-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AqHJXbv+KRyUbSj9Zi/1aY3myUjY0iNHptPxnTY7whYVs/ETO447Wkr02+Rf00uh 9HkI3olhMwPYyVMe1vnHiQ== 0001073307-06-000008.txt : 20060208 0001073307-06-000008.hdr.sgml : 20060208 20060208134855 ACCESSION NUMBER: 0001073307-06-000008 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20051227 FILED AS OF DATE: 20060208 DATE AS OF CHANGE: 20060208 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WINDSWEPT ENVIRONMENTAL GROUP INC CENTRAL INDEX KEY: 0000814915 STANDARD INDUSTRIAL CLASSIFICATION: HAZARDOUS WASTE MANAGEMENT [4955] IRS NUMBER: 112844247 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-17072 FILM NUMBER: 06588287 BUSINESS ADDRESS: STREET 1: 100 SWEENEYDALE AVE CITY: BAY SHORE STATE: NY ZIP: 11706 BUSINESS PHONE: 5166947060 MAIL ADDRESS: STREET 1: 100 SWEENEYDALE AVE CITY: BAY SHORE STATE: NY ZIP: 11706 FORMER COMPANY: FORMER CONFORMED NAME: COMPREHENSIVE ENVIRONMENTAL SYSTEMS INC DATE OF NAME CHANGE: 19950222 FORMER COMPANY: FORMER CONFORMED NAME: INTEGRATED RESOURCE TECHNOLOGIES INC /DE/ DATE OF NAME CHANGE: 19941014 FORMER COMPANY: FORMER CONFORMED NAME: INTERNATIONAL RESOURCE TECHNOLOGIES INC DATE OF NAME CHANGE: 19930630 10-Q 1 form10q-051227.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 27, 2005, OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to __________. Commission File Number: 000-17072 WINDSWEPT ENVIRONMENTAL GROUP, INC. ----------------------------------- (Exact name of registrant as specified in its charter) Delaware 11-2844247 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 Sweeneydale Avenue, Bay Shore, New York 11706 ------------------------------------------------- (Address of principal executive offices) (Zip Code) (631) 434-1300 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer Accelerated filer Non-accelerated filer X --- --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes No X --- --- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes No X --- --- The number of shares of Common Stock, par value $.0001, outstanding on January 27, 2006 was 33,571,215. PART 1 - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 27, 2005 AND JUNE 28, 2005
December 27, June 28, 2005 2005 -------------- -------------- (unaudited) (restated) ASSETS: CURRENT ASSETS: Cash $ 2,494,266 $ 512,711 Accounts receivable, net of allowance for doubtful accounts of $2,757,831 and $1,507,831, respectively 13,182,621 6,755,338 Inventory 202,950 146,079 Costs and estimated earnings in excess of billings on uncompleted contracts 215,997 30,466 Prepaid expenses and other current assets 394,773 47,253 -------------- -------------- Total current assets 16,490,607 7,491,847 -------------- -------------- PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $6,739,039 and $6,386,731, respectively 2,986,156 2,242,645 -------------- ------------- OTHER ASSETS Deferred financing costs 2,966,840 - Other 170,000 322,046 -------------- -------------- Total other assets 3,136,840 322,046 -------------- -------------- TOTAL $ 22,613,603 $ 10,056,538 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT): CURRENT LIABILITIES: Accounts payable $ 1,985,409 $ 1,174,840 Liability for repurchased accounts receivable 189,197 - Accrued expenses 1,575,391 1,611,256 Secured note payable to a related party - 5,000,000 Current portion of secured convertible note payable 413,234 - Billings in excess of cost and estimated earnings on uncompleted contracts 62,350 83,316 Accrued payroll and related fringe benefits 520,715 528,867 Current maturities of long-term debt 207,805 169,612 Income taxes payable 4,140,361 138,579 Other current liabilities 686,809 489,468 -------------- -------------- Total current liabilities 9,781,271 9,195,938 -------------- -------------- LONG-TERM DEBT: Secured convertible note payable 813,249 - Secured note payable 500,000 - Other 216,118 197,400 -------------- -------------- Total long-term debt 1,529,367 197,400 -------------- -------------- COMMITMENTS AND CONTINGENCIES Redeemable Common Stock - 76,089 -------------- -------------- SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK, $.01 par value; 1,300,000 shares authorized and outstanding at December 27, 2005 and June 28, 2005 1,300,000 1,300,000 -------------- -------------- STOCKHOLDERS' EQUITY (DEFICIT): Series B preferred stock, $.01 par value; 50,000 shares authorized; 0 shares outstanding - - Nondesignated preferred stock, no par value; 8,650,000 shares authorized; 0 shares outstanding at December 27, 2005 and June 28, 2005 - - Common stock, $.0001 par value; 150,000,000 shares authorized; 33,755,620 shares outstanding at December 27, 2005 and 77,936,358 shares outstanding at June 28, 2005. 3,375 7,794 Additional paid-in-capital 42,789,570 33,944,017 Accumulated deficit (32,789,980) (34,664,700) -------------- -------------- Total stockholders' equity (deficit) 10,002,965 (712,889) -------------- -------------- TOTAL $ 22,613,603 $ 10,056,538 ============== ==============
See notes to consolidated financial statements. 2 WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Thirteen Weeks Ended Twenty-Six Weeks Ended -------------------------------- -------------------------------- December 27, December 28, December 27, December 28, 2005 2004 2005 2004 -------------- -------------- -------------- -------------- Revenues $ 17,714,342 $ 7,359,279 $ 22,878,681 $ 12,837,785 Cost of revenues 8,190,707 4,369,867 12,575,980 8,731,991 -------------- -------------- -------------- -------------- Gross profit 9,523,635 2,989,412 10,302,701 4,105,794 -------------- -------------- -------------- -------------- Operating expenses (income): Selling, general and administrative expenses 2,503,303 1,502,846 4,009,705 2,735,450 -------------- -------------- -------------- -------------- Income from operations 7,020,332 1,486,566 6,292,996 1,370,344 -------------- -------------- -------------- -------------- Other expense (income): Interest expense 664,575 55,352 1,228,410 266,456 Other expense (income), net 457 (755) 22,510 (1,322) -------------- -------------- -------------- -------------- Total other expense (income) 665,032 54,597 1,250,920 265,134 -------------- -------------- -------------- -------------- Income before provision for income taxes 6,355,300 1,431,969 5,042,076 1,105,210 Provision for income taxes 3,159,138 43,659 3,167,356 46,248 -------------- -------------- -------------- -------------- Net income 3,196,162 1,388,310 1,874,720 1,058,962 Dividends on preferred stock 19,500 19,500 39,000 39,000 -------------- -------------- -------------- -------------- Net income attributable to common shareholders $ 3,176,662 $ 1,368,810 $ 1,835,720 $ 1,019,962 ============== ============== ============== ============== Basic and diluted net income per common share: Basic $0.09 $0.02 $0.05 $0.01 ====== ====== ====== ====== Diluted $0.02 $0.02 $0.01 $0.01 ====== ====== ====== ====== Weighted average number of common shares outstanding: Basic 33,755,620 77,936,358 33,593,275 77,936,358 ============== ============== ============== ============== Diluted 184,368,852 77,961,149 184,206,507 77,980,720 ============== ============== ============== ==============
See notes to consolidated financial statements. 3 WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
Common Stock ------------ Additional Number of Paid-in Accumulated Shares Par Value Capital Deficit Total ------ --------- ------- ------- ----- Balance at June 28, 2005 77,936,358 $7,794 $33,944,017 $(34,664,700) $ (712,889) Laurus Financing: Allocation of proceeds to warrants and options 2,200,927 2,200,927 Allocation of proceeds to beneficial conversion feature 2,200,927 2,200,927 Assumed exercise of shares available for nominal consideration, including partial actual exercise to purchase 1,684,405 168 (18) 150 1,500,000 shares Allocation of proceeds to beneficial conversion feature on second increase of financing 38,889 38,889 Allocation of proceeds to beneficial conversion feature on third increase of financing 650,000 650,000 Allocation of proceeds to beneficial conversion feature on 1,350,000 1,350,000 fourth increase of financing Spotless Transactions: Cancellation of Spotless shares, net of shares sold to Michael (45,865,143) (4,587) 4,587 0 O'Reilly Early extinguishment of Spotless Note, accrued interest and administrative fees (net of tax effect of $731,640) 1,230,228 1,230,228 Additional taxes attributable to cancellation of Spotless debt (107,434) (107,434) Surrender of Redemption Right with respect to Common Stock 76,089 76,089 Value of Spotless shares sold to Michael O'Reilly less consideration 1,195,708 1,195,708 Options granted to preferred stockholders for forbearance of mandatory redemption and dividends 44,650 44,650 Dividends on Series A preferred stock (39,000) (39,000) Net income - - - 1,874,720 1,874,720 ------------ ------- ------------ ------------- ------------ Balance at December 27, 2005 33,755,620 $3,375 $42,789,570 $(32,789,980) $10,002,965 ============ ======= ============ ============= ============
See notes to consolidated financial statements. 4 WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Twenty-Six Weeks Ended -------------------------------- December 27, December 28, 2005 2004 -------------- -------------- (unaudited) (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,874,720 $ 1,058,962 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 352,308 331,053 Provision for doubtful accounts, net 1,250,000 711,594 Amortization of deferred financing cost 587,690 - Amortization of beneficial conversion 317,216 - Changes in operating assets and liabilities: Accounts receivable (7,488,086) (4,175,461) Inventory (56,871) 31,889 Costs and estimated earnings in excess of billings on uncompleted contracts (185,531) 48,003 Income tax refund - 641,795 Prepaid expenses and other current assets (347,520) 50,908 Other assets 152,046 28,000 Accounts payable and accrued expenses 886,573 1,379,494 Accrued payroll and related fringe benefits (8,152) (19,326) Income tax payable 3,140,989 - Other current liabilities 133,532 613,807 Billings in excess of costs and estimated earnings on uncompleted contracts (20,966) (227,430) -------------- -------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 587,948 473,288 -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (938,756) (56,011) -------------- -------------- NET CASH USED IN INVESTING ACTIVITIES (938,756) (56,011) -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments of long-term debt (100,152) (134,508) Proceeds from long-term debt 157,063 - Exercise of stock options 150 - Payments for deferred financing costs (2,312,830) - Repayment of secured note payable to a related party (2,761,868) - Proceeds from secured notes payable 7,350,000 - -------------- -------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,332,363 (134,508) -------------- -------------- NET INCREASE IN CASH 1,981,555 282,769 CASH - BEGINNING OF PERIOD 512,711 63,562 -------------- -------------- CASH - END OF PERIOD $ 2,494,266 $ 346,331 ============== ============== Cash paid during the period for: Interest $ 91,477 $ 190,098 =============== ============== Income taxes $ - $ 2,250 =============== ============== SUPPLEMENTAL SCHEDULE OF NON-CASH ACTIVITIES: Financing cost related to beneficial conversion value of secured note $ 4,239,816 $ - =============== ============== Capitalized gain on extinguishment of secured note payable - related party $ 1,122,794 $ - =============== ============== Financing cost related to warrant and options $ 2,200,927 $ - =============== ============== Capitalized cancellation of put right relating to redeemable common stock $ 76,089 $ - =============== ============== Property and equipment acquired through financing $ 157,063 $ - =============== ============== Financing cost related to guaranties of CEO remunerated through sale of discounted shares $ 1,195,708 $ - =============== ============== Financing cost related to issuance of options to preferred stockholders $ 44,650 $ - =============== ============== Account receivable repurchased in connection with refinancing $ 189,197 $ - =============== ==============
See notes to consolidated financial statements. 5 WINDSWEPT ENVIRONMENTAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS FOR PRESENTATION - The accompanying unaudited consolidated financial statements include the accounts of Windswept Environmental Group, Inc. (the "Company") and its subsidiaries, Trade-Winds Environmental Restoration, Inc. ("Trade-Winds") and North Atlantic Laboratories, Inc. All intercompany accounts and transactions have been eliminated in consolidation. The unaudited consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America ("generally accepted accounting principles") for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of the Company, all adjustments (consisting of only normal and recurring accruals) considered necessary to present fairly the financial position of the Company and its subsidiaries on a consolidated basis as of December 27, 2005, the results of operations for the thirteen and twenty-six weeks ended December 27, 2005 and December 28, 2004 and cash flows for the twenty-six weeks ended December 27, 2005 and December 28, 2004, have been included. Certain prior period amounts have been reclassified to conform to the December 27, 2005 presentation. The results for the thirteen and twenty-six weeks ended December 27, 2005 and December 28, 2004 are not necessarily indicative of the results for an entire year. These unaudited consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's Form 10-K for the fiscal year ended June 28, 2005, as amended. The Company has recognized the value of the equity instruments issued in connection with financing transactions described in Note 6 in accordance with Accounting Principles Board Opinion No. 14 and Emerging Issues Task Force (EITF) Consensuses 98-5 and 00-27. The intrinsic value of the options and the fair value of the warrants are calculated and the proportionate values of the resulting debt and equity components have been recognized as debt discounts with equivalent credits to equity. The beneficial conversion features of the warrants, including the effective values under EITF 00-27, have also been recognized. All of the discounts are being amortized over the life of the debt in accordance with the latter pronouncement. 2. STOCK-BASED COMPENSATION - The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations including FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25", issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", ("SFAS 123") established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123, as amended by SFAS 148, "Accounting for Stock-Based Compensation-Transition and Disclosure an Amendment of FASB Statement No. 123." 6 The following table illustrates the effect on net (loss) income attributable to common shareholders and net (loss) income per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation for all periods:
Thirteen Weeks Ended Twenty-Six Weeks Ended -------------------------------- -------------------------------- December 27, December 28, December 27, December 28, 2005 2004 2005 2004 -------------- -------------- -------------- -------------- Net income attributable to common shareholders as reported $ 3,176,662 $ 1,368,810 $ 1,835,720 $ 1,019,962 Less: Stock-based employee compensation cost determined under the fair value method, net of related tax 56,250 25,935 112,500 51,870 effects -------------- -------------- -------------- -------------- Pro forma net income attributable to common shareholders $ 3,120,412 $ 1,342,875 $ 1,723,220 $ 968,092 =============== =============== ============== ============= Net income per share: Basic - as reported $0.09 $.02 $0.05 $.01 ====== ===== ====== ===== Basic - pro forma $0.09 $.02 $0.05 $.01 ====== ===== ====== ===== Diluted - as reported $0.08 $.02 $0.05 $.01 ====== ===== ====== ===== Diluted - pro forma $0.02 $.02 $0.01 $.01 ====== ===== ====== =====
3. NET INCOME PER COMMON SHARE -The calculation of basic and diluted net (loss) income per common share was calculated for all periods in accordance with the requirements of Statement of Financial Accounting Standards No. 128, "Earnings per Share." 7 The following table sets forth the computation of the basic and diluted net income per share for the thirteen and twenty-six weeks ended December 27, 2005 and December 28, 2004, respectively:
Thirteen Weeks Ended Twenty-Six Weeks Ended -------------------------------- -------------------------------- December 27, December 28, December 27, December 28, 2005 2004 2005 2004 -------------- -------------- -------------- -------------- Numerator: Net income attributable to common shareholders $ 3,176,662 $ 1,368,810 $ 1,835,720 $ 1,019,962 Plus: Series A Preferred Stock Dividends 19,500 - 39,000 - Interest on Convertible Debt 168,491 - 289,656 - -------------- -------------- -------------- -------------- Net Income Attributable to common shareholders and Assumed Conversion $ 3,364,653 $ 1,368,810 $ 2,164,376 $ 1,019,962 ============== ============== ============== ============== Denominator: Share reconciliation: Shares used for basic income per share 33,755,620 77,936,358 33,593,275 77,936,358 Effect of dilutive items: Stock options/warrants 56,101,565 24,791 56,101,565 44,362 Convertible Debt 81,666,667 - 81,666,667 - Interest on Convertible Debt 11,545,000 - 11,545,000 - Series A Convertible Preferred Stock 1,300,000 - 1,300,000 - -------------- -------------- -------------- -------------- Shares used for dilutive income per share 184,368,852 77,961,149 184,206,507 77,980,720 ============== ============== ============== ============== Net income per share: Basic $.09 $.02 $.05 $.01 Diluted $.02 $.02 $.01 $.01
The dilutive net income per share computations for the thirteen and twenty-six week periods ended December 27, 2005 assume an increase in the authorized capital of the Company sufficient to accomodate the full exercise of and conversion of outstanding options, warrants and the Laurus Note. The dilutive net income per share computations for the thirteen and twenty-six week periods ended December 27, 2005 exclude 1,700,000 and 1,700,000 shares, respectively, related to stock options because the effect of including them would be anti-dilutive. The dilutive net income per share computations for the thirteen week and twenty-six week periods ended December 28, 2004 exclude 3,910,309 and 3,710,309 shares, respectively, related to stock options and warrants because the effect of including them would be anti-dilutive. For the periods ended December 28, 2004, 1,300,000 shares of common stock issuable upon the exercise of the Series A Redeemable Convertible Preferred Stock were excluded from diluted earnings per share because the effect of including them would be anti-dilutive. 8 4. PROVISION FOR INCOME TAXES - The provision for income taxes for the thirteen and twenty-six weeks ended December 27, 2005 and December 28, 2004 consists of the following:
Thirteen Weeks Ended Twenty-Six Weeks Ended -------------------------------- -------------------------------- December 27, December 28, December 27, December 28, 2005 2004 2005 2004 -------------- -------------- -------------- -------------- Federal - current $ 2,235,624 $ 41,070 $ 2,235,624 $ 41,070 State - current 923,514 2,589 931,732 5,178 -------------- -------------- -------------- -------------- Total $ 3,159,138 $ 43,659 $ 3,167,356 $ 46,248 ============== ============== ============== ==============
The effective rate for income taxes differs from the statutory rate primarily as a result of the utilization of federal and state net operating losses. The Company has a 100% valuation allowance against deferred tax assets because management believes that it is more likely than not that such deferred tax assets will not be realized. 5. CONTINGENCIES - On August 5, 2004, the Company commenced an action in the New York State Supreme Court, County of New York, seeking to collect approximately $1,255,000 of contractual billings relating to a large roof tar removal project. On October 15, 2004, the Economic Development Corporation filed an answer, denying the Company's claims. On November 4, 2004, the Economic Development Corporation filed an amended answer denying the Company's claims and asserting counterclaims in unspecified amounts seeking liquidated damages, reimbursement for consultant's fees and breach of contract. The case is currently in pre-trial discovery. This aggregate amount of $1,255,000 was recorded when billed as revenues of $32,561, $726,257 and $496,182 during the Company's fiscal years ended July 2, 2002, July 1, 2003 and June 29, 2004, respectively, and is included in the Company's accounts receivable because management believes that the realization of the full amount thereof is probable. In April 2003, the Company commenced a remediation project in New York City for a local utility to remove sediment from an oil storage tank. During the course of the project, the sediment in the tank was found to be substantially different than the sediment that the customer represented to be in the tank prior to the inception of the project. The Company continued to work on the project so as not to default on the terms which it understood to exist with the customer. The additional costs incurred to remove this matter were approximately $1,600,000. As of June 28, 2005, the Company recognized revenue of approximately $1,700,000 with respect to the original scope of this project. All amounts due under the original contract have been paid. The Company has not recognized the revenue associated with its claim because the amount thereof is not presently reliably estimable. The project has been completed and the customer has refused to acknowledge its liability for these additional charges billed. On October 22, 2004, the Company commenced an action against a local utility company in the New York State Supreme Court, County of New York, claiming that it is entitled to approximately $2,000,000 of contractual billings and related damages in connection with this matter. On December 6, 2004, the local utility company filed an answer, denying its claims. The case is currently in pre-trial discovery. The Company is a plaintiff in approximately 18 lawsuits, including those described above, claiming an aggregate of approximately $5,000,000 pursuant to which it is seeking to collect amounts it believes owed to it by customers that are included in its accounts receivable, primarily with respect to changed work orders or other modifications to its scope of work. The defendants in these actions have asserted counterclaims for an aggregate of approximately $500,000. The Company is a party to other litigation matters and claims that are normal in the course of its operations, and while the results of such litigation and claims cannot be predicted with certainty, management believes that the final outcome of such matters will not have a materially adverse effect on the Company's consolidated financial statements. 9 6. FINANCING AND RELATED PARTY TRANSACTIONS - As of June 28, 2005, the Company owed Spotless Plastics (USA) Inc. $5,000,000 under the Spotless Loan, in the original principal amount of $1,700,000. The Spotless note was collateralized by all of the Company's assets. During the fiscal year ended June 29, 2004, the Company borrowed $3,300,000 from Spotless for working capital requirements and to fund losses. During the fiscal year ended July 1, 2003, the Company borrowed $2,325,000 from Spotless for working capital requirements and to fund certain fixed asset purchases. The Company repaid $825,000 to Spotless in the fiscal year ended July 1, 2003. As of June 28, 2005, Spotless was due payment from third parties for accounts receivable in the amount of $158,469 purchased under its account receivable agreement dated February 5, 2004, with the Company. As of such date, Spotless had purchased from the Company an aggregate amount of its accounts receivable equaling $4,991,252 at an aggregate purchase discount of $911,202, for an aggregate purchase price of $4,080,050. The aggregate amount of the purchase discounts and monthly discount fees under this agreement were $255,585 for the fiscal year ending June 28, 2005. Pursuant to the account receivable finance agreement, Spotless was able to purchase certain of the Company's accounts receivable without recourse for cash, subject to certain terms and conditions. Pursuant to an administrative services arrangement, Spotless also provided the Company with certain administrative services including the services of its former vice president of finance and administration. During the Company's fiscal years 2005, 2004 and 2003, the Company was charged by Spotless an administrative fee of $84,138, $131,556 and $101,256, respectively, of which $84,138 remained unpaid and included in accrued expenses as of June 28, 2005. On June 30, 2005, Spotless agreed to forgive the $84,138 in administrative fees that was outstanding. On June 30, 2005, the Company entered into a financing transaction with Laurus Master Fund, Ltd. pursuant to the terms of a securities purchase agreement, as amended, and related documents. Under the terms of the financing transaction, the Company issued to Laurus: o pursuant to the terms of a secured convertible term note, dated June 30, 2005, a three-year note in the principal amount of $5,000,000. The Note bears interest at the prime rate as published in the Wall St. Journal plus 2% (but not to less than 7.25%), decreasing by 2% (but not less than 0%) for every 25% increase in the Market Price (as defined therein) of the Company's common stock above the fixed conversion price of $.09 following the effective date(s) of the registration statement or registration statements covering the shares of the Company's common stock underlying the Note and the warrant issued to Laurus; o pursuant to the terms of an Option Agreement, dated June 30, 2005, a twenty-year option to originally purchase 30,395,179 shares of the Company's common stock at a purchase price of $0.0001 per share; and o pursuant to the terms of a Common Stock Purchase Warrant, dated June 30, 2005 a seven-year common stock purchase warrant to purchase 13,750,000 shares of the Company's common stock at a purchase price of $.10 per share. After consummating the transaction on June 30, 2005 and prior to December 27, 2005, Laurus subsequently provided additional financing to the Company on the same terms and conditions as follows: o On July 13, 2005, Laurus loaned the Company an additional $350,000, and the Company amended and restated the Note, to be in the principal amount of $5,350,000. The shares issuable upon conversion of the face value of this amended and restated Note had a beneficial conversion feature valued at $38,889 and was allocated to additional paid-in capital. The remaining $311,111 was added to the carrying value of the Note on the Company's balance sheet. o On September 9, 2005, Laurus loaned the Company an additional $650,000, and the Company further amended and restated the Note to be in the principal amount of $6,000,000. The shares issuable upon conversion of the additional face value of this amended and restated Note had a beneficial conversion feature amounting to $650,000, which was allocated to additional paid-in capital. As a result, the carrying value thereof was $0. o On October 6, 2005, Laurus loaned the Company an additional $1,350,000, and the Company further amended and restated the Note to be in the principal amount of $7,350,000. The shares 10 issuable upon conversion of the additional face value of this amended and restated Note had a beneficial conversion feature amounting to $1,350,000, which was allocated to additional paid-in capital. As a result, the carrying value thereof of $0. (unaudited) The Note, in the principal amount of $6,890,625 as of February 2, 2006, is the only note issued to Laurus by the Company that is currently outstanding. Principal repayments were due to commence starting November 1, 2005 but, in November 2005, Laurus agreed to defer the initial repayment date until January 1, 2006. The principal monthly payments due November 1, 2005 and December 1, 2005 in the aggregate amount of $495,375 were deferred until June 30, 2008. Interest is payable monthly and started to accrue on August 1, 2005. In conjunction with the Laurus transactions, the Company entered into a registration rights agreement, as amended, which obligated it, among other things, to file its initial registration statement on Form S-1 with the SEC on or before November 22, 2005 or be subject to a liquidated damages claim. Laurus waived the liquidated damages accruing on November 23, 2005 and granted an extension until March 1, 2006, during which time no liquidated damage claims will be assessed. The Company also issued a subordinated secured promissory note to Spotless in the principal amount of $500,000, bearing interest at LIBOR plus 1%. Pursuant to the terms of the note the Company issued to Spotless, amortized payments of $50,000 per month become due and payable beginning July 1, 2007 until all amounts due thereunder are fully paid, so long as the Company is not in default on the Laurus Note. The note the Company issued to Spotless, together with the $2,750,000 payment to Spotless referred to above, fully satisfied all of the Company's financial obligations to Spotless. In connection with this financing transaction, the Company, along with Spotless, terminated the account receivable finance agreement between them, except with respect to the Company's obligation to continue to collect and remit payment of accounts receivable that Spotless purchased under the agreement. As part of the transactions, Spotless assigned to the Company an account receivable with a balance of $189,197 and to the Company agreed to pay this amount to Spotless no later than June 30, 2006. On June 30, 2005, Messrs. Peter Wilson, John Bongiorno, Ronald Evans and Brian Blythe, who were nominees of Spotless, resigned as directors of the Company, and Mr. Charles L. Kelly, Jr., also a Spotless nominee, resigned as the Company's chief financial officer and as a director. In addition, Mr. Joseph Murphy, an employee of Spotless, resigned as the Company's vice president of finance and administration and secretary. Pursuant to a transition services agreement, Spotless agreed to provide the services of Mr. Murphy to the Company, including in relation to advice in the areas of: o administration; o accounting, finance and risk management; and o assisting in the preparation and review of its reports filed with the SEC during a six-month transitional process for a fee of $5,000 per month and a payment of $25,000 to Mr. Murphy at the end of the transitional period. On June 30, 2005, Spotless, through one of its wholly owned subsidiaries, sold 15,469,964 shares of common stock of the Company to Michael O'Reilly, the Company's president and chief executive officer, in consideration for a non-recourse ten-year balloon promissory note in the principal amount of $120,500 issued by Mr. O'Reilly to Spotless, bearing interest at LIBOR plus 1%. Spotless also surrendered its remaining 45,865,143 shares to the Company for cancellation, which resulted in a credit of $4,587 to additional paid-in capital. Mr. O'Reilly issued a personal guaranty to Laurus for $3,250,000 of the Note. In addition, the Company issued a ten-year option exercisable at $.09 per share to Mr. O'Reilly to purchase 15,469,964 shares of common stock in connection with his: 11 o agreement to a new employment agreement, which (a) does not include a put right that existed in his old employment agreement requiring the Company, under certain circumstances, to buy his shares of common stock and shares underlying his options, and (b) calls for a base salary of $285,000 per year and a bonus equal to 2.5% of its pre-tax income, as defined in the employment agreement; and o agreement to personally guarantee the Company's bonding obligations, each of which was a condition precedent to the consummation of its financing transaction with Laurus. The Company recorded the option pursuant to APB No. 25 because it was agreed to be issued in connection with Mr. O'Reilly's employment. No portion of this option was allocated to Mr. O'Reilly's guaranty to Laurus. On May 24, 2005, the Company issued non-plan five-year options exercisable at $.01 per share and $0.1875 per share to Michael O'Reilly to purchase 2,000,000 and 250,000 shares of common stock, respectively, in an effort to continue incentivizing him in his capacity as the Company's president and chief executive officer. The Company recorded these options based on the intrinsic value method and recognized an expense of $100,000 in connection therewith pursuant to APB No. 25. On June 30, 2005, the Company issued ten-year options exercisable at $.09 per share to its series A convertible stock preferred stockholders, including Dr. Kevin Phillips, one of its directors, to purchase an aggregate of 500,000 shares of its common stock. The Company valued these options using the Black-Scholes valuation method and recorded deferred financing costs of $44,650 as a credit to additional paid-in capital in connection therewith. The Company also agreed to pay, out of legally available funds, accrued and unpaid dividends in an aggregate of (1) $35,000 to the series A convertible preferred stockholders, on each June 30, 2005, September 30, 2005 and December 30, 2005 and (2) $50,000 to the series A convertible preferred stockholders on February 28, 2007. In the aggregate, this was in consideration for their agreement to: o propose and vote in favor of an amendment to its certificate of incorporation in order to accommodate the full issuance of the shares of its common stock underlying the Note and the option and warrant the Company issued to Laurus; o postpone their right, upon six months' notice after February 2007, to require the Company to redeem their series A convertible preferred stock, until the earlier of six months after the repayment of the Note or June 30, 2010; o defer receipt of dividend payments on the series A convertible preferred stock due after June 30, 2005, until the earlier of six months after the repayment of the Note or June 30, 2010; and o forbear from appointing a second director until the earlier of (a) June 30, 2008 or (b) the repayment in full of the secured convertible term note that the Company has issued to Laurus. As of December 27, 2005, the Company has paid an aggregate of $70,000 to the series A convertible preferred stockholders for the payments due June 30, 2005 and September 30, 2005. On June 30, 2005, Michael O'Reilly and the series A convertible preferred stock stockholders, including Dr. Kevin Phillips, who is a director, agreed, pursuant to a forbearance and deferral agreement to which the Company is a party, to propose and vote in favor of an amendment to the Company's Certificate of Incorporation in order to accommodate the full issuance of the shares of its common stock underlying the Note, the option and warrant the Company issued to Laurus at the Company's next annual shareholders meeting to be held by March 1, 2006. In addition, Mr. O'Reilly, the series A convertible preferred stock stockholders and Anthony P. Towell, a director, entered into lock-up agreements with Laurus that prohibit a disposition of their shares of common stock and any and all related derivative securities until the earlier of (a) the repayment in full of the note the Company issued to Laurus or (b) June 30, 2010. On December 6, 2004, the Company issued a ten-year option exercisable at $0.035 per share to Dr. Kevin Phillips to purchase 100,000 shares under its 2001 Equity Incentive Plan in connection with his service as a director of the Company. 12 As a result of these transactions, the Company has recorded deferred financing costs as follows: ITEM AMOUNT Transactional, insurance costs and professional fees $2,314,172 Deemed cost to the Company of the 15,469,964 shares of common stock sold by Spotless to the Company's president and CEO 1,195,708 Options granted to preferred stockholders for forbearance of mandatory redemption and other rights 44,650 ------------ Balance 3,554,530 Amortization of deferred financing cost for the twenty-six weeks ended December 27, 2005 587,690 ------------ Total deferred financing costs $ 2,966,840 ------------ During its fiscal year ended July 1, 2003, the Company repaid a $100,000 convertible note held by Anthony P. Towell, a director. This note was issued in 1997, provided for interest at a rate equal to 12% per annum and was convertible at a rate of $.15 per share of common stock. On May 24, 2005, the Company issued a non-plan ten-year option exercisable at $0.06 per share to Tony Towell to purchase 250,000 shares in connection with his service on the then-existing special committee of the Company. On December 6, 2004, the Company issued a ten-year option exercisable at $0.035 per share to Tony Towell under its 2001 Equity Incentive Plan in connection with his service as a director of the Company. On December 16, 1998, the Company entered into an operating lease agreement with Michael O'Reilly, its president and chief executive officer. Pursuant to the terms of the arrangement that expired in December 2002 and has continued on a month-to-month basis thereafter, the Company leases a forty-two foot custom Topaz boat for monthly rental payments of $5,000. The leasing arrangement was necessitated by a marine assistance contract that expired on December 31, 2000, although the arrangement continues to provide the Company with its largest floating vessel capable of handling specialty equipment and facilitating an offshore support crew. The Company is responsible for all taxes, insurance and repairs pertaining to this boat. The Company had an oral understanding with Michael O'Reilly pursuant to which the Company paid the full carrying costs, including mortgage payments, of a condominium that he beneficially owned and that the Company used for marketing and employee-relations purposes. The full carrying costs during the Company's fiscal years ended June 28, 2005 and June 29, 2004 were approximately $7,150 and $17,800, respectively. In connection with this arrangement, we also provided mitigation and restoration goods and services to Mr. O'Reilly in connection with severe water damage caused by a failed water heater at the condominium that he beneficially owned and allowed us to use for marketing and employee-relations purposes. In connection with these services, the Company's entire direct costs and allocated overhead, without a markup, equaled approximately $56,780. In February 1997, the Company issued 650,000 shares of redeemable convertible preferred stock to Dr. Kevin Phillips, a director and an additional 650,000 shares of redeemable convertible preferred stock to a business partner of Dr. Phillips. During fiscal years 2005, 2004 and 2003, the Company paid an aggregate of $0, $39,000 and $78,000, respectively, of dividends and accrued interest to the redeemable convertible preferred stockholders. 13 The Company paid a former director $24,385 and $46,926 for consulting services in its fiscal years 2004 and 2003, respectively. The Company believes that all transactions that the Company has entered into with its officers, directors and principal stockholders, except its provision of mitigation and restoration services to its president and chief executive officer as discussed above, have been on terms no less favorable to the Company than those available from unrelated third parties. 7. SUBSEQUENT EVENTS - On January 13, 2006, Laurus agreed to (a) postpone the date by which the Company must have the Form S-1 declared effective until March 1, 2006 and (b) postpone the date by which the Company must increase its authorized capital from January 31, 2006 until March 1, 2006. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We, through our wholly-owned subsidiaries, provide a full array of emergency response, remediation and disaster restoration services to a broad range of clients. We have expertise in the areas of hazardous materials remediation, microbial remediation, testing, toxicology, training, wetlands restoration, wildlife and natural resources rehabilitation, asbestos and lead abatement, technical advisory services, restoration and site renovation services. Our revenues are derived primarily from providing emergency response, remediation and disaster restoration services to new and repeat customers on time and materials basis or pursuant to fixed-price contracts, including in connection with sudden catastrophes, such as in connection with the services that we are providing in the aftermath of Hurricanes Katrina and Wilma. In the thirteen and twenty-six week periods ended December 27, 2005 and fiscal 2005, substantially all of our revenues were derived from time and materials contracts. Under our fixed-price contracts, we assess the scope of work to be done and contract to perform a specified scope of work for a fixed price, subject to adjustment for work outside such scope of work, upon prior approval by our customers. Because most of our projects consist of emergency or disaster responses, which do not permit a definitive prior assessment of the full scope of work entailed and require immediate attention in order to mitigate loss and maximize recovery, most of our projects are performed on a time and materials basis. Under our time and materials contracts, we charge our customers for labor, equipment usage, allocated overhead and a markup relating thereto. Our cost of revenues consists primarily of labor and labor-related costs, insurance, benefits and insurance, travel and entertainment repairs, maintenance, equipment rental, materials and supplies, disposal costs and depreciation of capital equipment. Our selling, general, and administrative expenses primarily consist of expenses related to provisions for doubtful accounts, legal fees, sales salaries, marketing and consulting. We have encountered difficulty with cash collections and slow cash flow due primarily to factors including: o customers refusing to pay prior to receiving insurance reimbursements; o customers' facility managers needing to wait for insurance adjustors to approve work before the remission of payment; and o certain customers refusing to pay in connection with disputed change orders. In an effort to enhance our cash flows from operations, beginning in our 2005 fiscal year, we began implementing improvements in our billing and invoicing procedures as follows: o we generally do not commence projects until we have a fully executed contract; o our service contracts provide that our customers are directly obligated for our services; o we require client approval with respect to the work performed or to be performed; o we generally seek deposits or mobilization fees for our time and materials contracts; o we engage local legal counsel in the areas in which we operate to file liens against customers' real property in the event of contract disputes; and o all invoices submitted for payment are reviewed for proper documentation. 14 Because some of these are relatively new changes, no assurances can be given that they will be successful in improving our collections and cash flows. Further, approximately 4% of our current projects are performed under procedures that predate these improvements. In light of the foregoing, we expect to generate sufficient cash flow from operations to support our working capital needs and to adequately fund our current operations for at least the next twelve months. However, any further difficulty collecting our accounts receivable or further significant growth could adversely affect our liquidity. In the event that we do not generate sufficient positive cash flow from operations, we may need to seek additional financing in addition to the financing provided by Laurus. Laurus is under no obligation to provide any funding to us. Currently, we have no credit facility for additional borrowing. On June 30, 2005, we issued to Laurus a three-year secured convertible term note in the principal amount of $5,000,000. Subsequently, Laurus loaned us an additional $2,350,000, and we amended and restated the note accordingly. As of February 2, 2006, the principal amount of the Laurus note outstanding equaled $6,890,625. On November 10, 2005, Laurus agreed to defer the principal monthly payments due in November and December 2005 in the aggregate amount of $495,375 until June 30, 2008, the maturity date of the Laurus note, in order to facilitate financing of our gulf coast and Florida operations. We currently are engaged on various projects within our customary scope of services for private sector commercial and residential customers in the gulf coast and Florida regions. Under time and materials contracts or other arrangements, we have billed in excess of $9.8 million of work that we have completed in connection with these projects through January 31, 2006. We have also billed in excess of $8.9 million for projects in these areas that are still in progress. As of January 1, 2006 we have billed an aggregate of over $20 million of time and materials projects during our fiscal 2006. Management believes that we will be engaged to perform additional projects in this region in the near term; however, no assurance can be given in this regard until contracts relating to these projects have been executed. CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of our financial position and results of operations is based upon our audited consolidated financial statements for our fiscal year ended June 28, 2005, which have been prepared in accordance with accounting principles generally accepted in the United States of America, and our unaudited interim consolidated financial statements for our fiscal quarter ended December 27, 2005. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates. We believe that the critical accounting policies and areas that require the most significant judgments and estimates to be used in the preparation of our consolidated financial statements are accounting for stock based transactions, contracts, allowance for doubtful accounts and the valuation allowance related to deferred tax assets. Stock Based Transactions - We consummated various transactions where we paid the consideration primarily in options or warrants to purchase our common stock. These transactions include financing transactions and providing incentives to attract, retain and motivate employees, officers and directors. We have recognized the value of the equity instruments issued in connection with financing transactions in accordance with Accounting Principles Board Opinion No. 14 and Emerging Issues Task Force Consensuses 98-5 and 00-27. The intrinsic value of the options and the fair value of the warrants were calculated and the proportionate values of the resulting debt and equity components have been recognized as debt discounts with equivalent increases in amounts reflected as equity. The beneficial conversion feature of the Note, including the effective values under EITF 00-27, has also been recognized as a debt discount, with an equivalent increase in the amount reflected as equity. All of these discounts are being amortized over the three-year life of the debt in accordance with EITF 00-27. Once the transaction value is determined, we record the transaction value as an expense with a corresponding increase in paid-in capital. 15 When options or warrants to purchase our common stock are used as incentives for employees, officers or directors, we use the intrinsic value method in accordance with the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," as permitted by Statement of Financial Accounting Standards "SFAS" No. 123. The intrinsic value method calculates the value of the option or warrant at the difference between the exercise price per share and the market price per share of the common stock on the day the option or warrant is granted, except that such value is zero if the exercise price is higher than the market price of the common stock. Once the transaction value is determined, we record the transaction value as an expense with a corresponding increase in paid-in capital. When options or warrants to purchase our common stock are used in transactions with third parties, the transaction is valued using the Black-Scholes valuation method. The Black-Scholes valuation method is widely accepted as providing the fair market value of an option or warrant to purchase stock at a fixed price for a specified period of time. Black-Scholes uses five variables to establish market value of stock options or warrants: o exercise price (the price to be paid for a share in our stock); o price of our stock on the day the options or warrants are granted; o number of days that the options or warrants can be exercised before they expire; o trading volatility of our stock; and o annual interest rate on the day the option or warrant is granted. The determination of expected volatility requires management to make an estimate and the actual volatility may vary significantly from that estimate. Accordingly, the determination of the resulting expense is based on a management estimate. Contract Accounting - Revenue derived from services provided to customers over periods of less than one month is recognized at the completion of the related contracts. Revenue from fixed price contracts that extend over periods of one month or more is recognized using the percentage-of-completion method, measured by the percentage of costs incurred to date compared to estimated total costs for each contract. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, estimated profitability, the effect of contract penalty provisions and final contract settlements may result in revisions to estimates of costs and income and are recognized in the period in which the revisions are determined. Revenue from claims, such as claims relating to disputed change orders, is recognized when realization is probable and the amount can be reliably estimated. Revenues from time and material contracts that extend over a period of more than one month are recognized as services are performed. Allowance for Doubtful Accounts - We maintain an allowance for doubtful trade accounts receivable for estimated losses resulting from the inability of our customers to make required payments. In determining collectibility, we review available customer account and financial information, including public filings and credit reports, current trends, credit policy, and accounts receivable aging and may also consult legal counsel when appropriate. A considerable amount of judgment is required when we assess the likelihood of our realization of accounts receivables, including assessing the probability of collection and the current credit worthiness of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional provision for doubtful accounts could be required. When it is deemed probable that a specific customer account is uncollectible, that balance is included in the reserve calculation. Actual results could differ from these estimates. Deferred Tax Asset Valuation Allowance - We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Due to our history of losses, we have recorded a full valuation allowance against our net deferred tax assets as of June 28, 2005 and December 27, 2005. We currently provide for income taxes only to the extent that we expect to pay cash taxes on current income. When we are profitable at levels which cause management to conclude that is more likely than not that we will realize all or a portion of our deferred tax assets, we record the estimated net realizable value of our deferred tax assets at that time and provide for income taxes at our combined federal and state effective rates. 16 RESULTS OF OPERATIONS THIRTEEN WEEKS ENDED DECEMBER 27, 2005 AND DECEMBER 28, 2004 Revenue Total revenues for the thirteen weeks ended December 27, 2005 increased by $10,355,063, or 140.7%, to $17,714,342 from $7,359,279 for the thirteen weeks ended December 28, 2004. This increase in revenue was primarily attributable to $14,108,400 of revenues from work relating to Hurricane Katrina and $1,320,769 of revenues from work relating to Hurricane Wilma, and was partially offset by a $573,968 decrease in spill related work. Cost of Revenues ---------------- Cost of revenues increased $3,820,840 or 87.4%, to $8,190,707 for the thirteen weeks ended December 27, 2005 as compared to $4,369,867 for the thirteen weeks ended December 28, 2004. This increase was primarily attributable to labor and other costs relating to our work in connection with Hurricanes Katrina and Wilma. Our cost of revenues consists primarily of labor and labor-related costs, payroll taxes, benefits, training, job-related insurance costs, travel and travel-related costs, repairs, maintenance and rental of job equipment, materials and supplies, testing and sampling, transportation, disposal, and depreciation of capital equipment. Gross Profit ------------ Gross profit increased by $6,534,223, or 218.6%, to $9,523,635, or 53.7%, of total revenues for the thirteen weeks ended December 27, 2005 as compared to $2,989,412, or 40.6%, of total revenues for the thirteen weeks ended December 28, 2004. This increase in gross profit was due primarily to a higher percentage of higher margin equipment usage in connection with our hurricane-related projects. Selling, General and Administrative Expenses -------------------------------------------- Selling, general and administrative expenses increased by $1,000,457, or 66.6%, to $2,503,303 for the thirteen weeks ended December 27, 2005 from $1,502,846 for the thirteen weeks ended December 28, 2004 and constituted approximately 14.1% and 20.4% of revenues in such periods, respectively. This increase was primarily attributable to an increased provision of $700,000 to our allowance for doubtful accounts, increased accounting and legal fees of $71,628, and a $15,090 increase in marketing expenses. These were partially offset by a decrease of $25,314 in management fees. Our selling, general, and administrative expenses primarily consist of expenses related to provisions for doubtful accounts, professional fees, salaries and related benefits, insurance, marketing and all other office- and administrative-related expenses. Benefit Related to Variable Accounting Treatment for Officer Options -------------------------------------------------------------------- Under the terms of a previous employment agreement we entered into and a separate agreement with Spotless, our president and chief executive officer was able to sell to us, or in certain circumstances to Spotless, all shares of our common stock held by him and all shares of our common stock underlying vested options to purchase shares of our common stock held by him upon the occurrence of certain events. Due to the terms of the options, changes in the market price of our common stock, in either direction, resulted in a corresponding expense or benefit. There was no benefit or expense required to be recorded in the thirteen weeks ended December 27, 2005 due to the elimination of this risk on June 30, 2005. There was no benefit or expense required to be recorded in the thirteen weeks ended December 28, 2004 due to the low market price of our common stock. Interest Expense ---------------- Interest expense increased by $609,223, or 1,100.6%, to $664,575 for the thirteen weeks ended December 27, 2005 from $55,352 for the thirteen weeks ended December 28, 2004. This increase was primarily due to an increase of $168,491 of interest expense incurred to Laurus, $181,958 of amortization of discounts, and an increase of $296,211 attributable to the amortization of deferred financing costs relating to the Laurus transaction, partially offset by a reduction of $40,620 in interest expense incurred to Spotless. 17 Provision for Income Taxes -------------------------- The provision for income taxes for the thirteen weeks ended December 27, 2005 was $3,159,138 as compared to $43,659 for the thirteen weeks ended December 28, 2004. This increase was the result of higher taxable income for the thirteen weeks ended December 27, 2005, primarily attributable to our hurricane-related work in that period. Net Income ---------- We generated net income of $3,196,162 and net income attributable to common stockholders of $3,176,662 for the thirteen weeks ended December 27, 2005, as compared to net income of $1,388,310 and net income attributable to common stockholders of $1,368,810 incurred for the thirteen weeks ended December 28, 2004. These changes were the result of the factors discussed above. TWENTY-SIX WEEKS ENDED DECEMBER 27, 2005 AND DECEMBER 28, 2004 -------------------------------------------------------------- Revenue ------- Total revenues for the twenty-six weeks ended December 27, 2005 increased by $10,040,896, or 78.2%, to $22,878,681 from $12,837,785 for the twenty-six weeks ended December 28, 2004. This increase in revenue was primarily attributable to $15,070,747 of revenues from work relating to Hurricane Katrina and $1,320,769 of revenues from work relating to Hurricane Wilma. This increase was partially offset by a $1,063,799 decrease in spill related work. Cost of Revenues ---------------- Cost of revenues increased $3,843,989 or 44.0%, to $12,575,980 for the twenty-six weeks ended December 27, 2005 as compared to $8,731,991 for the twenty-six weeks ended December 28, 2004. This increase was primarily attributable to labor and other costs relating to our work in connection with Hurricanes Katrina and Wilma. Our cost of revenues consists primarily of labor and labor-related costs, payroll taxes, benefits, training, job-related insurance costs, travel and travel-related costs, repairs, maintenance and rental of job equipment, materials and supplies, testing and sampling, transportation, disposal, and depreciation of capital equipment. Gross Profit ------------ Gross profit increased by $6,196,907, or 150.9%, to $10,302,701, or 45.0%, of total revenues for the twenty-six weeks ended December 27, 2005 as compared to $4,105,794, or 32.0%, of total revenues for the twenty-six weeks ended December 28, 2004. This increase in gross profit was due primarily to a higher percentage of higher margin equipment usage in connection with our hurricane-related projects. Selling, General and Administrative Expenses -------------------------------------------- Selling, general and administrative expenses increased by $1,274,255, or 46.6%, to $4,009,705 for the twenty-six weeks ended December 27, 2005 from $2,735,450 for the twenty-six weeks ended December 28, 2004 and constituted approximately 17.5% and 21.3% of revenues in such periods, respectively. This increase was primarily attributable to an increased provision of $1,250,000 to our allowance for doubtful accounts, increased accounting and legal fees of $303,726, and a $40,256 increase in marketing expenses. These were partially offset by a decrease of $114,316 in consulting fees. Our selling, general, and administrative expenses primarily consist of expenses related to provisions for doubtful accounts, professional fees, salaries and related benefits, insurance, marketing and all other office- and administrative-related expenses. 18 Benefit Related to Variable Accounting Treatment for Officer Options -------------------------------------------------------------------- Under the terms of a previous employment agreement we entered into and a separate agreement with Spotless, our president and chief executive officer was able to sell to us, or in certain circumstances to Spotless, all shares of our common stock held by him and all shares of our common stock underlying vested options to purchase shares of our common stock held by him upon the occurrence of certain events. Due to the terms of the options, changes in the market price of our common stock, in either direction, resulted in a corresponding expense or benefit. There was no benefit or expense required to be recorded in the twenty-six weeks ended December 27, 2005 due to the elimination of this risk on June 30, 2005. There was no benefit or expense required to be recorded in the twenty-six weeks ended December 28, 2004 due to the low market price of our common stock. Interest Expense ---------------- Interest expense increased by $961,954, or 361.0%, to $1,228,410 for the twenty-six weeks ended December 27, 2005 from $266,456 for the thirteen weeks ended December 28, 2004. This increase was primarily due to an increase of $289,656 of interest expense incurred to Laurus, $317,216 of amortization of discounts, and an increase of $587,690 attributable to the amortization of deferred financing costs relating to the Laurus transaction, partially offset by a reduction of $226,021 in interest expense incurred to Spotless, including a decrease of $145,846 in interest expense recognized in connection with sales of accounts receivable to Spotless because there were no such sales in the twenty-six week period ended December 27, 2005. Provision for Income Taxes -------------------------- The provision for income taxes for the twenty-six weeks ended December 27, 2005 was $3,167,356 as compared to $46,248 for the twenty-six weeks ended December 28, 2004. This increase was the result of higher taxable income for the twenty-six weeks ended December 27, 2005, primarily attributable to hurricane-related work in that period. Net Income ---------- We generated net income of $1,874,720 and net income attributable to common stockholders of $1,835,720, for the twenty-six weeks ended December 27, 2005, as compared to net income of $1,058,962 and net income attributable to common stockholders of $1,019,962 incurred for the twenty-six weeks ended December 28, 2004. These changes were the result of the factors discussed above. LIQUIDITY AND CAPITAL RESOURCES As of December 27, 2005, we had a cash balance of $2,494,266, working capital of $6,079,337 and stockholders' equity of $10,002,965. As of September 27, 2005, we had a cash balance of $147,493, working capital of $1,845,015 and stockholders' equity of $5,583,738. As of June 28, 2005, we had a cash balance of $512,711, a working capital deficit of ($1,704,091) and a stockholders' deficit of ($712,889). As of June 29, 2004, we had cash balances of $63,562, a working capital deficit of ($2,103,971) and stockholders' deficit of ($787,955). We generated a net profit of $1,874,720, a net profit of $53,066 and a net loss of ($3,535,334) for our fiscal quarter ended December 27, 2005 and our fiscal years ended June 28, 2005 and June 29, 2004, respectively. Net cash provided by operating activities was $587,948 for the twenty-six weeks ended December 27, 2005, as compared to the net cash provided by operations of $473,288 for the twenty-six weeks ended December 28, 2004. Accounts receivable increased by $4,233,848, or 36.8%, as of December 27, 2005 to $15,751,255, from $11,517,407 as of December 28, 2004, primarily as a result of work performed in connection with Hurricanes Katrina and Wilma. Accounts payable and accrued expenses decreased by $1,156,854, or 24.0%, as of December 27, 2005 to $3,672,669, from $4,829,523 as of December 28, 2004, primarily as a result of accelerated payments to our venders as a result of our favorable cash position. Net cash provided by financing activities for the twenty-six weeks ended December 27, 2005 was $2,332,363, as compared to cash used by financing activities of $134,508 for the twenty-six weeks ended December 28, 2004, primarily as a direct result of $7,350,000 received in connection with our borrowings from Laurus, the proceeds of which borrowings were used to pay related transaction and other expenses in the amount of $2,314,172 and repay indebtedness to Spotless in the amount of $2,650,000. These transactions resulted in a net increase of $2,350,000 in borrowings 19 and the cancellation of $1,230,228 of our previous secured note payable to Spotless. The balance of the proceeds, in the amount of $2,053,011, was used to fund working capital and our initial Hurricane Katrina mobilization costs. Financing activities for the twenty-six weeks ended December 28, 2004 used net cash of $134,508 for long-term debt repayment. Cash used for capital expenditures increased to $938,756, during the twenty-six weeks ended December 27, 2005, as compared to $56,011 for the twenty-six weeks ended December 28, 2004, due to the cost of equipment purchased to perform the work in the Gulf Coast region. At this time, we do not have any other material commitments or plans for capital expenditures. We intend, however, to make additional capital expenditures, to the extent our financial condition permits, as may be required in connection with rendering our services in the future. Historically, we have financed our operations primarily through issuance of debt and equity securities, through short-term borrowings from our former majority shareholder, and through cash generated from operations. We expect to generate sufficient cash flow from operations to support our working capital needs and to adequately fund our current operations for at least the next twelve months. However, any further difficulty collecting our accounts receivable or further significant growth could adversely affect our liquidity. In the event that we do not generate sufficient positive cash flow from operations, or if we experience changes in our plans or other events that adversely affect our operations or cash flow, we may need to seek additional financing in addition to the financing provided by Laurus. Laurus is under no obligation to provide any funding to us. Currently, we have no credit facility for additional borrowing. Our future cash requirements are expected to depend on numerous factors, including, but not limited to our ability to: o Obtain profitable environmental or related construction contracts. So long as we have sufficient working capital, we anticipate continued revenue growth in new and existing service areas and to continue to bid on large projects, though there can be no assurance that any of our bids will be accepted or that we will have sufficient working capital. We currently are engaged on various projects within our customary scope of services for private sector commercial and residential customers in the gulf coast and Florida regions in connection with the aftermath of Hurricanes Katrina and Wilma. Under time and materials contracts or other arrangements, we have billed in excess of $9.8 million of work that we have completed in connection with these projects through January 31, 2006. We have also billed in excess of $8.9 million for projects in these areas that are still in progress. As of January 1, 2006 we have billed an aggregate of over $20 million of time and materials projects during our fiscal 2006. In this connection, we also intend to focus on procuring time and materials contracts, which have historically generated higher gross margins. We also intend to continue our marketing campaign, including radio and newspaper advertising and a public relations program, to inform residents of New Orleans and the surrounding gulf areas about our services. Our management believes that we will be engaged to perform additional projects in this region for the foreseeable future; however, no assurance can be given in this regard until contracts relating to these projects have been executed. o Control our selling, general and administrative expenses, which have recently increased in connection with our need to incur labor, operating and equipment expenses in relation to our operations in the gulf coast and Florida regions. In order to control our selling, general and administrative expenses, we have or are in the process of optimizing the efficiency of our support staff through training and enhanced task allocation while reducing unneeded resources and reviewing non-project related expenses in an effort to reduce costs where appropriate while preserving the quality of our service. o Raise additional capital or obtain additional financing. Management has preliminarily explored additional funding sources, but has been unable to attract additional debt or equity capital. Laurus indicated to us that it did not intend to provide any additional financing at the time that it loaned an additional $1,350,000 to us in October 2005. In addition, the existence of the Laurus and Spotless security interests may impair our ability to raise additional debt capital. No assurance can be given that we will be able to obtain additional debt or equity capital although our management expects to continue seeking any such favorable opportunities. o Generate positive cash flow from operations. We seek to obtain profitable contracts that generate gross profits more than sufficient to pay our expenses. Our plans for our 2006 fiscal year include 20 concentrating our efforts in the gulf coast and Florida regions in connection with the aftermath of Hurricanes Katrina and Wilma and addressing our difficulty with cash collections and slow cash flow. We have experienced difficulties with cash collections and slow cash flow due primarily to factors including: o customers refusing to pay prior to receiving insurance reimbursements; o customers' facility managers needing to wait for insurance adjustors to approve work before the remission of payment; and o certain customers refusing to pay in connection with disputed change orders. In an effort to enhance our cash flows from operations, beginning in our 2005 fiscal year, we began implementing and are continuing to implement improvements in our billing and invoicing procedures as follows: o we generally do not commence projects until we have a fully executed contract; o our service contracts provide that our customers are directly obligated for our services; o we require client approval with respect to the work performed or to be performed; o we generally seek deposits or mobilization fees for time and materials contracts; o we engage local legal counsel in the areas in which we operate to file liens against customers' real property in the event of contract disputes; and o all invoices submitted for payment are reviewed for proper documentation. Because some of these are relatively new changes, no assurances can be given that they will be successful in improving our collections and cash flows. Further, approximately 4% of our current projects are performed under procedures that predate these improvements. On June 30, 2005, we issued to Laurus Master Fund, Ltd. a three-year secured convertible term note in the principal amount of $5,000,000. Subsequently, Laurus loaned us an additional $2,350,000, and we amended and restated the note accordingly. As of February 2, 2006, the principal amount of the Note, as a result of repayments, outstanding equaled $6,890,625. On November 10, 2005, Laurus agreed to defer the principal monthly payments due in November and December 2005 in the aggregate amount of $495,375 until June 30, 2008, the maturity date of the Note. Laurus holds a senior security interest in our and our subsidiaries assets collateralizing the Note, including a pledge of the stock of our subsidiaries. In addition, Spotless holds a subordinated security interest collateralizing our $500,000 note issued to Spotless, which bears interest at a rate of LIBOR plus 1% per annum and is required to be repaid at a rate of $50,000 per month commencing July 1, 2007. The existence of these security interests may impair our ability to raise additional debt capital. Under the terms of the Note, which matures on June 30, 2008, we are required to make monthly repayments of principal, on the first of each month, to Laurus in the amount of $229,687.50, which commended as of January 1, 2006. Principal repayments were originally due to commence starting November 1, 2005 but, in November 2005, Laurus agreed to defer the initial repayment date until January 1, 2006. The principal monthly payments due November 1, 2005 and December 1, 2005 in the aggregate amount of $495,375 have been deferred until June 30, 2008. Interest is payable monthly and started to accrue on August 1, 2005. All required interest payments as of the date of this report have been made. We are required to pay such amounts in shares of our common stock should all of the following conditions be satisfied: o the average closing price of our common stock for the five (5) trading days immediately prior each first of the month is equal to or greater than $.10; o the amount of the payment then due is not an amount greater than thirty percent (30%) of the aggregate dollar trading volume of the common stock for the period of twenty-two (22) trading days immediately prior to the first of each month; o the common stock underlying the Note and the warrant issued to Laurus has been registered under an effective registration statement under the Securities Act of 1933 or is otherwise covered by an exemption from registration for resale pursuant to Rule 144 of the Securities Act of 1933; 21 o Laurus' aggregate beneficial ownership of our shares of common stock does not and would not by virtue thereof exceed 4.99%; and o we are not in default of the Note. If any of these conditions are not satisfied, we will be required to make payments in cash in an amount equal to 103% of the principal amount, plus accrued interest, then due. Should we be required to pay cash, this may have an adverse effect on our cash flow and liquidity. The Note may be redeemed by us in cash by paying the holder of the Note 120% of the principal amount, plus accrued interest. As discussed below, the holder of the Note may convert all or a portion of the Note, together with related interest and fees, into fully paid shares of our common stock at any time. The number of shares to be issued shall equal the total amount of the Note to be converted, divided by an initial fixed conversion price of $.09. If we issue shares of common stock to a third-party for consideration below the fixed conversion price of $.09 per share or issue derivative securities convertible into or exercisable for shares of common stock at prices below the fixed conversion price of $.09 per share, then the fixed conversion price of the Note will be reduced to such lower issuance or exercise price. In addition, the conversion price of the Note may be adjusted pursuant to customary anti-dilution provisions, such as if we pay a stock dividend, reclassify our capital stock or subdivide or combine our outstanding shares of common stock into a greater or lesser number of shares. We may receive proceeds from the exercise of the option and the warrant described above if Laurus elects to pay the exercise price in cash rather than executing a cashless exercise. Laurus may effect a cashless exercise of the warrant if the market price of our common stock exceeds the per share exercise price, and it may effect a cashless exercise of the option if (a) the market price of our common stock exceeds the per share exercise price and (b) (1) we have not registered the shares underlying the option pursuant to an effective registration statement or (2) an event of default under the Note has occurred and is continuing. Upon a cashless exercise, in lieu of paying the exercise price in cash, Laurus would receive shares of our common stock with a value equal to the difference between the market price per share of our common stock at the time of exercise and the exercise price per share set forth in the option and the warrant, multiplied by the number of shares with respect to which the option or warrant is exercised. There would be no proceeds payable to us upon a cashless exercise of the option or the warrant. There can be no assurances that Laurus will exercise the option and warrant or that it will elect to pay the exercise price in cash in lieu of a cashless exercise. On September 12, 2005, we issued 1,500,000 shares of our common stock to Laurus in connection with its partial exercise of the Option at an exercise price of $.0001 per share for an aggregate exercise price of $150. Laurus has contractually agreed to restrict its ability to convert the Note and/or exercise its warrant and option if such conversion and/or exercise would cause its beneficial ownership of shares of our common stock to exceed 4.99% of the outstanding shares of our common stock. The 4.99% limitation is null and void without notice to us upon the occurrence and during the continuance of an event of default or upon 75 days' prior written notice to us. As of the date of this report, Laurus beneficially owns 1,500,000 shares of our common stock, or approximately 4.46% of our outstanding common stock. As a result, Laurus could only acquire up to approximately 184,405 additional shares, which would constitute a conversion of approximately $16,596 of the principal amount of the Note, while remaining in compliance with the 4.99% limitation. Because Laurus is irrevocably prohibited from waiving this 4.99% limitation, except as described above, even if the other conditions allowing us to pay in shares of common stock have been satisfied, if Laurus cannot or does not reduce its ownership of our common stock at a time when such reduction would be necessary to allow us to make a payment in shares of common stock, we would be required to pay Laurus in cash. This may have an adverse effect on our cash flow and liquidity. In the event we default on the Note, we will be required to pay 120% of the outstanding principal amount of the Note, plus accrued but unpaid interest. Upon the occurrence of an event of default, the interest rate changed will be increased by 2% per month until the default is cured. The Note is secured by a lien on substantially all of our assets, including the stock of our subsidiaries, all cash, cash equivalents, accounts, accounts receivable, deposit accounts, inventory, equipment, goods, fixtures, documents, instruments, including promissory notes, contract rights and general intangibles, including payment intangibles. The Master Security Agreement, dated June 30, 2005, between us and Laurus contains no specific financial covenants. The Master Security 22 Agreement and the Note define the circumstances under which they can be declared in default and subject to termination, including: o a failure to pay interest and principal payments under the Note when due on the first day of the month or prior to the expiration of the three-business day grace period, unless agreed otherwise; o a breach by us of any material covenant or term or condition of the Note or in any agreement made in connection therewith and, to the extent subject to cure, the continuation of such breach without remedy for a period of fifteen or thirty days, as the case may be; o a breach by us of any material representation or warranty made in the Note or in any agreement made in connection therewith; o any form of bankruptcy or insolvency proceeding instituted by or against us, which is not vacated within 30 days; o any attachment or lien in excess of $75,000 in the aggregate made upon our assets or a judgment rendered against our property involving a liability of more than $75,000 which shall remain unvacated, unbonded or unstayed for a period of 30 days; o a failure to timely deliver shares of common stock when due upon conversion of the Note or a failure to timely deliver a replacement note; o an SEC stop trade order or principal market trading suspension of our common stock is in effect for 5 consecutive trading days or 5 days during a period of 10 consecutive trading days, if we are not able to cure such trading suspension within 30 days of receiving notice or are not able to list our common stock on another principal market within 60 days of such notice; o a failure to have authorized and reserved shares of our common stock for issuance on or before January 31, 2006 sufficient to provide for the full conversion of the Note, and full exercise of the option and warrant issued by us to Laurus; o an indictment or threatened indictment of us or any of our executive officers under any criminal statute or commencement or threatened commencement of criminal or civil proceedings against us or any of our executive officers pursuant to which statutory or proceeding penalties or remedies available include forfeiture of any of our property; and o the departure of Michael O'Reilly from our senior management. We also entered into a Funds Escrow Agreement, dated June 30, 2005, with Laurus and Loeb & Loeb LLP, as escrow agent, pursuant to the requirements of the Security Agreement. Under the terms of the Funds Escrow Agreement, the funds from Laurus were placed in escrow pending receipt by the escrow agent of fully executed transaction documents and disbursement instructions, upon receipt of which such funds were released to us. No funds remain in escrow. Pursuant to the terms of a Registration Rights Agreement, dated June 30, 2005, as amended, we obligated to file a registration statement with the Securities and Exchange Commission registering the resale of shares of our common stock issuable upon a conversion of the Note and upon the exercise of the option and warrant issued to Laurus. We filed the registration statement on October 3, 2005 and are in the process of responding to a comment letter from the Securities and Exchange Commission dated October 31, 2005. If the registration statement is not declared effective by March 1, 2006 by the Securities and Exchange Commission, then we will be required to pay to Laurus the following amounts: o 1.5% of the principal outstanding on the Note, for the first thirty days, prorated for partial periods, which equals $3,445 per day based upon the $6,890,625 principal amount of the Note currently outstanding; and o 2.0% of the principal outstanding on the Note, for each thirty day period, prorated for partial periods, which equals $4,594 per day. 23 The proceeds we received in connection with the financing transaction and subsequent borrowings from Laurus were used to pay the amounts set forth below to the persons or for the purposes set forth below:
SPOTLESS DEBT o Former majority stockholder and senior secured lender (Spotless), consisting of approximately $2,650,000 in settlement of the principal and $100,000 in interest $ 2,750,000 -------------- TRANSACTION EXPENSES o Laurus transaction fee 1,750,000 o Laurus Capital Management, LLC management and due diligence fees 262,900 o Loeb & Loeb escrow fee 2,000 o Insurance premiums 37,500 o Legal fees 146,773 o Special committee and advisor fees 61,136 o Payments to series A preferred stockholders $ 35,000 -------------- Sub-total $ 2,295,309 -------------- OTHER PAYMENTS o Audit fees 50,000 o Insurance premiums 276,711 o Initial Hurricane Katrina mobilization costs 238,173 o Working capital 1,739,807 -------------- Sub-total $ 2,304,691 -------------- TOTAL $ 7,350,000 ==============
24 The table below summarizes contractual obligations and commitments as of December 27, 2005, including principal and interest payments on our debt(1):
Total 1 Year 2-3 Years 4-5 Years Operating Leases $ 953,727 $ 692,009 $ 261,718 $ - Capitalized Leases - Principal 423,923 207,806 196,087 20,030 Capitalized Leases - Interest 44,769 27,330 16,907 532 Laurus Note - Principal 7,350,000 1,378,128 5,971,872 - Laurus Note Interest Expense - Cash 888,623 538,496 350,127 - Spotless Note - Principal 500,000 - 500,000 - Spotless Note - Interest Expense 13,828 - 13,828 - ------------ ------------ ----------- -------- Total $10,174,870 $ 2,843,769 $7,310,539 $20,562 ------------ (1) This table reflects the effectiveness of Laurus' agreement to defer the initial monthly amortization repayment in the amount of $229,688 from November 1, 2005 until January 1, 2006.
These amounts are based on assumed interest payments reflecting: o the Laurus Note at a rate of 8.75% per annum; o the Spotless note at a rate of 5.86% per annum; and o an aggregate of $423,923 of other long-term debt with maturities ranging from 3 months to 54 months for financed trucks and vehicles with interest rates ranging from 3.95% to 13.99%. OFF-BALANCE SHEET ARRANGEMENTS Although we do not have any financing arrangements that have not been recorded in our financial statements, our transaction with Laurus resulted in a significant discount that reduced the carrying value on our balance sheet of our debt obligation to Laurus. As of December 27, 2005, the Note had a principal balance of $7,350,000 with a corresponding discount of $6,123,517, resulting in a carrying amount of $1,226,483 on our balance sheet, $413,234 of which is included as a current liability and $813,249 of which is included as long-term debt. EFFECT OF INFLATION Inflation has not had a material impact on our operations during fiscal years ended June 28, 2005, June 29, 2004 and July 1, 2003, except that we experienced an increase of 8.1% in fuel costs during the second quarter of this year due to increased oil prices. 25 SEASONALITY Since we and our subsidiaries are able to perform most of our services throughout the year, our business is not considered seasonal in nature. However, we are affected by: o the timing of large projects in certain of our service areas, i.e., asbestos and mold abatement and construction; o the timing of catastrophes; and o inclement weather conditions. In particular, extended periods of rain, cold weather or other inclement weather conditions may result in delays in commencing or completing projects, in whole or in part. Any such delays may adversely affect our operations and financial results and may adversely affect the performance of other projects due to scheduling and staffing conflicts. FORWARD-LOOKING STATEMENTS Statements contained in this Form 10-Q include "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on the beliefs and current expectations of and assumptions made by our management. Forward-looking statements may be identified by the use of forward-looking terminology such as "may," "will," "expect," "believe," "estimate," "anticipate," "continue" or similar terms, variations of those terms or the negative of those terms. Forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause the actual results, performance and achievements, whether expressed or implied by such forward-looking statements, not to occur or be realized. Such forward-looking statements generally are based upon our best estimates of future results, performance or achievement, based upon current conditions and the most recent results of operations. Actual results could differ materially from any expectation, estimate or projection conveyed by these statements and there can be no assurance that any such expectation, estimate or projection will be met. Numerous important factors, risks and uncertainties affect our operating results and could cause actual results to differ from the results implied by these or any other forward looking statements. These potential factors, risks and uncertainties include, among other things, such factors as: o the market acceptance and amount of sales of our services; o our success in increasing revenues and reducing expenses; o the frequency and magnitude of environmental disasters or disruptions resulting in the need for the types of services we provide; o our ability to service its debt and other financial obligations, particularly if required to pay in cash; o the extent of the enactment, enforcement and strict interpretations of laws relating to environmental remediation; o our ability to obtain and manage new and large projects; o the competitive environment within the industries in which we operate; o our ability to raise or access capital; o our ability to continue as a going concern; o our ability to effectively implement and maintain its internal controls and procedures; o our dependence on key personnel; o our ability to timely collect its accounts receivable; o our ability to attract and retain qualified personnel; and o the other factors and information disclosed and discussed in other sections of this quarterly report on Form 10-Q and in our report on Form 10-K for the fiscal year ended June 28, 2005. You should carefully consider such risks, uncertainties and other information, disclosures and discussions which contain cautionary statements identifying important factors that could cause actual results to differ materially from those provided in the forward-looking statements. Except as may be required, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 26 The foregoing discussion and analysis provides information which management believes is relevant to an assessment and understanding of our results of operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing in Item 1 and with the consolidated financial statements included in our annual report on Form 10-K for the period ended June 28, 2005. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Equity Price Risk - Our primary market risk exposure relates to the shares of common stock issuable upon conversion of the Note, which we originally issued to Laurus in June 2005. In connection with the issuance of the Note, we issued to Laurus a warrant to purchase 13,750,000 shares of our common stock and an option to purchase 30,395,175 shares of our common stock. On September 12, 2005, we issued 1,500,000 shares of our common stock to Laurus in connection with its partial exercise of its option. The option issued to Laurus has been recorded at its intrinsic value, which is based on the difference between the exercise price per share and the market price per share of our common stock on June 30, 2005, the date of issuance at the inception date of the agreement. The warrant, along with shares of common stock issuable upon exercise thereof have been recorded at their relative fair value at the June 30, 2005 inception date of the agreement, and will be recorded at fair value at each subsequent balance sheet date. Any change in value between reporting periods will be recorded as a non-operating, non-cash charge at each reporting date. The impact of these non-operating, non-cash charges could have an adverse effect on our stock price in the future. The Note also exposes us to additional risks also relating to our own common stock because if Laurus is unable to convert the loan into common stock due to low price or low trading volume in the market, we then must repay the loan in cash at a 3% premium. The intrinsic value of the option and the fair value of the warrant and the underlying shares of common stock are tied in a large part to our stock price. If our stock price increases between reporting periods, the option, warrant and underlying shares of common stock become more valuable. As such, there is no way to forecast what the non-operating, non-cash charges will be in the future or what the future impact will be on our financial statements. Interest Rate Sensitivity - Interest rate risk is the risk that interest rates on our debt is fully dependent upon the volatility of these rates. We do not use derivative financial instruments to manage interest rate risk. The Note bears interest at the prime rate as published in the Wall St. Journal plus 2% (but not to less than 7.25%), decreasing by 2% (but not to less than 0%) for every 25% increase in the Market Price (as defined therein) of our common stock above the fixed conversion price of $.09 following the effective date of the registration statement covering the common stock issuable upon conversion. Should the price of our common stock maintain a price equal to 125% of $.09 for a twelve month period and if our registration statement registering the shares of our common stock underlying the note and warrant has been declared effective by the Securities and Exchange Commission, we would benefit from a reduced interest rate of 2% on the outstanding principal amount for that twelve-month period. On June 30, 2005, we also issued a variable interest rate secured promissory note in the principal amount of $500,000 to Spotless Plastics (USA), Inc., bearing interest at LIBOR plus 1%. We also have various other debt with maturities ranging from 3 months to 54 months aggregating to $413,234 for financed trucks and vehicles. A hypothetical 1% increase in the interest rate applicable to the outstanding amounts of the Laurus and Spotless notes along with the various other debt for financed trucks and vehicles would increase our interest expense by approximately $70,000 annually. This hypothetical calculation reflects the assumed interest payments for the: o Note at a rate of 8.75% per annum; o Spotless note at a rate of 5.86% per annum; and o various other debt for financed trucks and vehicles with maturities ranging from 3 months to 54 months with interest rates ranging from 3.95% to 13.99%. 27 ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure. The design of any system of control 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 our stated purpose under all potential future conditions. As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, an evaluation was performed under the supervision and with the participation of the chief executive officer and the chief financial officer of the effectiveness of the design and operation of our "disclosure controls and procedures" (as defined under Rule 13a-15(e) and Rule 15d-15(e)) as of the end of the period covered by this quarterly report on Form 10-Q filed with the SEC. Based upon that evaluation and in connection with their determination that the matters described immediately below relating to changes to our internal control over financial reporting were not material, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures, as of December 27, 2005, were effective in timely alerting them to material company information required to be included in our periodic filings with the Securities and Exchange Commission. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING In connection with our first quarter fiscal 2006 review, we identified issues arising in connection with a change in our accounting staff during such period regarding the timing and related processing of cash receipts and allocation of costs associated with our contract and billing procedures and have implemented the following measures: o We have modified our calendar quarterly period end dates in our computer system to correspond with our actual quarterly period ending dates in order to enhance the accurate and timely processing of our cash receipts for each quarterly report. We have also emphasized to our accounting staff that they must record transactions on the dates that they occur instead of batching such transactions for processing at the end of one of our monthly, quarterly or annual periods. o We have modified the way in which we allocate our costs to specific projects in an effort to more precisely record our project costs. We are assigning a high priority to the short-term and long-term correction of our internal controls over financial reporting and will continue to evaluate the effectiveness of such internal controls on an on-going basis and will take further action as might be appropriate. Other than implementing the improvements discussed above, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, those controls. 28 PART 2 - OTHER INFORMATION -------------------------- ITEM 1. LEGAL PROCEEDINGS ----------------- On August 5, 2004, we commenced an action in the New York State Supreme Court, County of New York, seeking to collect approximately $1,255,000 of contractual billings relating to a large roof tar removal project. On October 15, 2004, the Economic Development Corporation filed an answer, denying our claims. On November 4, 2004, the Economic Development Corporation filed an amended answer denying our claims and asserting counterclaims. The case is currently in pre-trial discovery. In April 2003, we commenced a remediation project in New York City for a local utility to remove sediment from an oil storage tank. During the course of the project, the sediment in the tank was found to be substantially different than the sediment that the customer represented to be in the tank prior to the inception of the project. We continued to work on the project so as not to default on the terms which it understood to exist with the customer. The additional costs incurred to remove this matter were approximately $1,600,000. As of June 28, 2005, we recognized revenue of approximately $1,700,000 with respect to the original scope of this project. All amounts due under the original contract have been paid. We have not recognized the revenue associated with its claim. The project has been completed and the customer has refused to acknowledge its liability for these additional charges billed. On October 22, 2004, we commenced an action against a local utility company in the New York State Supreme Court, County of New York, claiming that we are entitled to approximately $2,000,000 of contractual billings and related damages in connection with this matter. On December 6, 2004, the local utility company filed an answer, denying our claims. The case is currently in pre-trial discovery. We are a plaintiff in approximately 18 lawsuits claiming an aggregate of approximately $5,000,000 pursuant to which we are seeking to collect amounts we believe are owed to us by customers that are included in our accounts receivable, primarily with respect to changed work orders or other modifications to our scope of work. The defendants in these actions have asserted counterclaims for an aggregate of approximately $500,000. We are a party to other litigation matters and claims that are normal in the course of our operations, and while the results of such litigation and claims cannot be predicted with certainty, management believes that the final outcome of such matters will not have a materially adverse effect on our consolidated financial statements. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS ----------------------------------------------------------- Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES ------------------------------- Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- Note applicable. ITEM 5. OTHER INFORMATION ----------------- Not applicable. 29 ITEM 6. EXHIBITS -------- The following exhibits are included as part of this report: 10.1 Amendment and Deferral Agreement, dated November 10, 2005, by and between Windswept and Laurus (Incorporated by reference to Exhibit 10.1 of Windswept's Current Report on Form 8-K (Date of Report: November 10, 2005) filed with the SEC on November 14, 2005). 10.2 Amendment and Deferral Agreement, dated November 23, 2005, by and between Windswept and Laurus (Incorporated by reference to Exhibit 10.1 of Windswept's Current Report on Form 8-K (Date of Report: November 23, 2005) filed with the SEC on November 29, 2005). 10.3 Amendment and Fee Waiver Agreement, dated January 13, 2006, by and between Windswept and Laurus (Incorporated by reference to Exhibit 10.1 of Windswept's Current Report on Form 8-K (Date of Report: January 13, 2006) filed with the SEC on January 18, 2006). 31.1 Certification of Chief Executive Officer pursuant to Sarbanes-Oxley Section 302(a). 31.2 Certification of Chief Financial Officer pursuant to Section 302(a). 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350. 30 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WINDSWEPT ENVIRONMENTAL GROUP, INC. Date: February 8, 2006 By: /s/ Michael O'Reilly ------------------------------------- MICHAEL O'REILLY, President and Chief Executive Officer (Principal Executive Officer) Date: February 8, 2006 By: /s/ Andrew C. Lunetta ------------------------------------- ANDREW C. LUNETTA Chief Financial Officer (Principal Financial Officer) 31 EX-31 2 exhibit311-051227.txt EXHIBIT 31.1 Exhibit 31.1 WINDSWEPT ENVIRONMENTAL GROUP, INC. OFFICER'S CERTIFICATE PURSUANT TO SECTION 302(A) CERTIFICATION I, Michael O'Reilly, the chief executive officer of Windswept Environmental Group, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Windswept Environmental Group, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a 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 officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this quarterly report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 8, 2006 /s/ Michael O'Reilly -------------------------------- Michael O'Reilly Chief Executive Officer (Principal Executive Officer) EX-31 3 exhibit312-051227.txt EXHIBIT 31.2 Exhibit 31.2 WINDSWEPT ENVIRONMENTAL GROUP, INC. OFFICER'S CERTIFICATE PURSUANT TO SECTION 302(A) CERTIFICATION I, Andrew C. Lunetta, the chief financial officer of Windswept Environmental Group, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Windswept Environmental Group, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a 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 officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this quarterly report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 8, 2006 /s/ Andrew C. Lunetta ----------------------- Andrew C. Lunetta Chief Financial Officer (Principal Financial Officer) EX-32 4 exhibit321-051227.txt EXHIBIT 32.1 Exhibit 32.1 WINDSWEPT ENVIRONMENTAL GROUP, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the quarterly report of Windswept Environmental Group, Inc. (the "Company") on Form 10-Q for the period ended December 27, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, Michael O'Reilly, the Chief Executive Officer of the Company and Andrew C. Lunetta, the Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. A signed original of this written statement required by Section 906 has been provided to Windswept Environmental Group, Inc. and will be retained by Windswept Environmental Group, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. Date: February 8, 2006 /s/ Michael O'Reilly ----------------------- Michael O'Reilly Chief Executive Officer (Principal Executive Officer) /s/ Andrew C. Lunetta ----------------------- Andrew C. Lunetta Chief Financial Officer (Principal Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----