sheets-
As of September 30, 2003 (unaudited) and December 31, 2002 3
Condensed Statements of Operations-
For the three and nine months ended September 30, 2003 and 2002 (unaudited) 4
Condensed Statements of Cash Flows-
For the nine months ended September 30, 2003 and 2002 (unaudited) 5
Notes to Condensed Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis or Plan of Operation 15
Item 3. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 31
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
SYSTEMONE TECHNOLOGIES INC.
CONDENSED BALANCE SHEETS
(In thousands, except share data)
September 30, December 31,
2003 2002
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,217 $ 505
Receivables, net of allowance of $123 and $123 3,744 2,586
Inventories 1,545 1,251
Prepaid and other assets 207 384
-------- --------
Total current assets 6,713 4,726
Property and equipment, net 867 1,133
Non-current portion of receivables, net of discount 2,220 2,009
Other assets 222 316
-------- --------
Total assets $ 10,022 $ 8,184
======== ========
LIABILITIES, REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses $ 1,772 $ 1,253
Warranty accrual 315 435
Deferred revenue 77 106
Current installments of long-term debt and obligations
under capital leases 287 142
-------- --------
Total current liabilities 2,451 1,936
Long-term debt 30,260 30,835
Warranty accrual, non-current 211 239
-------- --------
Total liabilities 32,922 33,010
-------- --------
Commitments & contingencies
Redeemable convertible preferred stock, $1.00 par value per
share. Authorized 1,500,000 shares, 193,522 and
182,270 issued and outstanding at liquidation value 19,352 18,227
Less unamortized discount (464) (1,008)
-------- --------
Net redeemable convertible preferred stock 18,888 17,219
-------- --------
Stockholders' deficit:
Common stock, $0.001 par value per share. Authorized
25,000,000 shares, issued and outstanding 4,960,087
and 4,742,923 5 5
Additional paid-in capital 20,723 20,723
Deficit (62,516) (62,773)
-------- --------
Total stockholders' deficit (41,788) (42,045)
-------- --------
Total liabilities, redeemable convertible
preferred stock and stockholders' deficit $ 10,022 $ 8,184
======== ========
See accompanying notes to condensed financial statements (unaudited).
3
SYSTEMONE TECHNOLOGIES INC.
CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(Unaudited)
(In thousands, except share and per share data)
Three Months Ended Nine Months Ended
-------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------ ------------- ------------- -------------
Revenue $ 5,519 $ 4,452 $ 16,829 $ 13,272
Cost of goods sold 3,470 2,775 10,347 8,006
----------- ----------- ----------- -----------
Gross profit 2,049 1,677 6,482 5,266
----------- ----------- ----------- -----------
Operating expenses:
Selling, general and administrative 863 770 2,306 2,200
Research and development 84 85 275 230
Restructuring and other charges (75)
----------- ----------- ----------- -----------
Total operating expenses 947 855 2,581 2,355
----------- ----------- ----------- -----------
Profit from operations 1,102 822 3,901 2,911
----------- ----------- ----------- -----------
Interest expense (754) (823) (2,324) (2,584)
Interest income 139 98 389 259
----------- ----------- ----------- -----------
Interest expense, net (615) (725) (1,935) (2,325)
----------- ----------- ----------- -----------
Income before income tax provision 487 97 1,966 586
----------- ----------- ----------- -----------
Income tax provision (7) -- (40) --
----------- ----------- ----------- -----------
Net income 480 97 1,926 586
Dividends and accretion of
discount on redeemable
convertible preferred stock (566) (537) (1,669) (1,584)
----------- ----------- ----------- -----------
Net (loss) income applicable to
common shareholders $ (86) $ (440) $ 257 $ (998)
=========== =========== =========== ===========
Basic net (loss) income per common share $ (.02) $ (.09) $ .05 $ (.21)
=========== =========== =========== ===========
Diluted net (loss) income per common share $ (.02) $ (.09) $ .04 $ (.21)
=========== =========== =========== ===========
Weighted average shares outstanding - basic 4,960,087 4,742,923 4,928,903 4,742,923
=========== =========== =========== ===========
Weighted average shares outstanding - diluted 4,960,087 4,742,923 5,726,007 4,742,923
=========== =========== =========== ===========
See accompanying notes to condensed financial statements (unaudited) .
4
SYSTEMONE TECHNOLOGIES INC.
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(Unaudited)
(In thousands)
September 30, September 30,
2003 2002
------------- -------------
Cash flows provided by operating activities:
Net income $ 1,926 $ 586
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 321 389
Amortization of debt issue costs 94 227
Interest accrued on convertible debt and amortization of
note discounts 1,419 1,854
Recoveries of doubtful accounts (30)
Changes in operating assets and liabilities:
Receivables (1,369) (1,134)
Inventories (294) (643)
Prepaid and other assets 177 (59)
Accounts payable and accrued expenses 519 (226)
Warranty accrual (148) (359)
Deferred revenue (29) (4)
------- -------
Net cash provided by operating activities 2,616 601
------- -------
Cash flows used in investing activities:
Purchase of equipment (32) (48)
------- -------
Net cash used in investing activities (32) (48)
------- -------
Cash flows used in financing activities:
Repayments of long-term debt (1,735) (80)
Repayments of capital lease obligations (137) (217)
------- -------
Net cash used in financing activities (1,872) (297)
------- -------
Net increase in cash and cash equivalents 712 256
Cash and cash equivalents at beginning of period 505 59
------- -------
Cash and cash equivalents at end of period $ 1,217 $ 315
======= =======
Supplemental disclosures:
Cash paid for interest $ 822 $ 497
------- -------
Non-cash financing and investing activities
Acquisition of equipment through a capital lease $ 23 $ 6
------- -------
See accompanying notes to condensed financial statements (unaudited).
5
SYSTEMONE TECHNOLOGIES INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NEW ACCOUNTING
PRONOUNCEMENTS
SystemOne Technologies Inc. (the "Company") designs, manufactures and sells a
full line of patented, self-contained, recycling industrial parts washers, (the
"SystemOne(R) Washers"), for use in the automotive, aviation, marine and general
industrial repair markets. The Company has been awarded eleven patents for its
products, which incorporate innovative, proprietary resource recovery and waste
minimization technologies to distill contaminated solvent and yield pure solvent
and a by-product comparable to used motor oil. The SystemOne(R) Washer
integrates a distillation and recovery process which allows the solvent to be
used, treated and re-used on demand, without requiring off-site processing. The
Company was incorporated in November 1990 and commenced the sale of SystemOne(R)
Washers in July 1996 and began to generate significant revenue from product
sales in 1997. During 2000, the Company's operating subsidiary was merged with
and into the Company and the Company changed its name to SystemOne Technologies
Inc.
The Company's operating expenses increased significantly between 1997 and 2000
in connection with the development of a national direct marketing and
distribution organization, including the establishment of regional distribution
centers and a service fleet. The Company could not sustain the cost of the
marketing and distribution organization, however, and elected to enter into an
exclusive marketing agreement with Safety-Kleen Systems, Inc., a wholly-owned
subsidiary of Safety-Kleen Corp. (collectively, "Safety-Kleen"), in November
2000. In connection with the implementation of the Second Amended and Restated
Marketing and Distribution Agreement (the "Exclusive Marketing Agreement" and
further described in note 2 below) with Safety-Kleen, the Company restructured
its operations in the fourth quarter of 2000. Pursuant to the Exclusive
Marketing Agreement, the Company began shipping SystemOne(R) parts washer
equipment to Safety-Kleen in January 2001.
The Exclusive Marketing Agreement has been tentatively terminated, effective
October 1, 2003, subject to the approval of the bankruptcy court administering
Safety-Kleen's reorganization (the "Bankruptcy Court"), and the Company plans to
transition from single customer distribution to multiple distribution channels.
For more information regarding the termination of the Exclusive Marketing
Agreement and its potential effect on the Company's financial position, see note
2 below.
(1) BASIS OF PRESENTATION
The accompanying unaudited condensed interim financial statements have been
prepared pursuant to the federal securities rules and regulations promulgated by
the Securities and Exchange Commission for reporting on a Quarterly Report on
Form 10-QSB. Accordingly, certain information and notes required by accounting
principles generally accepted in the United States of America for complete
financial statements are not included herein. The interim
6
statements should be read in conjunction with the financial statements and notes
thereto included in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2002 as filed with the Securities and Exchange Commission.
Management acknowledges its responsibility for the preparation of the
accompanying interim financial statements which reflect all adjustments
considered necessary, in the opinion of management, for a fair presentation. The
results of operations for the interim periods are not necessarily indicative of
the results of operations for the entire year. Where appropriate, certain
amounts have been reclassified to conform with the 2003 presentation.
(2) LIQUIDITY
On July 30, 2003, the Company entered into the SystemOne Equipment Inspection
and Repair Agreement (the "Repair Agreement") with Safety-Kleen to inspect and
repair any leaking tanks in SystemOne(R) Washers. During the third quarter,
Safety-Kleen had claimed a purported material breach of the Exclusive Marketing
Agreement by the Company, alleging that certain molded tanks in SystemOne(R)
Washers potentially developed leaks and were, therefore, defectively designed or
manufactured. During August and September, the Company proceeded to perform
under the Repair Agreement. However, in September, the Company and Safety-Kleen
determined that it was in their mutual best interests to enter into a
Comprehensive Settlement Agreement (the "Settlement Agreement"), dated September
30, 2003, with Safety-Kleen, in order to terminate the Exclusive Marketing
Agreement and the Repair Agreement (effective October 1, 2003), settle any
outstanding disputes and grant full and mutual releases of all claims that each
may have against the other.
Pursuant to the terms and conditions of the Settlement Agreement, which remains
subject to the approval of the Bankruptcy Court administering Safety-Kleen's
reorganization, Safety-Kleen's status as the exclusive North American
distributor of SystemOne parts washers and all remaining parts washer unit
purchase commitments for October 2003 through December 2005 under the Exclusive
Marketing Agreement have been terminated. SystemOne will remain obligated to
honor the balance of the three-year parts only warranty which is applicable to
all parts washers sold to Safety-Kleen. The Settlement Agreement settles
previously disclosed disputes between the parties and releases the parties from
all claims that each may have against the other. The Settlement Agreement also
required Safety-Kleen to surrender its warrant to purchase 1,134,615 shares of
common stock of the Company for cancellation and provides that Safety-Kleen will
have the right in 2005 to purchase the lesser of up to 3,000 SystemOne parts
washer units or one-sixth of the Company's then annual production capacity.
In consideration for the foregoing, and among other things, the Settlement
Agreement provides for a total payment of $14 million to the Company (the
"Settlement Consideration"), consisting of a termination fee and a lump sum
payment of the accumulated deferred price for the approximately 30,000 SystemOne
parts washer units shipped to Safety-Kleen under the Exclusive Marketing
Agreement prior to its termination. The Settlement Consideration consists of (i)
$2 million, which was paid to SystemOne on October 6, 2003, (ii) $1 million
payable to SystemOne within eleven days after the Safety-Kleen Bankruptcy Court
approval becomes final and non-appealable, (iii) $7 million payable to SystemOne
no later than December 31, 2003,
7
provided that Safety-Kleen's plan of reorganization which has already been
approved by the Bankruptcy Court becomes effective prior to December 1, 2003 and
(iv) a balance of $4 million payable to SystemOne in monthly installments with
the final payment due no later than March 31, 2004. Should Safety-Kleen's plan
of reorganization not become effective prior to December 1, 2003, the final $11
million is payable with interest in monthly installments with the final payment
due no later than March 31, 2004.
Because Safety-Kleen was the Company's only customer the Company will have to
develop new distribution channels for its products. In order to conserve
resources pending the development of a new distribution system, the Company
reduced its production force effective September 29, 2003. Although the
Settlement Agreement will provide the Company with $14 million, which will be
used to fund its transition from single customer distribution to multiple
distribution channels and to service its debt and other ongoing obligations,
there can be no assurance that the Company's efforts to develop new distribution
channels will be successful or that such amount will be sufficient to sustain
any such effort. Any failure to obtain new distributors and customers in a
timely manner could have a material adverse effect on the Company's results of
operations, cash flows and financial condition. If the payments under the
Settlement Agreement, together with any future sales revenue and other available
capital resources are insufficient to fund the Company's transition to a new
distribution system, the Company could be required to seek additional debt or
equity capital. There can be no assurance that any such additional capital would
be available on acceptable terms or at all. In addition, in light of the
termination of the Exclusive Marketing Agreement, there can be no assurance that
the lender under the Senior Revolver will continue to provide advances
thereunder.
Prior to the execution of the Settlement Agreement in September 2003, the
Company operated under the Exclusive Marketing Agreement which (a) made
Safety-Kleen the exclusive marketer, distributor and service provider for the
Company's Series 100, Series 300 and Series 500 SystemOne(R) parts washers in
the United States, Puerto Rico, Canada and Mexico (the "Territory"), and (b)
obligated Safety-Kleen to purchase minimum quantities of the Company's parts
washing equipment for each contract year through December 26, 2005, the initial
term of the Exclusive Marketing Agreement. The Company retained the rights to
sell, lease, rent and service all of the Company's parts washing equipment
outside the Territory and, subject to Safety-Kleen's right of first offer, other
product lines within the Territory.
The minimum annual sales under the Exclusive Marketing Agreement escalated from
10,000 equivalent units during each of the first two contract years to 12,500
equivalent units in year three (which began December 26, 2002) and were
scheduled to escalate to 15,000 equivalent units in year four (beginning
December 26, 2003) and 18,000 equivalent units in year five (beginning December
26, 2004), all at specified prices.
Under the Exclusive Marketing Agreement, the majority of the sales price payable
for each unit purchased by Safety-Kleen, was payable on net 30-day terms from
the date of shipment with a portion (approximately 12%) of the sales price
payable in equal installments over a 12-quarter period and is accounted for as
set forth in Note 4 to the condensed financial statements.
In December 2002, the Company completed an exchange of its then outstanding
8.25%
8
Subordinated Convertible Notes due February 23, 2003, and 16% Promissory Notes
due November 30, 2002 for now outstanding 8.25% Subordinated Convertible Notes
due December 31, 2005, 10% Promissory Notes due December 31, 2005, and warrants
to purchase shares of the Company's common stock, $.001 par value per share at
an exercise price of $.01 per share.
In connection with the Exchange, the holders of the Company's outstanding shares
of Preferred Stock agreed to extend the date upon which the Company must redeem
such shares from May 17, 2004 to the earlier of the 90th day after all of the
Subordinated Convertible Notes are paid in full or March 31, 2006 (but not
earlier than May 17, 2004).
Although the Company believes that it will continue to be able to meet its
operating cash requirements from accounts receivables of $5,964,000 (including
the lump sum payment representing the deferred portion of the sales price), the
approximately $9.8 million balance of payments expected to be collected under
the Settlement Agreement prior to March 31, 2004 (assuming Bankruptcy Court
approval) and the Senior Revolver, if none of the outstanding convertible debt
and convertible preferred stock is converted to common stock, significant
amounts of cash would be required, commencing in 2005, to repay long term debt,
accrued interest and redeemable preferred stock as follows:
Debt Plus Interest Preferred Stock Total
------------------ --------------- -----
2003 $ 14,775 $ -- $ 14,775
2004 14,236 -- 14,236
2005 33,976,784 -- 33,976,784
2006 -- 23,618,000* 23,618,000
----------- ----------- -----------
Total $34,005,795 $23,618,000 $57,623,795
=========== =========== ===========
* Assuming no pre-payment of Subordinated Convertible Notes.
The Company entered into an agreement on February 15, 2003 to extend the
maturity date of the Company's Senior Revolver from May 30, 2003 to May 30,
2005.
(3) STOCK BASED COMPENSATION
The Company applies Accounting Principles Board (APB) Opinion 25 and related
interpretations in accounting for the Company's stock compensation plan. No
compensation cost is reflected in the Company's net income related to the stock
option plans for the periods presented because all options had an exercise price
greater than or equal to the market value of the underlying common stock on the
date of the grant. Had the expense for the Company's stock-based compensation
been determined using the fair value method defined in Financial Accounting
Standard (FAS) 123, "Accounting for Stock-Based Compensation" and FAS 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure" the
Company's net income and net income per share would have been reduced to the pro
forma amounts indicated below:
9
Three Months Ended Nine Months Ended
-------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
(In thousands, except per share data) 2003 2002 2003 2002
------------- ------------- ------------- -------------
Net income (loss) to common shares:
As reported $ (86) $ (440) $ 257 $ (998)
Incremental compensation expense (21) (61) (64) (183)
------- ------- ------- ---------
As adjusted (107) (501) 193 (1,181)
======= ======= ======= =========
Basic earnings (loss) per share:
As reported (.02) (.09) .05 (.21)
As adjusted (.02) (.11) .04 (.25)
Diluted earnings (loss) per share:
As reported (.02) (.09) .04 (.21)
As adjusted (.02) (.11) .03 (.25)
(4) REVENUE RECOGNITION
Under the Exclusive Marketing Agreement, the majority of the sales price payable
for each unit purchased by Safety-Kleen, was payable on net 30-day terms from
date of shipment with a portion (approximately 12%) of the sales price payable
in equal installments over a 12-quarter period. Under the terms of the
Settlement Agreement, the sales price for the final units shipped in September
2003 did not include a deferred installment payment. The Company recognized
revenue at the time of shipment (F.O.B. shipping dock) for the entire sales
price, but applied a discount to reflect the present value of the 12 quarterly
payments utilizing a discount rate which is currently 14%. The discount rate
used is the Company's incremental borrowing rate which is determined to be the
interest paid on its Senior Revolver of 14%. In addition, the Company recognized
imputed interest income over the discount period as the deferred portion of the
purchase price was amortized over the scheduled payment period. At September 30,
2003, approximately $2,001,000 was included in receivables representing the then
current portion of the installment payments and approximately $2,220,000 was due
beyond 12 months as reflected in the balance sheet as Non-current portion of
receivables, net of discount. Safety-Kleen has generally made its payments in
accordance with the terms of the Exclusive Marketing Agreement and the Company
considers this receivable from Safety-Kleen to be collectable. Based on the
current level of the deferred portion of the purchase price, if the discount
rate were to vary by 100 basis points, up or down, the Company's annual income
would vary by approximately $42,000. The collectability of receivables is
evaluated routinely and, if deemed necessary, the Company records an allowance
for doubtful accounts. The allowance for doubtful accounts was $123,287 and
$123,174 at December 31, 2002 and September 30, 2003, respectively.
The Company expects to recognize approximately $9.8 million of other income in
the fourth quarter of 2003 should the Bankruptcy Court approve the Settlement
Agreement consisting of the difference between the $4.2 million deferred portion
of the sales price recognized in receivables as of September 30, 2003 and the
$14 million in termination payments.
10
Deferred revenue on the balance sheet relates to extended two-year warranty
contracts purchased by customers and is recognized in income on the
straight-line basis over the term of each contract.
(5) EARNINGS (LOSS) PER SHARE
The following reconciles the components of the earnings (loss) per share (EPS)
computation (in thousands):
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
2003 2002
----------------------------------------- -------------------------------------------
(In thousands, except Income Shares Per-Share Income (Loss) Shares Per-Share
per share data) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ------------- ------------- ---------
Earnings per common
share:
Net income (loss) $ 480 4,960 $ 97 4,743
Dividends on
Redeemable
Convertible
Preferred stock (566) (537)
----- ------- --------- ------ ------- ---------
Net loss applicable to
common shareholders $ (86) 4,960 $ (.02) $ (440) 4,743 $ (.09)
----- ------- --------- ------ ------- ---------
Effect of dilutive
securities:
----- ------- --------- ------ ------- ---------
Net loss applicable to
common shareholders
plus assumed conversions $ (86) 4,960 $ (.02) $ (440) 4,743 $ (.09)
===== ======= ========= ====== ======= =========
11
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
------------------------------------------ ------------------------------------------
(In thousands, except Income Shares Per-Share Income/(Loss) Shares Per-Share
per share data) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ------------- ------------- ---------
Earnings per common
share:
Net income (loss) $ 1,926 4,929 $ 586 4,743
Dividends on
Redeemable
Convertible
Preferred stock (1,669) (1,584)
------- ------- ------- ------- ------- ---------
Net income (loss)
applicable to common
shareholders $ 257 4,929 $ .05 $ (998) 4,743 $ (.21)
Effect of dilutive
securities:
Warrants 797
------- ------- ------- ------- ------- ---------
Net income (loss)
applicable to common
shareholders plus
assumed conversions $ 257 5,726 $ .04 $ (998) 4,743 $ (.21)
======= ======= ======= ======= ======= =========
As of September 30, 2003, the following were outstanding, but were not included
in the computation of diluted EPS because the respective conversion or exercise
prices were greater than the average market price of the common shares: (i)
warrants to purchase 29,750 shares, 1,250 shares, 942,858 shares and 571,428
shares at $19.50, $11.50, $3.50 and $3.50 per share respectively, (ii)
Convertible Preferred Stock Series B, C and D and Subordinated Convertible Notes
(including accrued payment-in-kind interest) of $7,192,651, $9,523,434, and
$2,636,070 and $23,146,060 convertible at $4.68, $3.50, $3.50 and $17.00,
respectively, and (iii) 533,716 stock options with exercise prices ranging from
$19.50 to $2.50. In addition to the above instruments, warrants to purchase
779,687 shares at $.01 per share were not included in the computation of diluted
EPS for the three months ended September 30, 2003 because they are antidilutive
due to the Company's loss.
As of September 30, 2002, the following were outstanding, but were not included
in the computation of diluted EPS because they are antidilutive due to the
Company's loss: (i) warrants to purchase 29,750 shares, 1,250 shares, 942,858
shares, 571,428 shares and 1,134,615 shares at $19.50, $11.50, $3.50, $3.50 and
$3.50 per share, respectively, (ii) Convertible Preferred Stock Series B, C and
D and Subordinated Convertible Notes (including accrued payment-in-kind
interest) of $6,635,593, $8,804,334 and $2,431,129 and $22,061,786 convertible
at $4.68, $3.50, $3.50 and $17.00, respectively, and (iii) 533,716 stock options
with exercise prices ranging from $19.50 to $2.50.
(6) WARRANT CONVERSIONS
In January 2003, 200,000 warrants previously issued to the holders of
Subordinated Convertible Notes were converted into common stock according to a
provision of the warrants providing for a cashless exercise transaction. The
200,000 warrants were converted to 197,142 shares of the Company's common stock
at the market price of $.70 on the day of the conversion.
12
In June 2003, 20,000 warrants previously issued to the holders of Subordinated
Convertible Notes were converted into common stock according to a provision of
the warrants providing for a cashless exercise transaction. The 20,000 warrants
were converted to 19,714 shares of the Company's common stock at the market
price of $.70 on the day of the conversion.
In July 2003, 313 warrants previously issued to the holders of Subordinated
Convertible Notes were converted into common stock according to a provision of
the warrants providing for a cashless exercise transaction. The 313 warrants
were converted to 308 shares of the Company's common stock at the market price
of $.70 on the day of the conversion.
(7) INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry-forwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Realization of deferred tax assets associated with federal and state net
operating loss carry-forwards ("NOLs") is dependent upon generating sufficient
taxable income prior to their expiration. The Company believes that there is a
risk that these NOLs may expire unused and accordingly, has established a
valuation reserve against them in full. The current income tax provision of
$40,000 represents the Company's estimated alternative minimum tax liability for
the nine months ended September 30, 2003. There was no such provision for the
same period ended 2002.
(8) PRODUCT WARRANTY
The Company generally warrants that its products will be free of material
defects during a three-year warranty period. Safety-Kleen assumed all service,
maintenance and repair responsibilities for the Company's installed base of
SystemOne(R) parts washers, including units sold before the Exclusive Marketing
Agreement and units sold pursuant to the Exclusive Marketing Agreement. The
Company is responsible for the cost of all parts required for service during the
warranty period for all units sold.
For units sold before the Exclusive Marketing Agreement, the Company agreed to
pay Safety-Kleen a total fee of $500,000 for all warranty service to be
performed by Safety-Kleen on these units. The balance of the $500,000 fee was
paid in full in the second quarter of 2003. For units sold pursuant to the
Exclusive Marketing Agreement, Safety-Kleen is responsible for the cost of all
service, maintenance and repair during the warranty period.
The Company accrues estimated standard warranty cost as the SystemOne(R) Washers
are sold to customers. Such estimated standard warranty cost includes the
estimated cost of parts and the call center. Estimated cost of parts is based on
actual parts used during the previous 16 months and the estimated cost of the
call center includes estimated costs to be incurred during the remaining
warranty period. Under the Settlement Agreement the Company is required to
13
continue to supply any parts free of charge for the balance of the three-year
warranty period applicable to units sold to Safety-Kleen. The Company will also
continue to provide repair and replacement parts for the items not covered by
warranty, at Safety-Kleen's expense.
The table below sets forth warranty accrual activity during the nine-month
periods ended September 30:
2003 2002
--------- ----------
Beginning balance $ 674,000 $1,072,000
Warranty provision 489,000 259,000
Warranty payments (637,000) (618,000)
--------- ----------
Ending balance $ 526,000 $ 713,000
--------- ----------
(9) NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging Issues Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." Under SFAS No. 146, a liability related to
an exit or disposal activity (including restructurings) is not recognized until
such liability has actually been incurred whereas under EITF Issue No. 94-3 a
liability was recognized at the time of a commitment to an exit or disposal
plan. The provisions of this standard are effective for disposal activities
initiated after December 31, 2002. The adoption of SFAS No. 146 did not
materially impact the Company's financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities ("VIE's") created after January 31, 2003, and to VIE's in which an
enterprise obtains an interest after that date. On October 9, 2003 the FASB
issued FASB Staff Position No. FIN 46-6 "Effective Date of FASB Interpretation
No.46 CONSOLIDATION OF VARIABLE INTEREST ENTITIES," which defers the
implementation date for public entities that hold an interest in a variable
interest entity or potential variable interest entity from the first fiscal year
or interim period beginning after June 15, 2003 to the end of the first interim
or annual period ending after December 15, 2003. This deferral applies only if
1) the variable interest entity was created before February 1, 2003 and 2) the
public entity has not issued financial statements reporting that variable
interest entity in accordance with FIN 46, other than disclosures required by
paragraph 26 of FIN 46. The adoption of FIN 46 is not expected to have a
material impact on the Company's financial position, liquidity or results of
operations.
14
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under FASB
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. The adoption of SFAS No. 149 did not materially impact the Company's
financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." The statement
requires that an issuer classify financial instruments that are within its scope
as a liability. Many of those instruments were classified as equity under
previous guidance. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003. Otherwise, it is effective on July
1, 2003 except for mandatorily redeemable non controlling (minority) interest
which, on October 29, 2003, the FASB decided to defer indefinitely. The adoption
of SFAS No. 150 did not materially impact the Company's financial position or
results of operations.
(10) Contingencies
On our about October 17, 2003, the Company, along with Safety-Kleen, was sued
in the Court of Common Pleas for Beaver County, Pennsylvania by plaintiff
Sirota's Machine Company, Inc. The plaintiff seeks damages in the amount of
approximately $335,000 resulting from a fire that the plaintiff claims was
caused by a SystemOne parts washer. Based upon an initial investigation by the
Company's insurance carrier, the Company believes that the claim is without
merit and anticipates that its insurance carrier will aggressively defend the
claim. Accordingly, the Company currently anticipates that this case will not
have a material adverse effect on the Company's financial position or its
results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis should be read in conjunction with the
Financial Statements, including the notes thereto, contained elsewhere in this
10-QSB and the Company's Form 10-KSB filed with the Securities and Exchange
Commission for the fiscal year ended December 31, 2002.
GENERAL AND RECENT DEVELOPMENTS
The Company was incorporated as Mansur Industries Inc. in November 1990 and, as
a development stage company, devoted substantially all of its resources to
research and development programs related to its full line of self-contained,
recycling industrial parts washers until June 1996. The Company commenced its
planned principal operations in July 1996 and began to generate significant
revenue from product sales in 1997. The Company's operating expenses, however,
increased significantly between 1997 and 2000 in connection with the development
of a national direct marketing and distribution organization, including the
establishment of regional distribution centers and a service fleet. The Company
could not sustain the cost of this marketing and distribution organization and,
as a result, elected to enter into a distribution agreement with Safety-Kleen.
Commencing in the first quarter of 2001, the Company appointed Safety-Kleen the
exclusive distributor for its Series 100, Series 300 and Series 500 SystemOne(R)
parts washers in the United States, Puerto Rico, Canada and Mexico under the
terms of the Exclusive Marketing Agreement. This strategic shift allowed the
Company to eliminate its entire national direct sales and service infrastructure
permitting a significant reduction in the Company's operating expenses.
On July 30, 2003, the Company entered into the SystemOne Equipment Inspection
and Repair Agreement (the "Repair Agreement") with Safety-Kleen to inspect and
repair any leaking tanks
15
in SystemOne(R) Washers. During the third quarter, Safety-Kleen had claimed a
purported material breach of the Exclusive Marketing Agreement by the Company,
alleging that certain molded tanks in SystemOne(R) Washers potentially developed
leaks and were, therefore, defectively designed or manufactured. During August
and September, the Company proceeded to perform under the Repair Agreement.
However, in September, the Company and Safety-Kleen determined that it was in
their mutual best interests to enter into a Comprehensive Settlement Agreement
(the "Settlement Agreement"), dated September 30, 2003, with Safety-Kleen, in
order to terminate the Exclusive Marketing Agreement and the Repair Agreement
(effective October 1, 2003), settle any outstanding disputes and grant full and
mutual releases of all claims that each may have against the other.
Pursuant to the terms and conditions of the Settlement Agreement, which remains
subject to the approval of the Bankruptcy Court administering Safety-Kleen's
reorganization, Safety-Kleen's status as the exclusive North American
distributor of SystemOne parts washers and all remaining parts washer unit
purchase commitments for October 2003 through December 2005 under the Exclusive
Marketing Agreement have been terminated. SystemOne will remain obligated to
honor the balance of the three-year parts only warranty which is applicable to
all parts washers sold to Safety-Kleen. The Settlement Agreement settles
previously disclosed disputes between the parties and releases the parties from
all claims that each may have against the other. The Settlement Agreement also
required Safety-Kleen to surrender its warrant to purchase 1,134,615 shares of
common stock of the Company for cancellation and provides that Safety-Kleen will
have the right in 2005 to purchase the lesser of up to 3,000 SystemOne parts
washer units or one-sixth of the Company's then annual production capacity.
In consideration for the foregoing, and among other things, the Settlement
Agreement provides for a total payment of $14 million to the Company (the
"Settlement Consideration"), consisting of a termination fee and a lump sum
payment of the accumulated deferred price for the approximately 30,000 SystemOne
parts washer units shipped to Safety-Kleen under the Exclusive Marketing
Agreement prior to its termination. The Settlement Consideration consists of (i)
$2 million, which was paid to SystemOne on October 6, 2003, (ii) $1 million
payable to SystemOne within eleven days after the Safety-Kleen Bankruptcy Court
approval becomes final and non-appealable, (iii) $7 million payable to SystemOne
no later than December 31, 2003, provided that Safety-Kleen's plan of
reorganization which has already been approved by the Bankruptcy Court becomes
effective prior to December 1, 2003 and (iv) a balance of $4 million payable to
SystemOne in monthly installments with the final payment due no later than March
31, 2004. Should Safety-Kleen's plan of reorganization not become effective
prior to December 1, 2003, the final $11 million is payable with interest in
monthly installments with the final payment due no later than March 31, 2004.
Because Safety-Kleen was the Company's only customer the Company will have to
develop new distribution channels for its products. In order to conserve
resources pending the development of a new distribution system, the Company
reduced its production force effective September 29, 2003. Although the
Settlement Agreement is expected to provide the Company with $14 million, prior
to March 31, 2004, which will be used to fund its transition from single
customer distribution to multiple distribution channels and to service its debt
and other ongoing obligations, there can be no assurance that the Company's
efforts to develop new distribution
16
channels will be successful or that such amount will be sufficient to sustain
any such effort. Any failure to obtain new distributors and customers in a
timely manner could have a material adverse effect on the Company's results of
operations, cash flows and financial condition. If the payments under the
Settlement Agreement, together with any future sales revenue and other available
capital resources are insufficient to fund the Company's transition to a new
distribution system, the Company could be required to seek additional debt or
equity capital. There can be no assurance that any such additional capital would
be available on acceptable terms or at all. In addition, in light of the
termination of the Exclusive Marketing Agreement, there can be no assurance that
the lender under the Senior Revolver will continue to provide advances
thereunder.
Management plans to distribute the SystemOne(R) Washers through multiple
distribution channels utilizing third party distributors rather than
establishing a direct marketing and distribution organization. The Company has
signed a distribution agreement with Hockman-Lewis Limited appointing them as
the Company's international sales distributor in all export markets worldwide
excluding Canada, Mexico and Puerto Rico. Although the Company has conducted
extensive research regarding the use of third party distributors, there can be
no assurance that these multiple distribution channels will successfully
penetrate the market or that the Company's overall marketing plans will prove to
be successful. The Company plans to commence the sale of its SystemOne(R)
Washers to distributors other than Safety-Kleen following the Bankruptcy Court's
approval of the Settlement Agreement which approval is anticipated during the
fourth quarter of 2003. Foreign sales are expected to occur before the
Bankruptcy Court approval because, under the Exclusive Marketing Agreement, the
Company retained the rights to sell, lease, rent and service all of the
Company's parts washing equipment outside the Safety-Kleen's territory.
As a result of anticipated near term reduced production requirements following
the termination of the Exclusive Marketing Agreement, the Company plans to
reduce plant space and personnel and reduce non-essential expenses wherever
practicable. The Company is in the process of finalizing an agreement to
sublease approximately 25,000 square feet of idle manufacturing and office space
to a non-related third party.
In June 2002, the Company began the process of attaining ISO 9001:2000
certification. ISO 9001:2000 is part of a family of international quality
standards which require the Company to establish and maintain a quality system.
The Company's quality system will include internal quality audits, corrective
and preventive action systems, management review and continual third party
assessments. This quality system is being implemented to ensure maximum customer
satisfaction by offering the highest quality product. The Company has
temporarily delayed attaining ISO 9001:2000 certification as it focuses on
transitioning from single customer distribution to multiple distribution
channels.
In December 2002, the Company completed an exchange (the "Exchange") of its then
outstanding 8.25% Subordinated Convertible Notes due February 23, 2003 and 16%
Promissory Notes due November 30, 2002 for (i) 8.25% Subordinated Convertible
Notes due December 31, 2005, (ii) 10% Promissory Notes due December 31, 2005 and
(iii) warrants to purchase shares of the Company's common stock, $.001 par value
per share at an exercise price of $.01 per share.
17
In connection with the Exchange, the holders of the Company's outstanding shares
of Preferred Stock agreed to extend the date upon which the Company must redeem
such shares from May 17, 2004 to the earlier of the 90th day after all of the
Subordinated Convertible Notes are paid in full or March 31, 2006 (but not
earlier than May 17, 2004).
The Company entered into an agreement on February 15, 2003 to extend the
maturity date of the Company's Senior Revolver from May 30, 2003 to May 30,
2005.
During the nine months ended September 30, 2003, an aggregate of 220,313
warrants with an exercise price of $.01 per share previously issued to the
holders of Subordinated Convertible Notes were converted by cashless exercises
(based on a market price of $.70 per share on the specific dates of the
conversions) into an aggregate of 217,164 shares of the Company's common stock.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2002
Revenue increased by $1,067,000, or 24.0%, to $5,519,000 for the three months
ended September 30, 2003 from $4,452,000 for the comparable period during 2002.
The revenue increase was a result of (i) a 23.0% increase in equivalent units
sold resulting from the increase in Safety Kleen's minimum annual purchase
commitment from 10,000 equivalent units in the prior year to 12,500 equivalent
units in 2003 (ii) a price increase of approximately 2.3% pursuant to the
Exclusive Marketing Agreement and (iii) a 10.7% increase in parts sold to
Safety-Kleen. Sales during the 2003 and 2002 periods were entirely to
Safety-Kleen. Revenue from sales for the fourth quarter is expected to be
significantly less than in prior quarters as a result of the tentative
termination of the Exclusive Marketing Agreement and the Company's efforts to
transition from single customer distribution to multiple distribution channels.
Gross margin as a percentage of sales was 37.1% and 37.7% for the three months
ended September 30, 2003 and 2002, respectively. The decrease in gross margin is
primarily due to an additional warranty accrual of approximately $147,000
associated with the Repair Agreement. The decrease in gross margin is partially
offset due to reductions in per unit production labor of approximately 7% and
plant overhead of approximately 20% as a result of producing more units
utilizing existing personnel and facilities.
Selling, general and administrative expenses for the three months ended
September 30, 2003 were $863,000, an increase of $93,000, or 12.1%, compared to
selling, general and administrative expenses of $770,000 for the three months
ended September 30, 2002. Selling, general and administrative costs increased
due to increased legal expenses related to the Repair Agreement of approximately
$165,000. Such increased expenses were partially offset by a reduction in rent
beginning in the second quarter of 2002. The reduction in rent was the result of
the Company's return of approximately 13,000 square feet of idle capacity to its
landlord.
Research and development expenses decreased by $1,000 from $85,000 for the three
months ended September 30, 2002 to $84,000 for the three months ended September
30, 2003. Fourth
18
quarter research and development expenditures are expected to be consistent with
prior periods, as the Company does not foresee a significant reduction as a
result of the tentative termination of the Exclusive Marketing Agreement.
The Company recognized an operating profit of $1,102,000 for the three months
ended September 30, 2003 compared to an operating profit of $822,000 for the
comparable period during 2002. This improvement is primarily due to the increase
in minimum annual sales pursuant to the Exclusive Marketing Agreement discussed
above. The Company does not expect this trend to continue in the fourth quarter
as a result of the tentative termination of the Exclusive Marketing Agreement.
Interest expense for the three months ended September 30, 2003 was $754,000, a
decrease of $69,000 or 8.4% compared to interest expense of $823,000 for the
three months ended September 30, 2002. The decrease in interest expense is due
to (i) a reduction in the outstanding principal on the Senior Revolver (ii) a
reduction in the interest rate on the Subordinated Promissory Notes from 16% in
2002 to 10% in 2003 and (iii) lower amortization of debt issue costs in 2003.
The interest expense decrease was partially offset by increased debt balances
attributable to capitalization of accrued interest in connection with the
December 9, 2002 debt restructuring and amortization of debt discount associated
with common stock warrants issued to lenders during the fourth quarter of 2002.
Interest income increased $41,000 from $98,000 in the three months ended
September 30, 2002 to $139,000 in the three months ended September 30, 2003. The
increase is primarily due to the increase in the deferred portion of the sales
price resulting from the cumulative increase in units sold under the Exclusive
Marketing Agreement. As a result of the tentative termination of the Exclusive
Marketing Agreement, it is expected that nominal interest income will be
recognized in the fourth quarter.
Income tax provision increased $7,000 from $0 in the three months ended
September 30, 2002 to $7,000 in the three months ended September 30, 2003. The
increase is due to the alternative minimum tax payable as a result of the
Company recognizing net income in the three months ended September 30, 2003.
Dividends on redeemable convertible preferred stock increased by $29,000, or
5.4%, to $566,000 for the three months ended September 30, 2003 from $537,000
for the comparable period during 2002. The increase is due to the compounding
effect of paying dividends on additional shares of preferred stock that were
previously issued as payment-in-kind dividends.
As a result of the foregoing, the Company recognized net loss attributable to
common shares of $86,000 for the three months ended September 30, 2003, an
increase of $354,000, or 80.5%, compared to a net loss attributable to common
shares of $440,000 for the three months ended September 30, 2002.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2002
Revenue increased by $3,557,000, or 26.8%, to $16,829,000 for the nine months
ended September 30, 2003 from $13,272,000 for the comparable period during 2002.
The revenue
19
increase was a result of (i) a 23.1% increase in equivalent units sold resulting
from the increase in Safety Kleen's minimum annual purchase commitment from
10,000 equivalent units in the prior year to 12,500 equivalent units in 2003,
(ii) a price increase of approximately 2.3% pursuant to the Exclusive Marketing
Agreement and (iii) a 101.9% increase in parts sold to Safety-Kleen. Sales
during the 2003 and 2002 periods were entirely to Safety-Kleen. Revenue from
sales for the fourth quarter is expected to be significantly less than in prior
quarters as a result of the tentative termination of the Exclusive Marketing
Agreement and the Company's efforts to transition from single customer
distribution to multiple distribution channels.
Gross margin as a percentage of sales was 38.5% and 39.7% for the nine months
ended September 30, 2003 and 2002, respectively. The decrease in gross margin is
primarily due to an additional warranty accrual of approximately $448,000
associated with the Repair Agreement. The decrease in gross margin is partially
offset due to reductions in per unit production labor of approximately 7% and
plant overhead of approximately 20% as a result of producing more units
utilizing existing personnel and facilities.
Selling, general and administrative expenses for the nine months ended September
30, 2003 were $2,306,000, an increase of $106,000, or 4.8%, compared to selling,
general and administrative expenses of $2,200,000 for the nine months ended
September 30, 2002. Selling, general and administrative costs increased due to
increased legal expenses related to the Repair Agreement of approximately
$283,000. Such increased expenses were partially offset by a reduction in rent
under the Company's property lease beginning in the second quarter of 2002. The
reduction in rent was the result of the Company's return of approximately 13,000
square feet of idle capacity to its landlord.
Research and development expenses increased by $45,000, or 19.6%, from $230,000
for the nine months ended September 30, 2002 to $275,000 for the nine months
ended September 30, 2003. The increase is primarily due to an increase in wages
for the Company's engineers and increased expenditures related to the
development and field testing of the Company's new SystemOne(R) Spray Gun
Cleaner. Fourth quarter research and development expenditures are expected to be
consistent with prior periods, as the Company does not foresee a significant
reduction as a result of the tentative termination of the Exclusive Marketing
Agreement.
Restructuring and other charges for the nine months ended September 30, 2002
consisted of a reversal of a restructuring accrual of $75,000 that was provided
in the fourth quarter of 2000.
The Company recognized an operating profit of $3,901,000 for the nine months
ended September 30, 2003 compared to an operating profit of $2,911,000 for the
comparable period during 2002. This improvement is due largely to the increase
in minimum annual sales pursuant to the Exclusive Marketing Agreement discussed
above. The Company does not expect this trend to continue in the fourth quarter
as a result of the tentative termination of the Exclusive Marketing Agreement.
Interest expense for the nine months ended September 30, 2003 was $2,324,000, a
decrease of $260,000, or 10.1%, compared to interest expense of $2,584,000 for
the nine months ended September 30, 2002. The decrease in interest expense is
due to (i) fully amortizing in January
20
2002 debt discount associated with common stock warrants issued to lenders
during the third and fourth quarters of 2000, (ii) a reduction in the
outstanding principal on the Senior Revolver (iii) a reduction in the interest
rate on the Subordinated Promissory Notes from 16% in 2002 to 10% in 2003 and
(iv) lower amortization of debt issue costs in 2003. The decrease is partially
offset by increased debt balances attributable to capitalization of accrued
interest in connection with the December 9, 2002 debt restructuring.
Interest income increased $130,000, or 50.2%, from $259,000 in the nine months
ended September 30, 2002 to $389,000 in the nine months ended September 30,
2003. The increase is mainly due to the increase in the deferred portion of the
sales price resulting from the cumulative increase in units sold under the
Exclusive Marketing Agreement. As a result of the tentative termination of the
Exclusive Marketing Agreement, it is expected that nominal interest income will
be recognized in the fourth quarter.
Income tax provision increased from zero in the nine months ended September 30,
2002 to $40,000 in the nine months ended September 30, 2003. The increase is due
to the alternative minimum tax payable as a result of the Company recognizing
net income in the nine months ended September 30, 2003.
Dividends on redeemable convertible preferred stock increased by $85,000, or
5.4%, to $1,669,000 for the nine months ended September 30, 2003 from $1,584,000
for the comparable period during 2002. The increase is due to the compounding
effect of paying dividends on additional shares of preferred stock that were
previously issued as payment-in-kind dividends.
As a result of the foregoing, the Company recognized net income attributable to
common shares of $257,000 for the nine months ended September 30, 2003, an
increase of $1,255,000, or 125.8%, compared to a net loss attributable to common
shares of $998,000 for the nine months ended September 30, 2002.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities for the nine months ended September
30, 2003 increased by $2,015,000 to $2,616,000, compared to net cash provided by
operating activities of $601,000 for the nine months ended September 30, 2002.
The increase is primarily attributable to an increase in net income of
$1,340,000 for the nine months ended September 30, 2003 as compared to the 2002
period. This increase from net income was offset by an increase in receivables
due to (i) an increase in sales volume attributable to the scheduled 25%
increase in equivalent units sold in the 2003 period, (ii) the increase in the
deferred portion of the sales price and (iii) a 2.3% increase in the sales
price. Operating cash benefited from the increase in accounts payable and
accrued expenses due primarily to the availability of more favorable terms from
vendors and increased purchases to support the higher inventory levels necessary
to sustain the scheduled increase in sales volume.
Net cash used in investing activities for the nine months ended September 30,
2003 was $32,000, a decrease of $16,000, compared to $48,000 used in investing
activities during the comparable period of the prior year. This decrease is
primarily a result of purchasing more manufacturing equipment with cash in the
first nine months of 2002 than in the same period in 2003. The
21
Company purchased manufacturing equipment totaling approximately $23,000 through
a capital lease during the first quarter of 2003.
Net cash used in financing activities for the nine months ended September 30,
2003 was $1,872,000 compared to net cash used in financing activities of
$297,000 for the nine months ended September 30, 2002. The increase of
$1,575,000 is primarily due to Senior Revolver repayments totaling $1,735,000 in
the 2003 period compared to repayments totaling $80,000 in the 2002 period. The
increase is offset by lower payments of capital lease obligations due to several
leases being paid off in 2002.
At September 30, 2003, the Company had working capital of $4,262,000 and cash
and cash equivalents of $1,217,000, compared to working capital of $2,790,000
and cash and cash equivalents of $505,000 at December 31, 2002. The increase in
working capital is mainly due to the increase in cash and cash equivalents and
receivables attributable to the accumulation of the deferred portion of the
sales price, which is offset, in part, by the increase in accounts payable and
accrued expenses explained above. Given the tentative termination of the
Exclusive Marketing Agreement effective October 1, 2003, the Company plans to
attempt to conserve cash while transitioning from single customer distribution
to multiple distribution channels utilizing third party distributors.
The Company's material short-term financial commitments are obligations to make
(i) lease payments on the Company's principal executive and manufacturing
facility in Miami, Florida, and equipment leases (approximately $39,000 per
month), (ii) installment payments for financed manufacturing equipment
(approximately $12,000 per month), (iii) interest payments on the Company's
8.25% Subordinated Convertible Notes (approximately $157,000 per month) of which
50% accrues interest and 50% requires cash interest payments beginning January
1, 2003, (iv) interest payments under the Secured Notes (as defined below) which
accrues and is due at maturity (approximately $37,000 per month) and (v)
interest payments on the Senior Revolver (up to approximately $34,000 per
month). Dividends on the Company's Series B, Series C and Series D Convertible
Preferred Stock are paid by issuance of additional shares of such series.
The Company anticipates that its primary sources of cash will be accounts
receivables of $5,964,000 (including the lump sum payment representing the
deferred portion of the sales price), the approximately $9.8 million balance of
payments expected to be collected under the Settlement Agreement prior to March
31, 2004 (assuming Bankruptcy Court approval) and the Senior Revolver. The
Senior Revolver provides the Company with a $5 million revolving line of credit.
Pursuant to the Senior Revolver, the Company may borrow twice a month up to the
Advance Limit (as defined below). The Advance Limit is the lesser of $5,000,000
or the sum of the Advance Supplement of $2,500,000 plus an amount based on the
Company's receivables and inventory. As of September 30, 2003, there was
approximately $2,065,000 of credit available under the Senior Revolver. However,
in light of the termination of the Exclusive Marketing Agreement, there can be
no assurance that the lender under the Senior Revolver will continue to provide
advances thereunder.
Because Safety-Kleen was the Company's only customer, the Company will have to
develop new distribution channels for its products. In order to conserve
resources pending the development of a new distribution system, the Company has
reduced its production force
22
effective September 29, 2003. Although the Settlement Agreement is expected to
provide the Company with $14 million prior to March 31, 2004, which will be
used to fund its transition from single customer distribution to multiple
distribution channels and to service its debt and other ongoing obligations,
there can be no assurance that the Company's efforts to develop new distribution
channels will be successful or that such amount will be sufficient to sustain
any such effort. Any failure to obtain new distributors and customers in a
timely manner could have a material adverse effect on the Company's results of
operations, cash flows and financial condition. If the payments under the
Settlement Agreement, together with any future sales revenue and other available
capital resources are insufficient to fund the Company's transition to a new
distribution system, the Company could be required to seek additional debt or
equity capital. There can be no assurance that any such additional capital would
be available on acceptable terms or at all. In addition, in light of the
termination of the Exclusive Marketing Agreement, there can be no assurance that
the lender under the Senior Revolver will continue to provide advances
thereunder.
In December 2002, the Company completed an exchange (the "Exchange") of its then
outstanding 8.25% Subordinated Convertible Notes due February 23, 2003 and 16%
Promissory Notes due November 30, 2002 for (i) 8.25% Subordinated Convertible
Notes due December 31, 2005, (ii) 10% Promissory Notes due December 31, 2005 and
(iii) warrants to purchase shares of the Company's common stock, $.001 par value
per share at an exercise price of $.01 per share.
In connection with the Exchange, the holders of the Company's outstanding shares
of preferred stock agreed to extend the date upon which the Company must redeem
such shares from May 17, 2004 to the earlier of the 90th day after all of the
Subordinated Convertible Notes are paid in full or March 31, 2006 (but not
earlier than May 17, 2004).
Although the Company believes that it will continue to be able to meet its
operating cash requirements from accounts receivables of $5,964,000 (including
the lump sum payment representing the deferred portion of the sales price), the
approximately $9.8 million balance of payments expected to be collected under
the Settlement Agreement prior to March 31, 2004 (assuming Bankruptcy Court
approval) and the Senior Revolver, if none of the outstanding convertible debt
and convertible preferred stock is converted to common stock, significant
amounts of cash would be required, commencing in 2005, to repay long term debt,
accrued interest and redeemable preferred stock as follows:
Debt Plus Interest Preferred Stock Total
------------------ --------------- ------------
2003 $ 14,775 $ -- $ 14,775
2004 14,236 -- 14,236
2005 33,976,784 -- 33,976,784
2006 -- 23,618,000* 23,618,000
----------- ----------- -----------
Total $34,005,795 $23,618,000 $57,623,795
=========== =========== ===========
*Assuming no pre-payment of Subordinated Convertible Notes.
There can be no assurance that the Company will have or be able to obtain
sufficient cash to
23
make such repayments. The Company is required to issue an additional 942,858
warrants to the holders of its Secured Notes if the Company (i) sells debt or
equity securities, or debt securities convertible into equity securities, (ii)
incurs debt yielding gross cash proceeds to the Company in an amount equal to or
greater than the outstanding principal amount of the Secured Notes and with a
scheduled final maturity date that exceeds 12 months from the date of issuance
or (iii) enters into a merger, consolidation, sale of all or substantially all
of its assets or other business combination transaction with a party that prior
to such transaction owns less than 25% of the voting power of the Company's then
outstanding equity securities. The fair market value of the warrants would be
charged to operations should the warrants become issuable.
The Company entered into an agreement on February 15, 2003 to extend the
maturity of the Company's Senior Revolver from May 30, 2003 to May 30, 2005.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging Issues Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." Under SFAS No. 146, a liability related to
an exit or disposal activity (including restructurings) is not recognized until
such liability has actually been incurred whereas under EITF Issue No. 94-3 a
liability was recognized at the time of a commitment to an exit or disposal
plan. The provisions of this standard are effective for disposal activities
initiated after December 31, 2002. The adoption of SFAS No. 146 did not
materially impact the Company's financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities ("VIE's") created after January 31, 2003, and to VIE's in which an
enterprise obtains an interest after that date. On October 9, 2003 the FASB
issued FASB Staff Position No. FIN 46-6 "Effective Date of FASB Interpretation
No.46 CONSOLIDATION OF VARIABLE INTEREST ENTITIES," which defers the
implementation date for public entities that hold an interest in a variable
interest entity or potential variable interest entity from the first fiscal year
or interim period beginning after June 15, 2003 to the end of the first interim
or annual period ending after December 15, 2003. This deferral applies only if
1) the variable interest entity was created before February 1, 2003 and 2) the
public entity has not issued financial statements reporting that variable
interest entity in accordance with FIN 46, other than disclosures required by
paragraph 26 of FIN 46. The adoption of FIN 46 is not expected to have a
material impact on the Company's financial position, liquidity or results of
operations.
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting
24
and reporting for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under FASB Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. The adoption of SFAS No.
149 did not materially impact the Company's financial position or results of
operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." The statement
requires that an issuer classify financial instruments that are within its scope
as a liability. Many of those instruments were classified as equity under
previous guidance. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003. Otherwise, it is effective on July
1, 2003 except for mandatorily redeemable non controlling (minority) interest
which, on October 29, 2003, the FASB decided to defer indefinitely. The adoption
of SFAS No. 150 did not materially impact the Company's financial position or
results of operations.
CRITICAL ACCOUNTING POLICIES
Management believes the following policies are critical to an understanding of
the Company's financial statements.
REVENUE RECOGNITION. Under the Exclusive Marketing Agreement, the majority of
the sales price payable for each unit purchased by Safety-Kleen, was payable on
net 30-day terms from date of shipment with a portion (approximately 12%) of the
sales price payable in equal installments over a 12-quarter period. Under the
terms of the Settlement Agreement, the sales price for the final units shipped
in September 2003 did not include a deferred installment payment. The Company
recognized revenue at the time of shipment (F.O.B. shipping dock) for the entire
sales price, but applied a discount to reflect the present value of the 12
quarterly payments utilizing a discount rate which is currently 14%. The
discount rate used is the Company's incremental borrowing rate which is
determined to be the interest paid on its Senior Revolver of 14%. In addition,
the Company recognized imputed interest income over the discount period as the
deferred portion of the purchase price was amortized over the scheduled payment
period. At September 30, 2003, approximately $2,001,000 was included in
receivables representing the then current portion of the installment payments
and approximately $2,220,000 was due beyond 12 months as reflected in the
balance sheet as Non-current portion of receivables, net of discount.
Safety-Kleen has generally made its payments in accordance with the terms of the
Exclusive Marketing Agreement and the Company considers this receivable from
Safety-Kleen to be collectable. Based on the current level of the deferred
portion of the purchase price, if the discount rate were to vary by 100 basis
points, up or down, the Company's annual income would vary by approximately
$42,000. The collectability of receivables is evaluated routinely and, if deemed
necessary, the Company records an allowance for doubtful accounts. The allowance
for doubtful accounts was $123,287 and $123,174 at December 31, 2002 and
September 30, 2003, respectively.
The Company expects to recognize approximately $9.8 million of other income in
the fourth quarter of 2003 should the Bankruptcy Court approve the Settlement
Agreement consisting of
25
the difference between the $4.2 million deferred portion of the sales price
recognized in receivables as of September 30, 2003 and the $14 million in
termination payments.
Deferred revenue on the balance sheet relates to extended two-year warranty
contracts purchased by customers and is recognized in income on the
straight-line basis over the term of each contract.
PRODUCT WARRANTY. The Company generally warrants that its products will be free
of material defects during a three-year warranty period. Safety-Kleen assumed
all service, maintenance and repair responsibilities for the Company's installed
base of SystemOne(R) parts washers, including units sold before the Exclusive
Marketing Agreement and units sold pursuant to the Exclusive Marketing
Agreement. The Company is responsible for the cost of all parts required for
service during the warranty period for all units sold.
For units sold before the Exclusive Marketing Agreement, the Company agreed to
pay Safety-Kleen a total fee of $500,000 for all warranty service to be
performed by Safety-Kleen on these units. The balance of the $500,000 fee was
paid in full in the second quarter of 2003. For units sold pursuant to the
Exclusive Marketing Agreement, Safety-Kleen is responsible for the cost of all
service, maintenance and repair during the warranty period.
The Company accrues estimated standard warranty cost as the SystemOne(R) Washers
are sold to customers. Such estimated standard warranty cost includes the
estimated cost of parts and the call center. Estimated cost of parts is based on
actual parts used during the previous 16 months and the estimated cost of the
call center includes estimated costs to be incurred during the remaining
warranty period. Under the Settlement Agreement the Company is required to
continue to supply any parts free of charge for the balance of the three-year
warranty period applicable to units sold to Safety-Kleen. The Company will also
continue to provide repair and replacement parts for the items not covered by
warranty, at Safety-Kleen's expense.
USE OF ESTIMATES. Management of the Company uses estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results could
differ from those estimates.
CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis contains various "forward
looking statements" within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), which represent the Company's expectations or
beliefs concerning future events, including, without limitation, statements
regarding the development of a new distribution system for the Company's
products in light of the termination of the Exclusive Marketing Agreement and
the sufficiency of the Company's cash and financial resources to support the
cost of developing such new distribution system as well as for its other ongoing
liquidity and capital resource needs. These forward looking statements are
further qualified by important factors that could cause actual events to differ
materially from those in such forward looking statements. These factors include,
26
without limitation, increased competition, the sufficiency of the Company's
patents, the ability of the Company to manufacture its products on a cost
effective basis, market acceptance of the Company's products, the effects of
governmental regulation and the ability of the Company to obtain adequate
financing to support its operational and marketing plans, the expansion of its
services network and future product development. Results actually achieved may
differ materially from expected results included in these statements as a result
of these or other factors. In particular, the Company's performance for the
foreseeable future will be dependent on, among other things, (i) the ability to
enter into satisfactory arrangements with distributors and other resellers of
SystemOne's parts washers, (ii) the ability of the Company and any such
distributors and resellers to penetrate the market for parts washers and to
offer the SystemOne(R) Washers on commercial terms and prices that will be
attractive to customers, (iii) the sufficiency of the Company's current
financial resources to sustain the Company's operations pending the development
of a new distribution system and sales revenue, (iv) the ability of the Company
to successfully market and sell its products in international markets and (v)
the ability of the Company to commercialize new products under development.
ITEM 3. CONTROLS AND PROCEDURES
EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS. As of the end of the period
covered by this quarterly report, the Company has evaluated the effectiveness of
the design and operation of its disclosure controls and procedures ("Disclosure
Controls"). This evaluation (the "Controls Evaluation") was done under the
supervision and with the participation of the Company's management, including
its Chief Executive Officer ("CEO") and Director of Finance and Administration /
Principal Financial Officer (PFO). Rules adopted by the SEC require that in this
section of the quarterly report the Company present the conclusions of its CEO
and the PFO about the effectiveness of the Company's Disclosure Controls based
on and as of the date of the Controls Evaluation.
CEO AND PFO CERTIFICATIONS. Appearing as Exhibits 31.1 and 31.2 to this
quarterly report are "Certifications" of the CEO and the PFO. The Certifications
are required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the
"Section 302 Certifications"). This section of this quarterly report is the
information concerning the Controls Evaluation referred to in the Section 302
Certifications and this information should be read in conjunction with the
Section 302 Certifications for a more complete understanding of the topics
presented.
DISCLOSURE CONTROLS. Disclosure Controls are procedures that are designed with
the objective of ensuring that information required to be disclosed in the
Company's reports filed under the Exchange Act, such as this quarterly report,
is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms.
Disclosure Controls are also designed with the objective of ensuring that such
information is accumulated and communicated to the Company's management,
including, without limitation, the CEO and PFO, as appropriate to allow timely
decisions regarding required disclosure.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS. The Company's management,
including, without limitation, the CEO and PFO, does not expect that the
Company's Disclosure Controls will prevent all error and fraud. A control system
no matter how well conceived and operated can provide only reasonable, not
absolute, assurance that the objectives of the control system are
27
met. Further, the design of a control system must reflect the fact that there
are resource constraints and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by (i) the
individual acts of certain persons, (ii) the collusion of two or more people, or
(iii) management override of the controls and procedures. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions. As
such, over time controls may become inadequate because of changes in conditions
or the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be detected.
SCOPE OF THE CONTROLS EVALUATION. The CEO/PFO evaluation of the Company's
Disclosure Controls included a review of the controls' objectives and design,
the controls' implementation by the Company and the effect of the controls on
the information generated for use in this quarterly report. In the course of the
Controls Evaluation, management sought to identify data errors, controls
problems or acts of fraud and to confirm that appropriate corrective action,
including process improvements, were being undertaken. This type of evaluation
will be done on a quarterly basis so that the conclusions concerning controls
effectiveness can be reported in the Company's Quarterly Reports on Form 10-QSB
and Annual Reports on Form 10-KSB. The overall goals of these various review and
evaluation activities are to monitor the Company's Disclosure Controls and to
make modifications, as necessary. In this regard, the Company's intent is that
the Disclosure Controls will be maintained as dynamic controls systems that
change (including with improvements and corrections) as conditions warrant.
CONCLUSIONS. Based upon the Controls Evaluation, the Company's CEO and PFO have
concluded, subject to the limitations noted above, that as of the end of the
period covered by this quarterly report, our Disclosure Controls are effective
to provide reasonable assurance that information required to be disclosed in the
Company's reports filed under the Exchange Act, such as this quarterly report,
is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms.
28
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On or about October 17, 2003, the Company, along with Safety-Kleen, was sued in
the Court of Common Pleas for Beaver County, Pennsylvania by plaintiff Sirota's
Machine Company, Inc. The plaintiff seeks damages in the amount of approximately
$335,000 resulting from a fire that the plaintiff claims was caused by a
SystemOne parts washer. Based upon an initial investigation by the Company's
insurance carrier, the Company believes that the claim is without merit and
anticipates that its insurance carrier will aggressively defend the claim.
Accordingly, the Company currently anticipates that this case will not have a
material adverse effect on the Company's financial position or its results of
operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
ITEM 5. OTHER INFORMATION
The Company has entered into a Marketing and Distribution Agreement, dated as of
October 23, 2003 (the "International Marketing Agreement"), with Hockman-Lewis
Limited ("Hockman Lewis"), an international distributor of automotive service
equipment, under which Hockman-Lewis has been appointed the exclusive marketer
and distributor of, and service provider for, the Company's parts, paint and
other industrial washer equipment throughout the world other than North America
and Puerto Rico (the "Territory"). The International Marketing Agreement has a
five year team subject to extension for up to two additional five year terms
unless either party provides not less than 180 days' notice of non-renewal.
Hockman-Lewis is required to make annual minimum purchases commencing in year
two of the term in the amount of $800,000, escalating to $5 million in year
five. If Hockman-Lewis fails to meet its minimum purchase commitments, the
Company has the right to terminate the International Marketing Agreement or to
maintain Hockman-Lewis on a non-exclusive basis and market its products directly
or through other third parties. In addition, if Hockman-Lewis has not entered a
market by the commencement of the third year of the term or fails to achieve
acceptable sales volume in a specific market, the Company has the right to
remove any such market from the Territory or to market its products directly or
through other third parties. The Company has also agreed to provide an 18 month
parts only warranty for washers sold under the International Marketing
Agreement.
29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
10 Marketing and Distribution Agreement dated as of October 23,
2003 between the Company and Hockman-Lewis Limited.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) under the Exchange Act.
31.2 Certification of Director of Finance and Administration
(Principal Financial Accounting Officer) pursuant to Rule
13a-14(a) under the Exchange Act.
32 Certification of Chief Executive Officer and Director of
Finance and Administration (Principal Financial Accounting
Officer) pursuant to Rule 13a-14(b) under the Exchange Act
and 18 U.S.C. Section 1350.
(b) REPORTS ON FORM 8-K
The following reports were filed on Form 8-K during the three
months ended September 30, 2003:
(1) The Registrant filed a Current Report on Form 8-K,
dated July 30, 2003, with the Securities and Exchange
Commission pursuant to Items 5 and 7.
(2) The Registrant filed a Current Report on Form 8-K,
dated August 20, 2003, with the Securities and Exchange
Commission pursuant to Items 7 and 12. (b)
30
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, as amended, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SYSTEMONE TECHNOLOGIES INC.
Date: November 14, 2003 /s/ PAUL I. MANSUR
-----------------------------------------
Paul I. Mansur
Chief Executive Officer
(Principal Executive Officer)
Date: November 14, 2003 /s/ STEVEN M. HEALY
-----------------------------------------
Steven M. Healy
Director of Finance and Administration
(Principal Financial Accounting Officer)
31
EXHIBIT INDEX
10 Marketing and Distribution Agreement dated as of October 23, 2003
between the Company and Hockman-Lewis Limited.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Exchange Act.
31.2 Certification of Director of Finance and Administration (Principal
Financial Accounting Officer) pursuant to Rule 13a-14(a) under the
Exchange Act.
32 Certification of Chief Executive Officer and Director of Finance and
Administration (Principal Financial Accounting Officer) pursuant to
Rule 13a-14(b) under the Exchange Act and 18 U.S.C. Section 1350.
32