--------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO ________________
COMMISSION FILE NO. 0-16401
---------------------------
ADVANCED MATERIALS GROUP, INC.
(Exact name of registrant as specified in its charter)
NEVADA 33-0215295
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3303 LEE PARKWAY SUITE 105 DALLAS, TEXAS 75219
(Address of principal executive offices)(Zip code)
(972) 432-0602
(Registant's telephone number, including area code)
---------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ ] Yes [X] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the
Exchange Act.) [ ] Yes [X] No
Indicate the number of shares outstanding of each of the issuer's class of
common equity, as of the latest practicable date:
COMMON STOCK, $.001 PAR VALUE, 12,116,000 ARE OUTSTANDING AS OF MAY 5,
2006.
--------------------------------------------------------------------------------
ADVANCED MATERIALS GROUP, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements: Page
Condensed Consolidated Statements of Operations for the three and nine months
ended August 31, 2004 and 2003 (unaudited)............................................. 3
Condensed Consolidated Balance Sheets at August 31, 2004 (unaudited) and
November 30, 2003...................................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months
Ended August 31, 2004 and 2003 (unaudited)............................................. 5
Notes to Condensed Consolidated Financial Statements (unaudited).......................... 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................. 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk................................ 20
ITEM 4. Controls and Procedures .................................................................. 20
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings......................................................................... 21
ITEM 2. Changes in Securities and Use of Proceeds................................................. 21
ITEM 3. Defaults Upon Senior Securities........................................................... 21
ITEM 4. Submission of Matters to a Vote of Security Holders....................................... 22
ITEM 5. Other Information......................................................................... 22
ITEM 6. Exhibits and Reports on Form 8-K.......................................................... 22
Signatures.............................................................................................. 22
Certifications.......................................................................................... 23
2
PART I - FINANCIAL INFORMATION
ITEM 1. - FINANCIAL STATEMENTS.
ADVANCED MATERIALS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------------ ------------------------------------
AUGUST 31, 2004 AUGUST 31, 2003 AUGUST 31, 2004 August 31, 2003
---------------- ---------------- ---------------- ----------------
Net sales $ 2,016,298 $ 2,587,000 $ 5,856,963 $ 12,175,000
Cost of sales 1,510,925 2,296,000 4,661,987 10,980,000
---------------- ---------------- ---------------- ----------------
Gross profit 505,373 291,000 1,194,976 1,195,000
---------------- ---------------- ---------------- ----------------
Operating expenses:
Selling, general and administrative 401,192 459,000 1,085,667 1,178,000
Impairment of fixed assets -- -- 108,232 --
Depreciation and amortization 50,180 53,000 136,508 158,000
---------------- ---------------- ---------------- ----------------
Total operating expenses 451,372 512,000 1,330,407 1,336,000
---------------- ---------------- ---------------- ----------------
Income (loss) from operations 54,001 (221,000) (135,431) (141,000)
Other income (expense):
Interest expense (34,451) (44,000) (82,038) (211,000)
Gain on settlement -- -- 974,000 --
Other, net 16,011 -- (73,926) (36,000)
---------------- ================ ---------------- ----------------
Total other income (expense) (18,440) (44,000) 818,036 (247,000)
---------------- ---------------- ---------------- ----------------
Income (loss) from continuing operations 35,561 (265,000) 682,605 (388,000)
Income (loss) from discontinued operations -- (70,000) -- (40,000)
---------------- ---------------- ---------------- ----------------
Net income (loss) $ 35,561 $ (335,000) $ 682,605 $ (428,000)
================ ================ ================ ================
Basic and diluted earnings (loss) per common share:
Earnings (loss) from continuing operations 0.00 (0.03) 0.07 (0.04)
================ ================ ================ ================
Earnings (loss) from discontinued operations $ 0.00 $ (0.01) $ 0.00 $ (0.00)
================ ================ ================ ================
Net income (loss) per share $ 0.00 $ (0.04) 0.07 $ (0.04)
================
Weighted average common shares outstanding
Basic 10,469,730 8,671,272 9,872,449 8,671,272
================ ================ ================ ================
Diluted 10,955,303 8,671,272 10,444,106 8,671,272
================ ================ ================ ================
See accompanying notes to condensed consolidated financial statements.
3
ADVANCED MATERIALS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
AUGUST, 31 NOVEMBER 30,
2004 2003
--------------- ---------------
Current assets:
Cash and cash equivalents $ 221,475 $ 81,000
Accounts receivable, net of allowance of $23,581 and $54,000
at August 31, 2004 and November 30, 2003, respectively 1,227,523 1,319,000
Inventories, net 703,718 939,000
Prepaid expenses and other 138,636 161,000
--------------- ---------------
Total current assets 2,291,352 2,500,000
Property and equipment, net 765,431 1,059,000
Other assets 278 48,000
--------------- ---------------
Total assets $ 3,057,061 $ 3,607,000
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 674,529 $ 1,181,000
Accrued liabilities 283,732 439,000
Restructuring reserve, current 25,312 56,000
Note payable - related parties 307,563 --
Line of credit 769,675 609,000
Term Loan 90,000 361,000
Convertible debentures 0 405,000
Current portion of long-term obligations 47,226 360,000
--------------- ---------------
Total current liabilities 2,198,037 3,411,000
Term loan 188,000 --
Deferred compensation, net of current portion -- 951,000
Restructuring reserve, net of current portion 6,328 76,000
Capital leases, net of current portion 34,648 57,000
--------------- ---------------
Total liabilities 2,427,013 4,495,000
--------------- ---------------
Stockholders' equity:
Preferred stock-$.001 par value; 5,000,000 shares authorized
no shares issued and outstanding -- --
Common stock-$.001 par value; 25,000,000 shares authorized;
10,516,026 shares issued and outstanding at August 31,
2004 and 8,671,272 as of November 30, 2003 10,516 9,000
Additional paid-in capital 7,958,097 7,124,000
Accumulated deficit (8,021,170) (7,390,000)
Net income/(loss) 682,605 (631,000)
--------------- ---------------
Total stockholders' equity 630,048 (888,000)
--------------- ---------------
Total liabilities and stockholders' equity $ 3,057,061 $ 3,607,000
=============== ===============
See accompanying notes to condensed consolidated financial statements.
4
ADVANCED MATERIALS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
AUGUST 31, 2004 AUGUST 31, 2003
--------------- ---------------
Cash flows from operating activities:
Net income/(loss) $ 682,605 $ (388,000)
Depreciation and amortization 299,268 383,000
Provision for obsolete inventory 22,000 --
Restructuring reserve adjustment (84,032) --
Interest on deferred compensation -- 48,000
Non-cash compensation-Bob Delk 80,000 --
Impairment of fixed assets 108,232 --
Gain on settlement (974,000)
Changes in operating assets and liabilities:
Accounts receivable 91,477 3,253,000
Inventories 213,282 740,000
Prepaid expenses and other 70,086 (47,000)
Accounts payable and accrued liabilities (388,738) (1,696,000)
Restructuring reserve (16,328) (308,000)
Deferred income (250,000) (97,000)
--------------- ---------------
Net cash (used in) provided by operating activities (146,148) 1,888,000
--------------- ---------------
Cash flows from investing activities:
Purchases of property and equipment (113,931) (108,000)
--------------- ---------------
Net cash used in investing activities (113,931) (108,000)
--------------- ---------------
Cash flows from financing activities:
Exercise of common stock options 6,609 --
Net borrowings (repayments) under line of credit 160,675 (2,657,000)
Repayments of other long-term obligations -- (260,000)
Proceeds received from issuance of debts 248,000 --
Sales of common stock 749,001 --
SPaymentstonndebterred Comp (763,562) --
--------------- ---------------
Net cash used in financing activities 400,723 (2,917,000)
--------------- ---------------
Net change in cash and cash equivalents 140,644 (1,137,000)
Cash provided by discontinued operations -- 1,045,000
Cash and cash equivalents, beginning of period 80,831 156,000
--------------- ---------------
Cash and cash equivalents, end of period $ 221,475 $ 64,000
=============== ===============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 61,839 $ 220,000
=============== ===============
Income taxes $ -- $ --
=============== ===============
See accompanying notes to condensed consolidated financial statements.
5
ADVANCED MATERIALS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1) BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission and therefore do not include all
information and footnotes necessary for a complete presentation of
financial position, results of operations and cash flows in conformity with
accounting principles generally accepted in the United States of America.
The unaudited condensed consolidated financial statements do, however,
reflect all adjustments, consisting of only normal recurring adjustments,
which are, in the opinion of management, necessary to state fairly the
financial position as of August 31, 2004 and November 30, 2003 and the
results of operations and cash flows for the related interim periods ended
August, 31, 2004 and 2003. However, these results are not necessarily
indicative of results for any other interim period or for the year. It is
suggested that the accompanying condensed consolidated financial statements
be read in conjunction with the Company's audited consolidated financial
statements and accompanying notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended November 30, 2003.
The Company's consolidated financial statements have been presented on the
basis that it is a going concern, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of
business. Management continues to streamline costs and improve company
sales. The Company has altered its focus in the last few months and will
now be concentrating on securing proprietary products primarily for the
medical and consumer industry. The continued objective is to create
advanced designs, using current materials. These products will be pursued
through aggressive product development and the licensing of patented
products or technology. These new products are expected to have higher
profit margins and be less subject to competition. There can be no
assurances that the Company will be successful in completing these critical
tasks. If the Company is unable to successfully complete these critical
tasks, it may be forced to significantly reduce, restructure or cease its
operations and/or liquidate inventory at amounts below current carrying
value to generate the necessary working capital to funds its operations,
and if necessary, seek other remedies available to the Company including
protection under the bankruptcy laws.
The condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded
asset amounts or the amounts and classification of liabilities that might
be necessary should the Company be unable to continue as a going concern.
2) SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of Advanced
Materials Group, Inc. and its wholly owned subsidiary, Advanced Materials,
Inc. and Advanced Materials, Ltd. All significant intercompany accounts and
transactions have been eliminated.
Reclassifications
-----------------
Certain fiscal 2003 amounts in the accompanying financial statements have
been reclassified to conform to the fiscal 2004 presentation.
Estimates
---------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporitng period. Actual
results could differ materially from those estimates.
6
Cash and Cash Equivalents
-------------------------
The Company considers highly liquid investments with a remaining maturity
of three months or less when purchased to be cash equivalents.
Fair Value of Financial Instruments
-----------------------------------
The Company's cash and cash equivalents, accounts receivable, accounts
payable and line of credit approximated fair value at August 31, 2004
because of the relatively short maturity of these instruments. The carrying
value of debt approximated fair value at August 31, 2004 due to the
Company's ability to obtain financing at similar interest rates from other
lenders.
Inventories
-----------
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Cost includes raw materials, labor, manufacturing overhead and
purchased products. Market is determined by comparison with recnet
purchases or net realizable value. Net realizable value is based on
forecasts for sales of the Company's products in the ensuing years. Should
demand for the Company's product prove to be significantly less than
anticipated, the ultimate realizable value of the Company's inventories
could be substantially less than the amount shown on the accompanying
consolidated balance sheet.
Property and Equipment
----------------------
Property and equipment are stated at cost. Expenditures for additions and
major improvements are capitalized. Repairs and maintenance costs are
charged to operations as incurred. When property and equipment are retired
or otherwise disposed of, the related cost and accumulated depreciation are
removed from the accounts, and gains or losses from retirements and
dispositions are credited or charged to operations.
Depreciation and amortization are computed using the straight-line method
over estimated useful lives of five to seven years. Leasehold improvements
are being amortized on a straight-line basis over the lesser of the useful
life of the related improvements or term of the lease.
Impairment of Long-Lived Assets
-------------------------------
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" provides a single
accounting model for long-lived assets to be disposed of. SFAS No. 144 also
changes the criteria for classifying an asset as held for sale, and
broadens the scope of businesses to be disposed of that qualify for
reporting as discontinued operations and changes the timing of recognizing
losses on such operations.
The Company adopted SFAS No. 144 on December 1, 2001. The adoption of SFAS
No.144 did not affect the Company's financial statements. In accordance
with SFAS No. 144, long-lived assets, such as furniture, fixtures and
equipment are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated undiscounted
future cash flows expected to be generated by the asset. If the carrying
amount of an asset exceeds its estimated future cash flows, and impairment
charge is recognized by the amount by which the carrying amount of the
asset exceeds the fair value of the asset. Assets to be disposed of would
be separately presented in the balance sheet and reported at the lower of
the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as
held for sale would be presented separately in the appropriate asset and
liability sections of the balance sheet.
Prior to the adoption of SFAS No. 144, the Company accounted for long-lived
assets to be disposed of in accordance with SFAS No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of".
7
Revenue Recognition
-------------------
The Company recognizes revenue from product sales when it is realized or
realizable and earned, which is generally at the time of shipment and
passage of title. Revenue is considered to be realized or realizable and
earned when there is persuasive evidence of a sales arrangement in the form
of a contract or a purchase order, the product has been shipped, the sales
price is fixed or determinable and collectibility is reasonably assured.
The Company records revenue for shipping costs charged to customers. The
related shipping costs incurred are recorded in cost of sales.
Risks and Uncertainties
-----------------------
ENVIRONMENTAL REGULATION AND OPERATING CONSIDERATIONS
The manufacture of certain products by the Company requires the purchase
and use of chemicals and other materials, which are or may be, classified
as hazardous substances. The Company and its subsidiaries do not maintain
environmental impairment insurance. There can be no assurance that the
Company and its subsidiaries will not incur environmental liability or that
hazardous substances are not or will not be present at their facilities.
The Company is subject to regulations administered by the United States
Environmental Protection Agency, various state agencies, county and local
authorities acting in conjunction with federal and state agencies. Among
other things, these regulatory bodies impose restrictions to control air,
soil and water pollution. The extensive regulatory framework imposes
significant complications, burdens and risks on the Company. Governmental
authorities have the power to enforce compliance with these regulations and
to obtain injunctions and/or impose civil and criminal fines or sanctions
in the case of violations.
The Federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980, as amended ("CERCLA"), imposes strict joint and
several liability on the present and former owners and operators of
facilities which release hazardous substances into the environment. The
Federal Resource Conservation and Recovery Act of 1976, as amended
("RCRA"), regulates the generation, governed by the law, which contains the
California counterparts of CERCLA and RCRA. The Company believes that its
manufacturing activities are in substantial compliance with all material
Federal and state laws and regulations governing its operations. Amendments
to existing statutes and regulations could require the Company to modify or
alter methods of operations at costs, which could be substantial. There can
be no assurance that the Company will be able, for financial or other
reasons, to comply with applicable laws and regulations.
The Company believes that it currently conducts, and in the past has
conducted, its activities and operations in substantial compliance with
applicable environmental laws, and believes that costs arising from
existing environmental laws will not have a material adverse effect on the
Company's consolidated financial condition or results of operations. There
can be no assurance, however, that environmental laws will not become more
stringent in the future or that the Company will not incur costs in the
future in order to comply with such laws.
Various laws and regulations relating to safe working conditions, including
the Occupational Safety and Health Act ("OSHA"), are also applicable to the
Company and its subsidiaries. The Company believes it and its subsidiaries
are in substantial compliance with all material Federal, state and local
laws and regulations regarding safe working conditions.
Earnings Per Share
------------------
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 requires the
presentation of basic and diluted net income per share. Basic earnings per
share exclude dilution and are computed by dividing net income by the
weighted average of common shares outstanding during the period. Diluted
earnings per share reflect the potential dilution that would occur if
securities or other contracts to issue common stock were exercised or
converted into common stock. Potential common shares including stock
options and convertible debentures have been excluded for the three and
nine-month periods ended August 31, 2003 as their effect would be
anti-dilutive. The difference in basic and diluted weighted average shares
for the three and nine-month periods ended August 31, 2004 represents
dilutive options and warrants.
8
There were 1,176,000 potentially dilutive options outstanding at August 31,
2004 that were not included in the computation of the earnings per share
because their effect would be anti-dilutive.
Stock Based Compensation
------------------------
In December 2002, the FASB issued FAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure", which amended FAS No. 123,
"Accounting for Stock-Based Compensation." The new standard provides
alternative methods of transition for a voluntary change to the fair market
value based method for accounting for stock-based employee compensation.
Additionally, the statement amends the disclosure requirements of FAS No.
123 to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. In
compliance with FAS No. 148, the Company has elected to continue to follow
the intrinsic value method in accounting for its stock-based employee
compensation plan as defined by APB No. 25.
The following table represents the effect on net income and earnings per
share if the Company had applied the fair value based method and
recognition provisions of Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation", to stock-based
employee compensation. For purposes of pro forma disclosures, the estimated
fair value of the options is amortized to expense over the options' vesting
period. The Company's pro forma information follows:
THREE MONTHS ENDED NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
--------------------------- ----------------------------
2004 2003 2004 2003
---------- ----------- ----------- -----------
Net income (loss) available to common
stockholders $ 35,561 $ (335,000) $ 682,605 $ (428,000)
---------- ----------- ----------- -----------
Plus: Stock-based employee compensation -- -- -- --
included in reported net income (loss)
Less: Total stock-based employee compensation
determined using fair value based method (30,040) (17,000) (112,145) (50,000)
Pro forma net income (loss) available to
common stockholders 5,521 (352,000) 570,460 (478,000)
Net income (loss) per common share - as reported:
Basic .00 (.04) .07 (.04)
Diluted .00 (.04) .07 (.04)
Net income (loss) per common share - pro forma:
Basic .00 (.04) .06 (.06)
Diluted .00 (.04) .05 (.06)
========== =========== =========== ===========
3) INVENTORIES
Inventories are stated at the lower of cost (determined on the first-in,
first-out method) or market. Inventories consisted of the following:
AUGUST 31, 2004 NOVEMBER 30, 2003
--------------- -----------------
(UNAUDITED)
Raw Materials $ 431,334 $ 532,000
Work-in-process 64,669 129,000
Finished Goods 267,093 359,000
--------------- ---------------
763,096 1,020,000
Less allowance for obsolete inventory (59,378) (81,000)
--------------- ---------------
$ 703,718 $ 939,000
=============== ===============
9
4) STOCKHOLDERS' EQUITY
The following table summarizes changes in equity components from
transactions during the nine months ended August 31, 2004:
COMMON STOCK ADDITIONAL
--------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT
----------- ----------- ----------- -----------
Balance as of December 1, 2003 8,671,272 $ 8,671 $ 7,123,942 $(8,021,170)
Stock sold in private placement 1,814,754 1,815 747,185 --
Exercise of common stock options 30,000 30 6,970 --
Non-cash compensation -- -- 80,000 --
Net Income for the period -- -- -- 682,605
----------- ----------- ----------- -----------
Balance as of August 31, 2004 10,516,026 $ 10,516 $ 7,958,097 $(7,338,565)
=========== =========== =========== ===========
In January 2004, the Company sold 1,219,515 shares of its common stock in a
private equity placement for $500,000. The shares were sold to parties
close to the Company, including its Chairman and its CEO, who were already
major shareholders. There was no agent for the transaction. Proceeds from
the sale were used to pay off existing vendors and for general working
capital purposes.
In June 2004, the Company sold 595,239 shares to Delk Partners, Ltd., Plus
4, and the Lenawee Trust in exchange for an aggregate of $250,000 cash.
Robert Delk is the general partner of Delk Partners, Ltd. and was a
director and Chief Executive Officer of the Company; Timothy Busch is a
beneficiary of the Lenawee Trust and a director of the Company; and Richard
H. Pickup is a partner of Plus 4 and a member of a group beneficially
owning more than 10% of the outstanding shares of common stock of the
Company. The proceeds were used to pay the settlement of deferred
compensation as discussed in Note 12. - Deferred Compensation.
5) SEGMENT REPORTING
The Company's foreign operations consist of a sales joint venture located
in Singapore which began operations in fiscal 1998. All of the sales are
made to unaffiliated customers. The following is a summary of selected
financial information by entities within geographic areas for the three and
nine-month periods ended August 31, 2004 and 2003. On October 31, 2003, the
Company sold its wholly-owned subsidiary in Ireland, Advanced Materials,
Ltd. ("AML-Ireland"). Operating results of AML-Ireland for the three and
six-month periods ended August 31, 2003 are shown separately in the
accompanying condensed consolidated statement of operations. Income from
discontinued operations is included in the amounts for US Operations.
THREE MONTHS ENDED AUGUST 31, 2004 AND 2003
US OPERATIONS SINGAPORE CONSOLIDATED
--------------- --------------- ----------------
REVENUE:
2004 $ 1,822,770 $ 193,528 $ 2,016,298
2003 $ 2,173,000 $ 414,000 $ 2,587,000
SEGMENT INCOME (LOSS):
2004 $ (157,967) $ 193,528 $ 35,561
2003 $ (389,000) $ 54,000 $ (335,000)
CORPORATE ALLOCATION (1):
2004 $ 29,000 $ (29,000) $ --
2003 $ 42,000 $ (42,000) $ --
NET INCOME (LOSS):
2004 $ (128,967) $ 164,528 $ 35,561
2003 $ (347,000) $ 12,000 $ (335,000)
10
NINE MONTHS ENDED AUGUST 31, 2004 AND 2003
US OPERATIONS SINGAPORE CONSOLIDATED
--------------- --------------- ----------------
REVENUE:
2004 $ 5,291,234 $ 565,729 $ 5,856,963
2003 $ 7,821,000 $ 4,354,000 $ 12,175,000
SEGMENT INCOME (LOSS):
2004 $ 116,875 $ 565,729 $ 682,604
2003 $ (823,000) $ 395,000 $ (428,000)
CORPORATE ALLOCATION (1):
2004 $ 90,372 $ (90,372) $ --
2003 $ 435,000 $ (435,000) $ --
NET INCOME (LOSS):
2004 $ 207,247 $ 475,358 $ 682,605
2003 $ (506,000) $ 78,000 $ (428,000)
----------
(1) Corporate allocation represents amounts allocated for general corporate
expenses including costs for management, professional services,
insurance and interest.
6) CONTINGENT LIABILITIES
Material legal proceedings to which the Company is a party are discussed in
Part 1, Item 3, in the Company's latest Annual Report on Form 10-K and in
Part II, Item 1 of this Form 10-Q.
7) LINE OF CREDIT
In October 2003, the Company entered into a new line of credit agreement
with a financial institution, which provides for borrowings up to
$3,750,000, as defined. The line had an outstanding balance of $769,675 at
August 31, 2004, expires in October 2005 and bears interest at prime plus
1.5% (8.75% at August 31, 2004). The line of credit is secured by
substantially all of the assets of the Company. The line of credit
agreement requires the Company to maintain certain financial covenants
including the maintenance of debt service and tangible net worth ratios. At
August 31, 2004, the Company was not in compliance with these ratios and
therefore is in technical default under the compliance provisions of its
bank line of credit and term loan. In order to fund present and future
operations, the Company needs to cure its covenant violations with its
lender. While the Company is in the process of attempting to cure its line
of credit and term loan violations, there can be no assurances that the
Company will be successful in completing these critical tasks. If the
Company is unable to successfully complete these critical tasks, it may be
forced to significantly reduce, restructure or cease its operations and/or
liquidate inventory at amounts below current carrying value to generate the
necessary working capital to fund its operations, and if necessary, seek
other remedies available to the Company including protection under the
bankruptcy laws.
11
Effective March 1, 2004, the lender increased the rate of interest on the
Company's line of credit and term loan to prime plus 3%, which is the
default rate specified in the loan agreement. The default rate will remain
in effect until all of the designated defaults have been cured. In October
2005, the Company extended the term of the line-of-credit.
8) TERM LOAN
In October 2003, the Company obtained a term loan in the amount of
$368,000. The term loan had an outstanding balance of $278,000 as of August
31, 2004 and amortizes straight line over 60 months with a balloon payment
due in October 2005. It bears interest at prime plus 2.0% (6.25% at August
31, 2004) and is secured by substantially all of the assets of the Company.
The loan is payable to the same lender as the Company's line of credit, for
which the Company is in technical default under the compliance provisions
and therefore has been classified as current in the financial statements as
of August 31, 2004.
9) CONVERTIBLE DEBENTURES
The Company had outstanding convertible debentures totaling $405,000 at
November 30, 2003. The debentures bore interest at 7.5% per annum, with
interest payable quarterly. The debentures matured through March 2004 and
were paid off at maturity.
10) RELATED PARTY DEBT
On April 22, 2004, the Company's President and CEO and the Company's
Chairman of the Board each loaned $150,000 to the Company pursuant to
certain promissory notes. The notes are payable on July 21, 2004 and bear
interest at 10%. Upon certain events of default, including the nonpayment
of principal, the interest rate increases to a default rate of 12%. The
Company is currently in default on these notes but continues to make
payments.
In conjunction with the promissory notes, the Company issued warrants to
purchase an aggregate of 100,000 shares of the Company's common stock at an
exercise price of $0.363 per share. The warrants are exercisable at any
time and expire on May 13, 2008. Upon default, the Company issued warrants
to purchase an additional 100,000 shares of the Company's common stock with
the same terms.
11) RESTRUCTURING CHARGES
In May 2001, the Company announced the closure of its manufacturing
facility in Dallas, Texas and its distribution centers in Portland, Oregon
and Parker, Colorado. The closure of the two distribution centers was
completed during the third quarter and the closure of the Texas facility
was completed by the end of the fourth quarter of fiscal 2001. The Company
closed these facilities in order to consolidate its U.S. operations into
its plant in Rancho Dominguez, California and reduce overhead costs in
response to its lower domestic sales. During the nine-month period ended
August 31, 2004, the Company reduced the remaining restructuring reserve
$6,328 due to continued use of the business facility in Dallas. This is
disclosed as a reduction to selling, general and administrative expenses in
the accompanying condensed consolidated statement of operations.
12) DEFERRED COMPENSATION
The Company had previously made monthly payments aggregating approximately
$8,000 to two former employees in conjunction with a liability it had
assumed in a business combination in 1992. As of March 2003, the Company
ceased making payments to these individuals, as the Company believes it has
fulfilled its obligation. In May, 2004 the Company settled the dispute for
a lump-sum payment of $250,000. The remainder of the reserve was released
and included as gain on settlement in the accompanying condensed
consolidated statement of operations for the nine-month period ended August
31, 2004. The $250,000 was paid during the current quarter using the
proceeds of common stock issuances.
12
13) DISCONTINUED OPERATIONS
On October 31, 2003, the Company sold its wholly-owned subsidiary in
Ireland, Advanced Materials, Ltd. ("AML-Ireland"). Total consideration for
the sale was approximately $3.2 million, consisting of $2.1 million in
forgiveness of debt and $1.1 million in cash.
Operating results of AML-Ireland for the three nine-month periods ended
August 31, 2003 are shown separately in the accompanying condensed
consolidated statement of operations. The condensed consolidated statement
of operations for the three and nine-month periods ended August 31, 2003
have been restated and operating results of AML-Ireland are shown
separately as discontinued operations for those periods.
Results of operations of AML-Ireland for the three and nine month periods
ended August 31, 2003 were are follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
AUGUST 31, AUGUST 31,
----------- -----------
2003 2003
----------- -----------
Revenues $ 2,648,000 $ 7,286,000
----------- -----------
Costs and expenses:
Cost of sales 2,173,000 5,889,000
General and administrative 545,000 1,406,000
Other -- 31,000)
----------- -----------
Total costs and expenses 2,718,000 7,326,000
----------- -----------
Income (loss) from discontinued
Operations $ (70,000) $ (40,000)
=========== ===========
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the unaudited
condensed consolidated financial statements and the related notes that appear
elsewhere in this report.
This document contains forward-looking statements that involve risks and
uncertainties that could cause the results of the Company and its consolidated
subsidiaries to differ materially from those expressed or implied by such
forward-looking statements. These risks include the timely development,
production and delivery of new products; the challenge of managing asset levels,
including inventory and trade receivables; the difficulty of keeping expense
growth at modest levels while increasing revenues and other risks described from
time to time in the Company's filings with the Securities and Exchange
Commission, including but not limited to the Annual Report on Form 10-K for the
year ended November 30, 2003 and in "Factors That Could Affect Future Results"
below.
Forward-looking statements reflect the current views of the Company with respect
to future events and are subject to certain risks, uncertainties and
assumptions. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results may vary
materially from those described herein as anticipated, believed, estimated or
expected.
The Company's condensed consolidated financial statements have been presented on
the basis that it is a going concern, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. The
Company generated net income from continuing operations of $35,561 and a net
loss from continuing operations of $265,000 in the three-month periods ended
August 31, 2004 and 2003, respectively. The Company generated net income from
continuing operations of $682,605 and a net loss from continuing operations of
$388,000 in the nine-month periods ended August 31, 2004 and 2003, respectively.
Net income for the nine-month period of 2004 was driven by a gain on settlement
of litigation and reversal of a restructuring accrual discussed below.
Management has implemented a plan to reduce expenses and improve sales. The
Company has altered its focus and will now be concentrating on securing
proprietary products primarily for the medical and consumer industry. The
objective is to create advanced designs, using current materials. These products
13
will be pursued through aggressive product development and the licensing of
existing patented products or technology. These new products are expected to
have higher profit margins and be less subject to competition. There can be no
assurances that the Company will be successful in completing these critical
tasks. If the Company is unable to successfully complete these critical tasks,
it may be forced to significantly reduce, restructure or cease its operations
and/or liquidate inventory at amounts below current carrying value to generate
the necessary working capital to fund its operations, and if necessary, seek
other remedies available to the Company including protection under the
bankruptcy laws. As a result of these and other factors, the Company's previous
independent certified public accountants, BDO Seidman, LLP, indicated in their
report on the 2003 consolidated financial statements, that there is substantial
doubt about the Company's ability to continue as a going concern.
CRITICAL ACCOUNTING POLICIES
The Company prepares its consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America.
Accordingly, the Company is required to make estimates, judgments and
assumptions that the Company believes are reasonable based upon the information
available. These estimates and assumptions affect the reported amounts of assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the periods presented. The critical accounting
policies which the Company believes are the most important to aid in fully
understanding and evaluating its reported financial results include the
following:
Revenue Recognition
-------------------
The Company recognizes revenue from product sales when it is realized or
realizable and earned, which is generally at the time of shipment and passage of
title. Revenue is considered to be realized or realizable and earned when there
is persuasive evidence of a sales arrangement in the form of a contract or a
purchase order, the product has been shipped, the sales price is fixed or
determinable and collectibility is reasonably assured. The Company records
revenue for shipping costs charged to customers. The related shipping costs
incurred are recorded in cost of sales.
Inventory Valuation
-------------------
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Cost includes raw materials, labor, manufacturing overhead and purchased
products. Market is determined by comparison with recent purchases or net
realizable value. Net realizable value is based on forecasts for sales of the
Company's products in the ensuing years. Should demand for the Company's
products prove to be significantly less than anticipated, the ultimate
realizable value of the Company's inventories could be substantially less than
the amount shown on the accompanying consolidated balance sheets.
Impairment of Long-Lived Assets
-------------------------------
The Company assesses the recoverability of its long-lived and certain intangible
assets, including goodwill, by determining whether the related asset balance can
be recovered through projected undiscounted cash flows. The amount of
impairment, if any is measured based on projected discounted future cash flows
(fair value) and charged to operations in the period in which impairment is
determined by management.
Restructuring Reserve
---------------------
Upon approval of a restructuring plan by management with the appropriate level
of authority, the Company records restructuring reserves for certain costs
associated with plant closures and business reorganization activities. Such
costs are recorded as a current liability and primarily include employee
severance and contractual obligations. These costs are not associated with nor
do they benefit continuing activities. Inherent in the estimation of these costs
are assessments related to the most likely expected outcome of the significant
actions to accomplish the restructuring. Changing business conditions may affect
the assumptions related to the timing and extent of facility closure activities.
The Company reviews the status of restructuring activities on a quarterly basis
and if appropriate records changes based on updated estimates.
14
Discontinued Operations
-----------------------
In October 2003, the Company sold its wholly owned subsidiary, Advanced
Materials Ltd. ("AML-Ireland"). The condensed consolidated statements of
operations for the three and nine-month periods ended August 31, 2003 have been
restated and operating results of AML-Ireland are shown separately as
discontinued operations for that period.
RESULTS OF OPERATIONS
FY 04 CURRENT THREE MONTHS VERSUS FY 03
Net sales for the quarter ended August 31, 2004 were $2,016,298 versus
$2,587,000 for the same period of fiscal 2003, a decrease of $570,702 or 22%.
Revenues from the Singapore strategic manufacturing venture declined to $193,528
in the three-month period ended August 31, 2004 from $414,000 in the comparable
period in 2003. Revenues from U.S. operations decreased to $1,822,770 in the
third quarter of 2004 from $2,173,000 in 2003.
The lower sales for the U.S. operations are due to both lower sales prices and
lower sales volumes. The Company has continued to face increased competition and
to feel the effects of customers moving their manufacturing operations from the
United States to Asia. For the shipping cost sensitive foam commodities that the
Company has primarily sold in the past, it has been very difficult to be
competitive with the local fabricators in Asia. The Company has recently begun
to shift its primary focus to generating its own proprietary opportunities with
both its existing customer base as well as new prospects in order to build a
more competitive base of business in the United States. Management does not
expect significant sales from the new opportunities in the next 6 to 12 months.
Sales may continue to decline in the interim period as the Company refocuses its
efforts.
The lower sales in Singapore are primarily attributable to an amendment to the
Company's manufacturing agreement in Singapore with Foamex Asia ("Foamex") to
change the vendor of record for the customer supplied under the agreement from
the Company to Foamex effective July 17, 2003. Although this change does not
affect the Company's share of the profitability under the agreement, it does
cause a significant reduction in its reported revenues. Previously, the Company
purchased the raw materials for the production of product and billed the end
customer and therefore recognized the gross sales and cost of sales on its
financials. Under the amended agreement, it no longer purchases the raw
materials or bills the end customer and only recognizes its portion of profit as
revenue. Management believes this change has been beneficial to the Company as
it stills maintains a share of the profits from the Singapore agreement, while
it has significantly reduced its capital requirements since it no longer needs
to purchase raw materials several months in advance of realizing sales.
Cost of sales for the three-month periods ended August 31, 2004 and 2003 were
$1,510,925 and $2,296,000, respectively. The Company's gross profit percentage
was 25% in 2004 period, compared to 11% in the 2003 period. The increase in
gross profit percentage for the second quarter of 2004 was primarily due to the
change in the Singapore agreement noted above. The remaining improvement in the
gross profit percentage is due to the Company's discontinuing certain low margin
sales, and lower labor and overhead costs due to the optimizing of manufacturing
processes.
Selling, general and administrative expenses for the three-month periods ended
August 31, 2004 and 2003 were $401,192 and $459,000, respectively, a decrease of
$57,808 or 13%. This decrease was due primarily to a reduction in the number of
employees as the Company continues to improve individual productivity.
Interest expense for the third quarter of fiscal 2004 and 2003 was $34,451 and
$44,000, respectively. Interest expense relates primarily to bank borrowings and
is not expected to fluctuate significantly in the near future.
Net income from continuing operations for the third quarter of fiscal 2004 was
$35,561, compared to a net loss from continuing operations of $265,000 for the
third quarter of fiscal 2003. Basic and diluted income per share from continuing
operations for the second quarter of fiscal 2004 was $0.00 per share, compared
to a net loss of $0.04 per share for the second quarter of fiscal 2003.
Net loss from discontinued operations for the third quarter of 2003 was $70,000
or $.01 per share.
Net income for the third quarter of fiscal 2004 was $35,561 or $.00 per share
compared to a net loss for the third quarter of 2003 of $335,000 or $.04 per
share.
15
FY 04 CURRENT NINE MONTHS VERSUS FY 03
Net sales for the nine-month period ended August 31, 2004 were $5,856,963 versus
$12,175,000 for the same period of fiscal 2003, a decrease of $6,318,037 or 52%.
Revenues from the Singapore strategic manufacturing venture declined to $565,729
in the nine-month period ended August 31, 2004 from $4,354,000 in the comparable
period in 2003. Revenues from U.S. operations decreased to $5,291,234 in the
nine-month period ended August 31, 2004 from $7,821,000 in 2003.
The lower sales for the U.S. operations are due to both lower sales prices and
lower sales volumes. The Company has continued to face increased competition and
to feel the effects of customers moving their manufacturing operations from the
United States to Asia. For the shipping cost sensitive foam commodities that the
Company has primarily sold in the past, it has been very difficult to be
competitive with the local fabricators in Asia. The Company has recently begun
to shift its primary focus to generating its own proprietary opportunities with
both its existing customer base as well as new prospects in order to build a
more competitive base of business in the United States. Management does not
expect significant sales from the new opportunities in the next 6 to 12 months.
Sales may continue to decline in the interim period as the Company refocuses its
efforts.
The lower sales in Singapore are primarily attributable to an amendment to the
Company's manufacturing agreement in Singapore with Foamex Asia ("Foamex") to
change the vendor of record for the customer supplied under the agreement from
the Company to Foamex effective July 17, 2003. Although this change does not
affect the Company's share of the profitability under the agreement, it does
cause a significant reduction in its reported revenues. Previously, the Company
purchased the raw materials for the production of product and billed the end
customer and therefore recognized the gross sales and cost of sales on its
financials. Under the amended agreement, it no longer purchases the raw
materials or bills the end customer and only recognizes its portion of profit as
revenue. Management believes this change has been beneficial to the Company as
it stills maintains a share of the profits from the Singapore agreement, while
it has significantly reduced its capital requirements since it no longer needs
to purchase raw materials several months in advance of realizing sales.
Cost of sales for the nine-month periods ended August 31, 2004 and 2003 were
$4,661,987 and $10,980,000, respectively. The Company's gross profit percentage
was 20% in 2004 period, compared to 10% in the 2003 period. The increase in
gross profit percentage for the second quarter of 2004 was primarily due to the
change in the Singapore agreement noted above. The remaining improvement in the
gross profit percentage is due to the Company's discontinuing certain low margin
sales, and lower labor and overhead costs due to the optimizing of manufacturing
processes.
Selling, general and administrative expenses for the nine-month periods ended
August 31,2004 and 2003 were $1,085,667 and $1,178,000, respectively, a decrease
of $92,333 or 8%. Additionally, the Company recorded an impairment charge
related to fixed assets of $108,232 during the nine-month period ended August
31, 2004.
Interest expense for the nine-month periods ended May 31, 2004 and 2003 was
$82,038 and $211,000, respectively. Interest expense relates primarily to bank
borrowings and is not expected to fluctuate significantly in the near future.
The Company had previously made monthly payments aggregating approximately
$8,000 to two former employees in conjunction with a liability it had assumed in
a business combination in 1992. As of March 2003, the Company ceased making
payments to these individuals, as the Company believes it has fulfilled its
obligation. In May, 2004 the Company settled the dispute for a lump-sum payment
of $250,000. The remainder of the reserve was released and included as gain on
settlement in the accompanying condensed consolidated statement of operations
for the nine-month period ended August 31, 2004. The $250,000 was paid during
the current quarter using the proceeds of common stock issuances.
In May 2001, the Company announced the closure of its manufacturing facility in
Dallas, Texas and its distribution centers in Portland, Oregon and Parker,
Colorado. The closure of the two distribution centers was completed during the
third quarter and the closure of the Texas facility was completed by the end of
the fourth quarter of fiscal 2001. The Company closed these facilities in order
to consolidate its U.S. operations into its plant in Rancho Dominguez,
California and reduce overhead costs in response to its lower domestic sales.
During the nine-month period ended August 31, 2004, the Company reduced the
remaining restructuring reserve $84,032 due to continued use of the business
facility in Dallas. This is disclosed as a reduction to selling, general and
administrative expenses in the accompanying condensed consolidated statement of
operations.
16
Net income from continuing operations for the nine-month period ended August 31,
2004 was $682,605, compared to a net loss from continuing operations of $388,000
for the same period of fiscal 2003. Basic and diluted income per share for the
nine-month period ended August 31, 2004 was $0.07 per share, compared to a net
loss of $0.04 per share for the same period of fiscal 2003.
Net loss from discontinued operations for the nine-month period of 2003 was
$40,000 or $.01 per share.
Net income for the nine-month period ended August 31, 2004 was $682,605 or $.07
per share compared to a net loss for the same period of 2003 of $428,000 or $.04
per share. Net income for 2004 includes gain on settlement of litigation of
$974,000 and the reversal of a restructuring reserve of $84,032.
Liquidity and Capital Resources
Cash and cash equivalents were $221,475 at August 31, 2004, compared with
$81,000 at November 30, 2003. Operating activities used $146,148 of cash during
the nine-month period ending August 31, 2004, compared with cash provided by
operating activities of $1,888,000 for the same period of 2003. The cash used in
operating activities in the 2004 period resulted primarily from a decrease in
accounts receivable, inventory and prepaids and other assets offset by a
decrease in accounts payable, accrued liabilities and deferred income.
Capital expenditures were $113,931 for the nine months ended August 31, 2004,
compared to $108,000 for the corresponding period in fiscal 2003.
During the nine-month period ended August 31, 2004, the Company generated
$400,723 in cash flows from financing activities. This included $755,610 through
the issuance of common stock through sales and exercise of stock options offset
by net repayments of debt of $354,887.
In October 2003, the Company entered into a new line of credit agreement with a
financial institution, which provides for borrowings up to $3,750,000, as
defined. The line had an outstanding balance of $769,675 at August 31, 2004,
expires in October 2005 and bears interest at prime plus 1.5% (8.75% at August
31, 2004). The line of credit is secured by substantially all of the assets of
the Company. The line of credit agreement requires the Company to maintain
certain financial covenants including the maintenance of debt service and
tangible net worth ratios. At August 31, 2004, the Company was not in compliance
with these ratios and therefore is in technical default under the compliance
provisions of its bank line of credit and term loan. In order to fund present
and future operations, the Company needs to cure its covenant violations with
its lender. While the Company is in the process of attempting to cure its line
of credit and term loan violations, there can be no assurances that the Company
will be successful in completing these critical tasks. If the Company is unable
to successfully complete these critical tasks, it may be forced to significantly
reduce, restructure or cease its operations and/or liquidate inventory at
amounts below current carrying value to generate the necessary working capital
to fund its operations, and if necessary, seek other remedies available to the
Company including protection under the bankruptcy laws.
Effective March 1, 2004, the lender increased the rate of interest on the
Company's line of credit and term loan to prime plus 3%, which is the default
rate specified in the loan agreement. The default rate will remain in effect
until all of the designated defaults have been cured. In October 2005, the
Company extended the term of the line-of-credit.
In October 2003, the Company obtained a term loan in the amount of $368,000. The
term loan had an outstanding balance of $278,000 as of August 31, 2004 and
amortizes straight line over 60 months with a balloon payment due in October
2005. It bears interest at prime plus 2.0% (6.25% at August 31, 2004) and is
secured by substantially all of the assets of the Company. The loan is payable
to the same lender as the Company's line of credit, for which the Company is in
technical default under the compliance provisions and therefore has been
classified as current in the financial statements as of August 31, 2004.
On April 22, 2004, the Company's President and CEO and the Company's Chairman of
the Board each loaned $150,000 to the Company pursuant to certain promissory
notes. The notes are payable on July 21, 2004 and bear interest at 10%. Upon
certain events of default, including the nonpayment of principal, the interest
rate increases to a default rate of 12%. The Company is currently in default on
these notes but continues to make payments.
17
In conjunction with the promissory notes, the Company issued warrants to
purchase an aggregate of 100,000 shares of the Company's common stock at an
exercise price of $0.363 per share. The warrants are exercisable at any time and
expire on May 13, 2008. Upon default, the Company issued warrants to purchase an
additional 100,000 shares of the Company's common stock with the same terms.
In January 2004, the Company sold 1,219,515 shares of its common stock in a
private equity placement for $500,000. The shares were sold to parties close to
the Company, including its Chairman and its CEO, who were already major
shareholders. There was no agent for the transaction. Proceeds from the sale
were used to pay off existing vendors and for general working capital purposes.
In June 2004, the Company sold 595,239 shares to Delk Partners, Ltd., Plus 4,
and the Lenawee Trust in exchange for an aggregate of $250,000 cash. Robert Delk
is the general partner of Delk Partners, Ltd. and was a director and Chief
Executive Officer of the Company; Timothy Busch is a beneficiary of the Lenawee
Trust and a director of the Company; and Richard H. Pickup is a partner of Plus
4 and a member of a group beneficially owning more than 10% of the outstanding
shares of common stock of the Company. The proceeds were used to pay the
settlement of deferred compensation as discussed above.
FACTORS THAT COULD AFFECT FUTURE RESULTS
Banking - The Company has incurred losses from operations, has a working capital
deficit and has not been in compliance with minimum book net worth and debt
service coverage ratio covenants, and therefore is in technical default under
the compliance provisions of its bank line of credit and term loan. In order to
fund present and future operations, the Company needs to cure its covenant
violations with its lender. While the Company is in the process of attempting to
cure its line of credit violations, there are no assurance that the Company will
be successful in completing this critical task. If the Company is unable to
successfully complete this critical task, it may be forced to reduce its
operations and/or liquidate inventory at amounts below current carrying value to
generate the necessary working capital to fund its operations.
Competition - The Company encounters aggressive competition in all areas of its
business. It has numerous competitors, ranging from several comparable-size
companies to many relatively small companies. The majority of the competitors
are private, closely held companies. There is also the risk that a supplier to
the Company could become a competitor. The Company competes primarily on the
basis of performance, price, quality and customer service. Product life cycles
are short, with numerous small one-time customer orders. To remain competitive,
the Company must be able to quickly develop new products and enhance existing
products in response to customer demands. In some of its markets, the Company
may not be able to successfully compete against current and future competitors,
and the competitive pressures faced could harm the Company's business and
prospects.
New Product Introductions - If the Company cannot continue to rapidly develop
and manufacture innovative products that meet customer requirements for
performance, price, quality and customer service, it may lose market share and
future revenue and earnings may suffer. The process of developing new products
and corresponding manufacturing processes is complex and uncertain. The customer
decision-making process can be lengthy and some raw materials have extremely
long lead times. These circumstances often lead to long delays in new product
introductions. After a product is developed, the Company must be able to
manufacture sufficient volumes quickly at low enough costs. To do this it must
accurately forecast volumes and mix of products. Customer orders have also been
subject to dramatic swings from customer provided forecasts. Thus, matching
customers' demand and timing for particular products makes the process of
planning production and managing inventory levels increasingly difficult.
Short Product Life Cycles - The short life cycles of many of the Company's
products pose a challenge to the Company's ability to effectively manage the
transition from existing products to new products. If the Company does not
manage the transition effectively, future revenue and earnings could suffer.
Among the factors that make a smooth transition from current products to new
products difficult are delays in the customer decision-making process,
development of manufacturing processes, long lead times for the delivery of raw
materials and variations in product costs. The Company's future revenues and
earnings could also suffer due to the timing and introduction of new product
offerings that compete directly or indirectly with its customers' products and
new product offerings by its competitors.
18
Reliance on Suppliers - The Company's manufacturing operations depend on its
suppliers' ability to deliver quality raw materials and components in time for
the Company to meet critical manufacturing and distribution schedules. The
Company sometimes experiences a short supply of certain raw materials as a
result of supplier out-of-stock situations or long manufacturing lead times. If
shortages or delays exist, the Company's future operating results could suffer.
Furthermore, it may not be able to secure enough raw materials at reasonable
prices to manufacture new products in the quantities required to meet customer
demand. Sudden or large raw materials price increases could also cause future
operating results to suffer if the Company is not able to increase its sales
prices to account for the materials price increases.
Earthquake - The corporate offices and manufacturing division in California are
located near major earthquake faults. The ultimate impact on the Company and its
general infrastructure is unknown, but operating results could be materially
affected in the event of a major earthquake. The Company is predominantly
uninsured for losses and interruptions caused by earthquakes.
Environmental - Some of the Company's operations use substances regulated under
various federal, state and international laws governing the environment. It is
the Company's policy to apply strict standards for environmental protection to
sites inside and outside the U.S., even when not subject to local government
regulations. The Company has not been notified of any environmental infractions.
Profit Margin - The Company's profit margins vary somewhat among its products.
Consequently, the overall profitability in any given period is partially
dependent on the product and customer mix reflected in that period's net sales.
Stock Price - The Company's stock price, like that of any other small-cap
company, can be volatile. Some of the factors that can affect the stock price
are:
o The Company's, its customer's or its competitor's announcement of new or
discontinued products,
o Quarterly increases or decreases in earnings,
o Changes in revenue or earnings estimates by the investment community, and
o Speculation in the press or investment community.
General market conditions and domestic or international macroeconomic factors
unrelated to the Company's performance may also affect the stock price. For
these reasons, investors should not rely on recent trends to predict future
stock prices or financial results. In addition, following periods of volatility
in a company's securities, securities class action litigation against a company
is sometimes instituted. This type of litigation could result in substantial
costs and the diversion of management time and resources.
Earnings Fluctuations - Although management believes the Company has products
and resources needed for successful results, it cannot reliably predict future
revenue and margin trends. Actual trends may cause it to adjust its operations,
which could cause period-to-period fluctuations in earnings.
The Company's common stock traded on The Nasdaq SmallCap Stock Market ("Nasdaq")
under the symbol "ADMG" from June 23, 1993 until December 13, 2000. Effective as
December 14, 2000, the Company's common stock was delisted from Nasdaq and
traded on the NASD-regulated OTC Bulletin Board ("Bulletin Board") under the
symbol "ADMG.OB." In April 2004, the Company's common stock was delisted from
the Bulletin Board, but still trades on the OTC Pink Sheets under the symbol
"ADMG.PK."
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
A discussion of the Company's exposure to, and management of, market risk
appears in Item 2 of this Form 10-Q under the heading "Factors That Could Affect
Future Results" and in Item 7A of the Company's 2003 Annual Report on Form 10-K
for the fiscal year ended November 30, 2003. There have been no material changes
in the Company's market risks during the six months ended May 31, 2004.
19
ITEM 4 - CONTROLS AND PROCEDURES
The Company's Chief Executive Officer (the Company's principal executive officer
and principal financial officer), evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rules 13a-
15(e), and 15d to 15(e) under the Securities Exchange Act of 1934) as of
February 29, 2004 (the "Evaluation Date"). Based on this evaluation, the
Company's disclosure controls and procedures were designed to provide reasonable
assurance that information required to be disclosed by the Company in the
reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms.
Our Chief Executive Officer evaluated the effectiveness of our Internal Controls
as of the Evaluation Date and concluded that our current practices and
procedures, albeit not as mature or as formal as management intends them to be
in the future, are appropriate under the circumstances. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Because
of the inherent limitations in all control systems no evaluation of controls can
provide absolute assurance that all control issues within a company have been
detected. No significant changes were made to our internal controls or other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
In connection with BDO Seidman, LLP's audit for the year ended November 30,
2003, our Chief Executive Officer and Audit Committee were made aware of
conditions that were considered to be reportable conditions in internal controls
under standards established by the American Institute of Certified Public
Accountants. BDO Seidman identified material weaknesses in the Company's
internal controls as of fiscal year end. The deficiencies noted were (a) the
lack of technical competence of the accounting staff, (b) the lack of
segregation of duties, (c) the lack of adequate account analysis and
reconciliations, which resulted in inaccuracies in the Company's records, (d)
insufficient supervision and oversight of the Company's accounting personnel,
(e) inability to timely and accurately close the books, (f) operating without a
full-time CFO and (g) the improper or lack of accounting for and/or failure to
identify transactions. The Company believes such deficiencies were primarily
attributable to changes in personnel within the accounting department combined
with a lack of management oversight. The Company has been operating without a
full-time CFO and was forced to reduce its accounting staff during fiscal 2003
due to financial constraints. Additionally, key accounting personnel resigned
during the year leaving the Company with inexperienced staff. Management's
primary focus during the later part of fiscal year 2003 has been on the
reorganization of the Company, including restructuring its joint venture in
Singapore, obtaining new bank financing and selling its subsidiary in Ireland.
With these critical tasks behind them, management has renewed their focus on
internal controls. Management is currently pursuing the hiring of additional and
more experienced accounting staff and a full-time CFO. Additionally, they are
establishing procedures for the timely reconciliation of all accounts and
manager's review of account reconciliations.
Management has performed additional reconciliation procedures which are designed
to ensure that these internal control deficiencies do not lead to future
material misstatements in our consolidated financial statements, and to permit
the Company's auditors to complete their audits of the Company's consolidated
financial statements, notwithstanding the presence of the internal control
weaknesses noted above.
Based on the investigation by the Company's audit committee and additional
procedures performed by management, the Company has concluded that, except as
noted above, and subject to the inherent limitations in all control systems, the
Company's current disclosure controls and procedures are sufficient to timely
alert them to material information relating to the Company that is required to
be included in our periodic Securities and Exchange Committee filings, and that
the internal controls are sufficient to provide reasonable assurance that the
financial statements are fairly presented in conformity with generally accepted
accounting principles.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company had previously made monthly payments aggregating approximately
$8,000 to two former employees in conjunction with a liability it had assumed in
a business combination in 1992. As of March 2003, the Company ceased making
payments to these individuals, as the Company believes it has fulfilled its
obligation. The Company is currently in litigation with the parties involved
regarding its obligations per the underlying agreement. As of February 29, 2004,
the Company had a reserve for retirement benefits to former employees of
$1,224,000. This legal proceeding was settled on May 27, 2004 with an agreement
for the Company to pay cash proceeds in the amount of $250,000.00. Please see
referenced 8K issued concerning this matter.
On or about December 14, 2004, the Company received a letter from the Inland
Revenue Authority of Singapore ("IRAS") stating that the IRAS believed that
through its relationship with Foamtec (Singapore) Pte Ltd. ("Foamtec") the
Company had a permanent establishment in Singapore and, thus its share of
profits from its arrangement with Foamtec in Singapore was "liable to tax in
Singapore." The IRAS has not provided specific information regarding, nor can
the Company make any specific judgments or determinations as to, a variety of
matters relating to, among other things, the type of tax which the IRAS is
claiming (income tax and/or royalty/withholding tax), the amount, if any, of
credits, exemptions and/or deductions which would be appropriate with respect to
any such tax calculation, the method by which any tax would be calculated, the
amount of any tax and whether would be due from the Company or Foamtec. Without
specific information from IRAS relative to, among whether a tax is due, and if
so, the amount of such tax. Moreover, without any specific information from IRAS
regarding the nature of the IRAS allegations and the answers to, among other
things, the issues referred to above, the Company is not in a position to
determines whether a tax is due and what period, if any, the tax would relate
to.
The Company disagrees with the claims by the IRAS that a tax is due and intends
to aggressively contest the matter should the IRAS make a specific claim for a
tax. Based upon the foregoing, and the fact that a final resolution of any
proposed tax is uncertain and would, in the Company's belief involve unsettled
areas of the law, based upon currently available information, the Company is
unable to provide an estimate or a range of estimates as to the probable tax
liability for this matter.An unfavorable resolution, depending upon the amount
of tax claimed by IRAS, could have a material effect on the Company's result of
operations or cash flows in the periods in which an adjustment is recorded or
the tax is due or paid.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
In January 2004, the Company sold approximately 1,220,000 shares of its common
stock in a private equity placement for $500,000. Proceeds from the sale were
used to pay off existing vendors and for general working capital purposes.
In June 2004, the Company sold 595,239 shares to Delk Partners, Ltd., Plus 4,
and the Lenawee Trust in exchange for an aggregate of $250,000 cash. Robert Delk
is the general partner of Delk Partners, Ltd. and was a director and Chief
Executive Officer of the Company; Timothy Busch is a beneficiary of the Lenawee
Trust and a director of the Company; and Richard H. Pickup is a partner of Plus
4 and a member of a group beneficially owning more than 10% of the outstanding
shares of common stock of the Company. The proceeds were used to pay the
settlement of deferred compensation.
These sales were made pursuant to the exemptions from registration provided by
Regulation D and/or Section 4(2) of the Securities Act of 1933, as amended.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
In October 2003, the Company entered into a new line of credit agreement with a
financial institution, which provides for borrowings up to $3,750,000, as
defined. The line had an outstanding balance of $769,675 at August 31, 2004,
expires in October 2005 and bears interest at prime plus 1.5% (8.75% at August
31, 2004). The line of credit is secured by substantially all of the assets of
the Company. The line of credit agreement requires the Company to maintain
certain financial covenants including the maintenance of debt service and
tangible net worth ratios. At August 31, 2004, the Company was not in compliance
21
with these ratios and therefore is in technical default under the compliance
provisions of its bank line of credit and term loan. In order to fund present
and future operations, the Company needs to cure its covenant violations with
its lender. While the Company is in the process of attempting to cure its line
of credit and term loan violations, there can be no assurances that the Company
will be successful in completing these critical tasks. If the Company is unable
to successfully complete these critical tasks, it may be forced to significantly
reduce, restructure or cease its operations and/or liquidate inventory at
amounts below current carrying value to generate the necessary working capital
to fund its operations, and if necessary, seek other remedies available to the
Company including protection under the bankruptcy laws.
Effective March 1, 2004, the lender increased the rate of interest on the
Company's line of credit and term loan to prime plus 3%, which is the default
rate specified in the loan agreement. The default rate will remain in effect
until all of the designated defaults have been cured. In October 2005, the
Company extended the term of the line-of-credit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
NONE
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS
(a) Exhibits.
EXHIBIT NO. DESCRIPTION
----------- -----------------------------------------------------------
31.1 Certifications Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of President and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
Pursuant to the requirements 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.
Dated: May 5, 2006 ADVANCED MATERIALS GROUP, INC.
By: /s/ William G. Mortensen
------------------------
William G. Mortensen
President and CFO
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