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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 SEPTEMBER 30, 2003
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: 0-21802
N-VIRO INTERNATIONAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 34-1741211
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
3450 W. CENTRAL AVENUE, SUITE 328
TOLEDO, OHIO 43606
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (419) 535-6374
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 the
filing requirements for at least the past 90 days. Yes X No.
---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12-2). Yes No X
---
As of November 30, 2003, 2,582,333 shares of N-Viro International
Corporation $ .01 par value common stock were outstanding.
PART I - FINANCIAL INFORMATION
N-VIRO INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Sept. 30 Nine Months Ended Sept. 30
2003 2002 (As Restated) 2003 2002 (As Restated)
----------- ------------------- ----------- -------------------
Revenues . . . . . . . . . . . . . . . $1,408,921 $ 1,503,466 $4,062,312 $ 4,197,469
Cost of revenues . . . . . . . . . . . 1,017,389 897,218 2,992,748 2,723,272
----------- ------------------- ----------- -------------------
Gross Profit . . . . . . . . . . . . . 391,532 606,248 1,069,564 1,474,197
Operating expenses:
Selling, general and administrative. . 577,577 454,421 1,672,644 1,436,289
Litigation settlement expense. . . . . 43,900 - 43,900 545
----------- ------------------- ----------- -------------------
621,477 454,421 1,716,544 1,436,834
----------- ------------------- ----------- -------------------
Operating income (loss). . . . . . . . (229,945) 151,827 (646,980) 37,363
Nonoperating income (expense):
Interest and dividend income . . . . . 358 17,671 2,754 33,011
Interest expense . . . . . . . . . . . (35,259) (5,633) (129,881) (25,278)
Loss on sale of assets . . . . . . . . (8,236) - (8,236) -
Income (loss) from equity
investment in joint venture. (15,798) (39,889) (28,621) 12,373
----------- ------------------- ----------- -------------------
(58,935) (27,851) (163,984) 20,106
----------- ------------------- ----------- -------------------
Income (loss) before income taxes. . . (288,880) 123,976 (810,964) 57,469
Federal and state income taxes . . . . - - - -
----------- ------------------- ----------- -------------------
Net income (loss). . . . . . . . . . . $ (288,880) $ 123,976 $ (810,964) $ 57,469
=========== =================== =========== ===================
Basic and diluted
earnings (loss) per share. . . . . $ (0.11) $ 0.05 $ (0.31) $ 0.02
=========== =================== =========== ===================
Weighted average common
shares outstanding . . . . . . . . 2,577,433 2,577,433 2,577,433 2,577,433
=========== =================== =========== ===================
See Notes to Consolidated Financial Statements
N-VIRO INTERNATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, 2003 December 31, 2002
(Unaudited) (As Restated)
ASSETS
CURRENT ASSETS
Cash and cash equivalents:
Unrestricted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32,078 $ 4,935
Restricted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 400,000
Receivables:
Trade, net of allowance of $40,000 in 2003 and 2002 . . . . . . . . . . . . . 1,154,529 874,421
Notes and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 16,358
Prepaid expenses and other assets . . . . . . . . . . . . . . . . . . . . . . 151,204 137,257
Inventory - stated at lower of cost or market . . . . . . . . . . . . . . . . 99,747 117,440
------------- -------------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,437,558 1,550,411
Property and Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . 493,455 559,095
Investment in Florida N-Viro, L.P.. . . . . . . . . . . . . . . . . . . . . . 461,962 490,583
Non-Compete Agreement, less current portion . . . . . . . . . . . . . . . . . 305,298 -
Intangible and Other Assets . . . . . . . . . . . . . . . . . . . . . . . . . 1,573,976 1,641,990
------------- -------------
$ 4,272,249 $ 4,242,079
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt. . . . . . . . . . . . . . . . . . . . . $ 251,991 $ 392,078
Line-of-credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 418,223 656,087
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,761,292 978,691
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 473,080 370,251
------------- -------------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 2,904,586 2,397,107
Long-term debt, less current maturities . . . . . . . . . . . . . . . . . . . 425,096 426,738
Non-Compete Agreement, less current portion . . . . . . . . . . . . . . . . . 305,298 -
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; authorized 7,000,000 shares; issued
2,700,933 shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,010 27,010
Preferred stock, $.01 par value; authorized 2,000,000 shares; issued 1 share. - -
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . . . . . . 13,525,602 13,495,602
Retained earnings (deficit) . . . . . . . . . . . . . . . . . . . . . . . . . (12,230,453) (11,419,488)
------------- -------------
1,322,159 2,103,124
Less treasury stock, at cost, 123,500 shares. . . . . . . . . . . . . . . . . 684,890 684,890
------------- -------------
Total stockholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . 637,269 1,418,234
------------- -------------
$ 4,272,249 $ 4,242,079
============= =============
See Notes to Consolidated Financial Statements
N-VIRO INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended Sept. 30
2003 2002 (As Restated)
---------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,728 $ 186,549
CASH FLOWS FROM INVESTING ACTIVITIES
Collections on notes receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,358 16,391
Collections on related party receivables. . . . . . . . . . . . . . . . . . . . . . . . . . . . - 145
Purchases of property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (15,277) (23,527)
Sales of property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,692 -
Expenditures for intangible assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (36,930) (81,674)
---------- ----------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (27,157) (88,665)
CASH FLOWS FROM FINANCING ACTIVITIES
Reductions to restricted cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . 400,000 -
Net borrowings (payments) on line-of credit . . . . . . . . . . . . . . . . . . . . . . . . . . (237,864) 146,387
Borrowings under long-term obligations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 336,003 71,811
Principal payments on long-term obligations . . . . . . . . . . . . . . . . . . . . . . . . . . (472,567) (302,383)
---------- ----------
Net cash provided (used) by financing activities. . . . . . . . . . . . . . . . . . . . . . . . 25,572 (84,185)
NET INCREASE IN CASH AND CASH EQUIVALENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,143 13,699
AND CASH EQUIVALENTS - BEGINNING . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . 4,935 45,427
---------- ----------
CASH AND CASH EQUIVALENTS - ENDING. . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . $ 32,078 $ 59,126
========== ==========
Supplemental disclosure of cash flows information:
Cash paid during the nine months ended for interest . . . . . . . . . . . . . . . .. . . . . . . $ 77,857 $ 32,431
========== ==========
During the nine months ended September 30, 2003, the Company issued
stock warrants with a fair value of $30,000 as part of debt refinancing.
During the nine months ended September 30, 2003, the Company purchased
a truck with a fair value of $44,000, for $10,000 cash and sale of product at retail for the balance.
During the nine months ended September 30, 2003, the Company recorded an asset and a liability,
each for $353,298, to recognize the value of the non-compete agreement with its former CEO.
See Notes to Consolidated Financial Statements
N-VIRO INTERNATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. ORGANIZATION AND BASIS OF PRESENTATION
The accompanying consolidated financial statements of N-Viro International
Corporation (the "Company") are unaudited but, in management's opinion, reflect
all adjustments (including normal recurring accruals) necessary to present
fairly such information for the period and at the dates indicated. The results
of operations for the nine months ended September 30, 2003 may not be indicative
of the results of operations for the year ended December 31, 2003. Since the
accompanying consolidated financial statements have been prepared in accordance
with Article 10 of Regulation S-X, they do not contain all information and
footnotes normally contained in annual consolidated financial statements;
accordingly, they should be read in conjunction with the consolidated financial
statements and notes thereto appearing in the Company's Form 10-K for the period
ending December 31, 2002.
The financial statements are consolidated as of September 30, 2003 and
December 31, 2002 for the Company. Adjustments have been made to eliminate all
intercompany transactions.
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
following are certain significant estimates and assumptions made in preparation
of the financial statements:
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has in the past and
continues to sustain net and operating losses. In addition, the Company has
used substantial amounts of working capital in its operations which has reduced
the Company's liquidity to a low level. These matters raise substantial doubt
about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded assets or the amounts and classification of
liabilities that may result from the outcome of these uncertainties.
Non-domestic license and territory fees - The Company does not recognize
revenue on any non-domestic license or territory fee contracts until the cash is
received, assuming all other tests of revenue recognition are met. Canada is
excluded from this definition of non-domestic.
Allowance for Doubtful Accounts - The Company estimates losses for
uncollectible accounts based on the aging of the accounts receivable and the
evaluation of the likelihood of success in collecting the receivable.
Property and Equipment/Long-Lived Assets - Property and equipment is
reviewed for impairment pursuant to the provisions of SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." The carrying amount of an
asset (group) is considered impaired if it exceeds the sum of our estimate of
the undiscounted future cash flows expected to result from the use and eventual
disposition of the asset (group), excluding interest charges.
Equity Method Investment - The Company accounts for its investments in
joint ventures under the equity method. The Company periodically evaluates the
recoverability of its equity investments in accordance with APB No. 18, "The
Equity Method of Accounting for Investments in Common Stock." If circumstances
were to arise where a loss would be considered other than temporary, the Company
would record a write-down of excess investment cost. Management has determined
that no write-down was required at September 30, 2003.
Intangible Assets - Intangible assets deemed to have indefinite lives are
tested for impairment by comparing the fair value with its carrying value.
Significant estimates used in the determination of fair value include estimates
of future cash flows. As required under current accounting standards, the
Company tests for impairment when events and circumstances indicate that the
assets might be impaired and the carrying value of those assets may not be
recoverable.
Fair Value of Financial Instruments - The carrying amounts of cash and cash
equivalents, receivables, accounts payable and accrued liabilities approximate
their fair values because of the short-term nature of these instruments.
Management believes the carrying amounts of the current and long-term debt
approximate their fair value based on interest rates for the same or similar
debt offered to the Company having the same or similar terms and maturities.
Income Taxes - The Company assumes the deductibility of certain costs in
income tax filings and estimates the recovery of deferred income tax assets.
Preferred Stock - The Company has authorized, issued and outstanding one
share of Series A Redeemable Preferred Stock (the "Preferred Stock"). The holder
of the Preferred Stock is Mr. J. Patrick Nicholson, the former Chief Executive
Officer and Chairman of the Board. The Preferred Stock is non-transferable. The
holder of the Preferred Stock has the right to elect one member to the Board.
Furthermore, the Preferred Stock has a term equal to ten years, and such stock
is subject to re-purchase by the Company for a nominal sum if Mr. Nicholson
ceases to control at least 17.5% of the aggregate number of shares of the
Company's voting, common stock issued and outstanding. The Preferred Stock has
no voting rights, but has the special right, voting separately as a single
class, to nominate and elect one member of the Board of Directors of the
Corporation at the 2003 annual meeting of the shareholders of the Corporation
and to nominate and elect his or her successor at each succeeding annual meeting
of the shareholders of the Corporation thereafter at which such successor is to
be elected. The Preferred Stock is not convertible or exchangeable for any other
securities or property of the Company and has no liquidation preference. The
Company has filed a Form 8-K on August 29, 2003, which included a copy of the
Certificate of Designation of the Series A Redeemable Preferred Stock as Exhibit
C to the filing.
Stock Options - The Company accounts for stock-based compensation issued to
its employees and directors in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no
compensation cost has been recognized for the stock option plans, as all options
granted under the plans have an exercise price equal to the market value of the
underlying common stock on the date of the grant. The fair value of options
granted was determined using the Black-Scholes option pricing model.
The following table illustrates the effect on net income (loss) and net
income (loss) per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock-based Compensation"
to stock-based employee compensation. The figures for 2002 take into account
the adjustments described in Footnote 8:
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
----------------------------- ----------------------------
2003 2002 (as restated) 2003 2002 (as restated)
---- ------------------ ---- ------------------
Net income (loss), as reported. . . . . . . $(288,880) $123,976 $(810,964) $ 57,469
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects . . . . . . . (18,621) (65,287) (57,536) (195,861)
---------- --------- ---------- ----------
Pro forma net income (loss) . . . . . . . . $(307,501) $ 58,689 $(868,500) $(138,392)
========== ========= ========== ==========
Income (loss) per share:
Basic and diluted - as reported . . . . . . $ (0.11) $ 0.05 $ (0.31) $ 0.02
========== ========= ========== ==========
Basic and diluted - pro-forma . . . . . . . $ (0.12) $ 0.02 $ (0.34) $ (0.05)
========== ========= ========== ==========
2. RELATED PARTY TRANSACTIONS
The Company has an unsecured receivable from a related party, N-Viro Energy
Systems, Inc., a corporation of which Mr. J. Patrick Nicholson is the
controlling stockholder, of $24,606 at September 30, 2003. The amount due from
the related party has been deemed to be noncurrent by management in the
accompanying balance sheets. No additional advances were made to the related
party during the nine months ended September 30, 2003. This debt is scheduled
to be repaid per the terms of a Settlement Agreement involving Mr. Nicholson
signed August 28, 2003. See Part II, Item 1 "Legal Proceedings" in this filing
for further discussion of this Settlement Agreement.
3. LONG-TERM DEBT
In February 2003 the Company closed on an $845,000 credit facility with a
local bank. This senior debt credit facility is comprised of a $295,000 four
year term note at 7.5% and a line of credit up to $550,000 at Prime plus 1.5%
and secured by a first lien on all assets of the Company. The Company used the
funds to refinance its prior debt and to provide working capital. Previously,
the Company had a $750,000 line of credit with another financial institution,
secured by a $400,000 restricted Certificate of Deposit, required and held by
this financial institution. Effectively, the former line of credit provided
only $350,000 of additional working capital. The effective increase in the line
provides the Company with additional working capital, and the debt refinance
provides lower cost and longer term debt, improving cash flow. To secure the
credit facility, the Company was required by the financial institution to obtain
additional collateral of $100,000 (the "Additional Collateral") from a real
estate mortgage from a third party. Messrs. J. Patrick Nicholson, the former
Chairman of the Board and Consultant to the Company; Michael G. Nicholson, the
Company's Chief Operating Officer and a Director; Robert F. Nicholson, a Company
employee, and Timothy J. Nicholson, a Company employee, ("the Nicholsons")
collectively provided the $100,000 Additional Collateral. In exchange for their
commitment, the Company has agreed to provide the Nicholsons the following: (1)
an annual fee in an amount equal to $2,000 per annum; (2) interest at an annual
rate of 5% of the $100,000 value of the Additional Collateral beginning on the
first anniversary date of the closing of the credit facility, and (3) a warrant
to acquire in the aggregate, 50,000 shares of the Company's voting common stock
at a purchase price of $0.90 per share, which was the closing market price of
the Company's common stock on the prior business day to the closing of the
Credit Facility. The warrant is exercisable, in whole or in part, at any time
and from time to time until February, 2006. In addition, the Company granted to
the Nicholsons a lien upon the Company's inventory and accounts receivable.
This lien is subordinated to both existing liens on the Company's assets and all
liens granted by the Company in favor of the financial institution providing the
Credit Facility. The value of the warrants is estimated to be $30,000 based
upon a calculation using the Black-Scholes pricing model. In estimating the
value of the warrants, the following assumptions were used: no assumed dividend
rate; risk-free interest rate of 2.05% on expected life of 3 years; and expected
price volatility of 108%. The fair value is being amortized over the 4-year
life of the guarantee. The warrants are exercisable during the period from
February 26, 2003 to February 28, 2006.
The Company was in violation of financial covenants governing the credit
facility, concerning the maintenance of both a tangible net worth amount and
positive debt service coverage ratio for the period, of which requires positive
earnings. The Company's bank (the "Bank") waived this violation in light of the
Company's net loss for the nine months ended September 30, 2003, but required
additional consideration in exchange for this waiver. The Company obtained a
certificate of deposit in the amount of $75,000 with the Bank, and transferred
custodianship of its treasury stock to the Bank. At September 30, 2003, the
Company had $131,777 of borrowing capacity under the Credit Facility.
4. CONTINGENCIES
The Company leases its executive and administrative offices in Toledo,
Ohio. The Company believes its relationship with its lessor is satisfactory.
The total minimum annual rental commitment through 2006 is approximately $56,000
each year. The total rental expense included in the statements of operations
for the nine months ended September 30, 2003 and 2002 is approximately $42,000
and $46,800, respectively. The Company also leases various equipment on a
month-to-month basis.
During 1999, the Company entered into employment and consulting agreements
with an officer of the Company, Dr. Terry J. Logan. The employment agreement
will expire in June 2004. Future compensation amounts are to be determined
annually by the Board. The consulting agreement begins upon termination of the
employment agreement and extends through July 2014, respectively. The agreement
requires Dr. Logan to provide minimum future services to be eligible for
compensation.
In the third quarter of 2003, the Company entered into an employment with
another officer of the Company, Michael G. Nicholson. The employment agreement
will expire in June 2007. Future compensation amounts are to be determined
annually by the Board. The agreement was disclosed in a filing on June 10, 2003
on Form 8-K.
During 1999, the Company entered into employment and consulting agreements
with its former Chief Executive Officer and Chairman of the Board, J. Patrick
Nicholson. The employment agreement expired in July 2002, at which point the
consulting agreement became effective. The agreements provided for payment of
life insurance premiums and the provision of health insurance coverage to Mr.
Nicholson and his spouse for their lives. The present value of estimated costs
related to the provisions of this agreement totalled approximately $101,700 at
September 30, 2003. The cost was recognized over the term of the employment
agreement. The Company charged approximately $4,100 in cash payments against the
liability for the nine months ended September 30, 2003, but also reduced the
liability in the third quarter of 2003 by approximately $35,600 to reflect the
revised requirements of a new consulting agreement entered into in August, 2003.
In August 2003, the Company entered into a Settlement Agreement with Mr.
Nicholson and negotiated a new consulting agreement. The new consulting
agreement will expire in August 2008, and Mr. Nicholson will be required to
provide future services to be eligible for compensation. Mr. Nicholson is also
entitled to payments for non-competition and office space reimbursement, in
addition to life and health insurance coverage similar to the provision
contained in his 1999 employment and consulting agreements previously discussed.
The net present value of the total payments due on the non-compete portion of
this new consulting agreement totals approximately $353,000, and has been
recorded both as a liability and as an intangible asset on the balance sheet of
the Company to reflect the total value of the non-compete portion of the
agreement. The details of this new agreement were disclosed in a filing on
August 29, 2003 on Form 8-K.
5. NEW ACCOUNTING STANDARDS
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which is effective the first quarter of fiscal year
2003. SFAS 143 addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement cost.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-lived Assets," which was adopted by the Company
in 2002. SFAS No. 144 supercedes SFAS No. 121 and modifies and expands the
financial accounting and reporting for the impairment or disposal of long-lived
assets other than goodwill.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Provisions of SFAS No. 145 become effective in 2002 and 2003.
Under SFAS No. 145, gains and losses from the extinguishment of debt should be
classified as extraordinary items only if they meet the criteria of Accounting
Principles Board Opinion No. 30. SFAS No. 145 also addresses financial
accounting and reporting for capital leases that are modified in such a way as
to give rise to a new agreement classified as an operating lease.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which is effective for exit or
disposal activities initiated after December 31, 2002. SFAS No. 146 nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." Under SFAS No. 146, a liability is
required to be recognized for costs, including certain lease termination costs
and employee termination benefits, associated with an exit or disposal activity
when the liability is incurred. SFAS No. 146 applies to costs associated with an
exit activity that does not involve an entity newly acquired in a business
combination or with a retirement or disposal activity covered by SFAS Nos. 143
and 144.
In November 2002, the FASB issued FIN 45, which expands previously issued
accounting guidance and disclosure requirements for certain guarantees. FIN 45
requires the recognition of an initial liability for the fair value of an
obligation assumed by issuing a guarantee. The provision for initial recognition
and measurement of the liability will be applied on a prospective basis to
guarantees issued or modified after December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based, Compensation - Transition and Disclosure," that amends SFAS No.
123, "Accounting for Stock-Based Compensation," to provide alternative methods
of transition to the fair value method of accounting for stock-based employee
compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123
and APB Opinion No. 28, "Interim Financial Reporting," to require disclosure in
the summary of significant accounting policies of the effects of an entity's
accounting policy with respect to stock-based employee compensation on reported
net income and earnings per share in annual and interim financial statements.
The Statement does not amend SFAS No. 123 to require companies to account for
employee stock options using the fair value method.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. The Company does not expect the application of the provisions of SFAS No.
149 to have a material impact on its financial position, results of operations
or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The Company does not expect
the application of the provisions of SFAS No. 150 to have a material impact on
its financials position, results of operations or cash flows.
The adoption of the new standards did not, or is not expected to,
materially affect the Company's financial position and results of operations.
6. SEGMENT INFORMATION
EARNINGS VARIATION DUE TO BUSINESS CYCLES AND SEASONAL FACTORS. The
Company's operating results can experience quarterly or annual variations due to
business cycles, seasonality and other factors. The market price for its common
stock may decrease if its operating results do not meet the expectations of the
market.
For the third quarter of 2003, approximately 39% of the Company's revenue
is from management operations, 58% from other domestic operations, 2% from
research and development grants and the remaining 1% from foreign operations.
Sales of the N-Viro technology are affected by general fluctuations in the
business cycles in the United States and worldwide, instability of economic
conditions (such as the current conditions in the Asia Pacific region and Latin
America) and interest rates, as well as other factors. In addition, operating
results of some of the Company's business segments are influenced by particular
business cycles and seasonality, as well as other factors such as interest
rates.
COMPETITION. The Company does business in a highly competitive market and
has fewer resources than most of its competitors. Businesses in this market
compete within and outside the United States principally on the basis of price,
product quality, custom design, technical support, reputation, equipment
financing assistance and reliability. Competitive pressures and other factors
could cause the Company to lose market share or could result in decreases in
prices, either of which could have a material adverse effect on its financial
position and results of operations.
RISKS OF DOING BUSINESS IN OTHER COUNTRIES. The Company conducts business
in markets outside the United States, and expects to continue to do so. In
addition to the risk of currency fluctuations, the risks associated with
conducting business outside the United States include: social, political and
economic instability; slower payment of invoices; underdeveloped infrastructure;
underdeveloped legal systems; and nationalization. The Company has not entered
into any currency swap agreements which may reduce these risks. The Company may
enter into such agreements in the future if it is deemed necessary to do so.
Current economic and political conditions in the Asia Pacific and Middle East
regions have affected the Company outlook for potential revenue there. The
Company cannot predict the full impact of this economic instability, but it
could have a material adverse effect on revenues and profits.
The Company has determined that its reportable segments are those that are
based on the Company's method of internal reporting, which segregates its
business by product category and service lines. The Company's reportable
segments are as follows:
Management Operations - The Company provides employee and management
services to operate the Toledo Wastewater Treatment Facility.
Other Domestic Operations - Sales of territory or site licenses and
royalty fees to use N-Viro technology in the United States.
Foreign Operations - Sale of territory or site licenses and royalty
fees to use N-Viro technology in foreign operations.
Research and Development - The Company contracts with Federal and
State agencies to perform or assist in research and development on the Company's
technology.
The accounting policies of the segments are the same as the Company's
significant accounting policies. Fixed assets generating specific revenue are
identified with their respective segments and are accounted for as such in the
internal accounting records. All other assets, including cash and other current
assets and all long-term assets, other than fixed assets, are not identified
with any segments, but rather the Company's administrative functions. The
Company allocates a total of approximately 8% of its labor cost contained in
selling, general, and administrative expenses to the segments, to reflect the
indirect cost of maintaining these segments. All of the net nonoperating income
(expense) are non-apportionable and not allocated to a specific segment. The
Company accounts for and analyzes the operating data for its segments generally
by geographic location, with the exception of the Management Operations and
Research and Development segments. These segments represent both a significant
amount of business generated as well as a specific location and unique type of
revenue.
The domestic and foreign operations segments differ in terms of
environmental and municipal legal issues, nature of the waste disposal
infrastructure, political climate and availability of funds for investing in the
Company's technology. These factors have not changed significantly over the
past several years and are not expected to change in the near term.
The Research and Development segment accounts for approximately 2% of the
total year-to-date revenue of the Company, and is unlike any other revenue in
that it is generated as a result of a specific project to conduct initial or
additional ongoing research into the Company's emerging technologies.
The table below presents information about the segment profits and segment
identifiable assets used by the chief operating decision makers of the Company
for the periods ended September 30, 2003 and 2002 (dollars in thousands):
Other
Management Domestic Foreign Research &
Operations Operations Operations Development Total
----------- ----------- ----------- ------------ ------
Quarter Ended September 30, 2003
Revenues . . . . . . . . . . . . . . . . . . . . . $ 558 $ 815 $ 13 $ 23 $1,409
Cost of revenues . . . . . . . . . . . . . . . . . 367 631 - 19 1,017
Segment profits. . . . . . . . . . . . . . . . . . 191 184 13 4 392
Identifiable assets. . . . . . . . . . . . . . . . 379 88 - - 467
Depreciation . . . . . . . . . . . . . . . . . . . 16 11 - - 27
Quarter Ended September 30, 2002 (as restated)
Revenues . . . . . . . . . . . . . . . . . . . . . $ 705 $ 718 $ 13 $ 68 $1,504
Cost of revenues . . . . . . . . . . . . . . . . . 403 484 1 10 898
Segment profits. . . . . . . . . . . . . . . . . . 302 234 12 58 606
Identifiable assets. . . . . . . . . . . . . . . . 354 75 - 46 475
Depreciation . . . . . . . . . . . . . . . . . . . 11 10 - 2 23
Nine Months Ended September 30, 2003
Revenues . . . . . . . . . . . . . . . . . . . . . $ 1,565 $ 2,390 $ 38 $ 69 $4,062
Cost of revenues . . . . . . . . . . . . . . . . . 1,082 1,847 - 63 2,992
Segment profits. . . . . . . . . . . . . . . . . . 483 543 38 6 1,070
Identifiable assets. . . . . . . . . . . . . . . . 379 88 - - 467
Depreciation . . . . . . . . . . . . . . . . . . . 47 32 - - 79
Nine Months Ended September 30, 2002 (as restated)
Revenues . . . . . . . . . . . . . . . . . . . . . $ 1,846 $ 2,084 $ 38 $ 230 $4,198
Cost of revenues . . . . . . . . . . . . . . . . . 1,147 1,454 2 121 2,724
Segment profits. . . . . . . . . . . . . . . . . . 699 630 36 109 1,474
Identifiable assets. . . . . . . . . . . . . . . . 354 75 - 46 475
Depreciation . . . . . . . . . . . . . . . . . . . 32 30 - 6 68
A reconciliation of total segment revenues, cost of revenues, and segment
profits to consolidated revenues, cost of revenues, and segment information to
the consolidated financial statements for the periods ended September 30, 2003
and 2002 is as follows (dollars in thousands):
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
----------------------------- ----------------------------
2003 2002 (as restated) 2003 2002 (as restated)
------- ------------------- -------- -------------------
Segment profits:
Segment profits for reportable segments. . . . $ 392 $ 606 $ 1,070 $ 1,474
Corporate selling, general and administrative
expenses and research and development costs. . (621) (454) (1,717) (1,437)
Other income (expense) . . . . . . . . . . . . (59) (28) (164) 20
------- ------------------- -------- -------------------
Consolidated earnings before taxes . . . . . . $ (288) $ 124 $ (811) $ 57
======= =================== ======== ===================
Identifiable assets:
Identifiable assets for reportable segments. . $ 467 $ 475 $ 467 $ 475
Corporate property and equipment . . . . . . . 26 116 26 116
Current assets not allocated to segments . . . 1,438 1,418 1,438 1,418
Intangible and other assets not allocated to
segments . . . . . . . . . . . . . . . . . . . 2,575 2,493 2,575 2,493
Consolidated eliminations. . . . . . . . . . . (234) (234) (234) (234)
------- ------------------- -------- -------------------
Consolidated assets. . . . . . . . . . . . . . $4,272 $ 4,268 $ 4,272 $ 4,268
======= =================== ======== ===================
Depreciation and amortization:
Depreciation for reportable segments . . . . . $ 27 $ 23 $ 79 $ 68
Corporate depreciation and amortization. . . . 35 41 119 105
------- ------------------- -------- -------------------
Consolidated depreciation and amortization . . $ 62 $ 64 $ 198 $ 173
======= =================== ======== ===================
7. INVESTMENT IN FLORIDA N-VIRO, L. P.
Florida N-Viro, L.P. was formed in January 1996 pursuant to a joint venture
agreement between the Company and VFL Technology Corporation. The Company owns
a 47.5% interest in the joint venture.
Condensed financial information of the partnership for the quarters ended
September 30, 2003 and 2002 is as follows:
For the Quarter Ended For the Nine Months Ended
September 30 September 30
------------ ------------
2003 2002 2003 2002
Net sales . . . . . . . . . . . . . . . . . . . . $456,225 $599,640 $1,965,000 $2,428,260
Gross profit. . . . . . . . . . . . . . . . . . . 22,940 (4,824) 114,224 225,066
Income (loss) from continuing
operations. (33,258) (83,975) (60,255) 26,051
Net income (loss) . . . . . . . . . . . . . . . . (33,258) (83,975) (60,255) 26,051
8. PRIOR PERIOD ADJUSTMENT
During the third quarter of 2003, the Company determined it had underbilled
a customer for certain services which resulted in an understatement of revenue
totaling approximately $214,000 and gross profit of approximately $194,000 over
a two and one-half year period beginning in the third quarter of 2000 and ending
in the fourth quarter of 2002. As a result, the Company has restated its
previously issued financial statements included herein and has recorded a prior
period adjustment to reduce, by $110,000, its accumulated deficit as of December
31, 2001. The Company previously reported net income of $106,000, or $0.04 per
share, and $4,000, or $0.00 per share, for the three and nine month periods
ended September 30, 2002, respectively. The restatements resulted in the
Company reporting net income of $124,000, or $0.05 per share, and $57,000, or
$0.02 per share, for the three and nine month periods ended September 30, 2002,
respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company was incorporated in April, 1993, and became a public company on
October 12, 1993. The Company's business strategy is to market the N-Viro
Process, which produces an "exceptional quality" sludge product as defined in
the Section 503 Sludge Regulations under the Clean Water Act of 1987, with
multiple commercial uses. To date, the Company's revenues primarily have been
derived from the licensing of the N-Viro Process to treat and recycle wastewater
sludge generated by municipal wastewater treatment plants and from the sale to
licensees of the alkaline admixture used in the N-Viro Process. The Company has
also operated N-Viro facilities for third parties on a start-up basis and
currently operates one N-Viro facility on a contract management basis.
During the third quarter of 2003, the Company determined it had underbilled
a customer for certain services which resulted in an understatement of revenue
totaling approximately $214,000 and gross profit of approximately $194,000 over
a two and one-half year period beginning in the third quarter of 2000 and ending
in the fourth quarter of 2002. As a result, the Company has restated its
previously issued financial statements included herein and has recorded a prior
period adjustment to reduce, by $110,000, its accumulated deficit as of December
31, 2001. The Company previously reported net income of $106,000, or $0.04 per
share, and $4,000, or $0.00 per share, for the three and nine month periods
ended September 30, 2002, respectively. The restatements resulted in the
Company reporting net income of $124,000, or $0.05 per share, and $57,000, or
$0.02 per share, for the three and nine month periods ended September 30, 2002,
respectively.
Total revenues were approximately $1,409,000 for the quarter ended
September 30, 2003 compared to approximately $1,503,000 for the same period of
2002. The net decrease in revenue is due primarily to a decrease in facility
management revenue. The Company's cost of revenues increased to approximately
$1,017,000 in 2003 from approximately $897,000 for the same period in 2002, and
the gross profit percentage decreased to 28% from 40% for the quarters ended
September 30, 2003 and 2002, respectively. The decrease in gross profit
percentage was primarily the result of an increase in costs on purchasing the
alkaline admixture used in the process. Operating expenses increased for the
comparative period, while the Company's share of the income of a joint venture,
the Company's interest in Florida N-Viro, L.P., increased for the same period of
2003. These changes collectively resulted in a net loss of approximately
$289,000 for the quarter ended September 30, 2003 compared to net income of
approximately $124,000 for the same period in 2002.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2003 WITH THREE MONTHS ENDED
SEPTEMBER 30, 2002
Overall revenue decreased $94,000, or 6%, to $1,409,000 for the quarter
ended September 30, 2003 from $1,503,000 for the quarter ended September 30,
2002. The net decrease in revenue was due primarily to the following:
a) Sales of alkaline admixture decreased $44,000 from the same period
ended in 2002;
b) Revenue from the service fees for the management of alkaline admixture
increased $152,000 from the same period ended in 2002;
c) The Company's processing revenue, including facility management
revenue, showed a net decrease of $168,000 over the same period ended in 2002.
This was primarily the direct result of increased competition from local
alternative processing companies. Further changes in revenue were;
d) Miscellaneous revenues increased $10,000 from the same period ended in
2002;
e) Research and development revenue decreased $44,000 from the same period
ended in 2002.
Gross profit decreased $215,000, or 35%, to $391,000 for the three months
ended September 30, 2003 from $606,000 for the three months ended September 30,
2002. This decrease in gross profit was primarily due to the Company's higher
percentage of overall sales from alkaline admixture and the service fees for the
management of alkaline admixture. The gross profit margin decreased to 28% from
40%, and was primarily the result of an increase in costs on purchasing the
alkaline admixture used in the process.
Operating expenses increased $167,000, or 37%, to $621,000 for the three
months ended September 30, 2003 from $454,000 for the three months ended
September 30, 2002. The increase was primarily due to an increase of $225,000
in outside professional fees and settlement costs, partially offset by a
decrease of $56,000 in personnel-related and selling costs. Included in the
increase of $225,000 for outside professional fees and settlement costs was
$216,000 for expenses directly related to a derivative action filed by a
stockholder. See Part II Item 1 "Legal Proceedings" for further discussion.
As a result of the foregoing factors, the Company recorded an operating
loss of $230,000 for the three months ended September 30, 2003 compared to
operating income of $152,000 for the three months ended September 30, 2002, an
increase in the loss of approximately $382,000.
Net nonoperating expense increased by $31,000 to a net nonoperating expense
of $59,000 for the three months ended September 30, 2003 from net nonoperating
expense of $28,000 for the three months ended September 30, 2002. The increase
was primarily due to an increase in interest expense of $30,000, a decrease in
interest and dividend income of $17,000, partially offset by a decrease in the
loss of $24,000 in the equity of a joint venture, to a loss of $16,000 in 2003
from a loss of $40,000 in 2002.
The Company recorded a net loss of $289,000 for the three months ended
September 30, 2003 compared to net income of $124,000 for the same period ended
in 2002, an increase in the loss of approximately $413,000.
For the three months ended September 30, 2003 and 2002, the Company has not
fully recognized the tax benefit of the losses incurred in prior periods.
Accordingly, the effective tax rate for each period was zero.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2003 WITH NINE MONTHS ENDED
SEPTEMBER 30, 2002
Overall revenue decreased $135,000, or 3%, to $4,062,000 for the nine
months ended September 30, 2003 from $4,197,000 for the nine months ended
September 30, 2002. The net decrease in revenue was due primarily to the
following:
a) Sales of alkaline admixture decreased $77,000 from the same period
ended in 2002;
b) Revenue from the service fees for the management of alkaline admixture
increased $463,000 from the same period ended in 2002;
c) The Company's processing revenue, including facility management
revenue, showed a net decrease of $317,000 over the same period ended in 2002.
This was primarily the direct result of increased competition from local
alternative processing companies. Further changes in revenue were;
d) Miscellaneous revenues increased $43,000 from the same period ended in
2002;
e) Licensing of the N-Viro Process, including territory fees, earned the
Company $-0- for the period, a decrease of $92,000 from 2002; and,
f) Research and development revenue decreased $165,000 from the same
period ended in 2002.
Gross profit decreased $405,000, or 27%, to $1,069,000 for the nine months
ended September 30, 2003 from $1,474,000 for the nine months ended September 30,
2002. This decrease in gross profit was primarily due to the increase in the
cost of supplying alkaline admixture to all domestic facilities. The gross
profit margin decreased to 26% from 35%, and was primarily due to the increased
costs associated with the sale of alkaline admixture for the same period.
Operating expenses increased $280,000, or 19%, to $1,717,000 for the nine
months ended September 30, 2003 from $1,437,000 for the nine months ended
September 30, 2002. The increase was primarily due to an increase of $324,000
in outside professional fees and settlement costs. Included in the increase of
$324,000 for outside professional fees and settlement costs was $235,000 for
expenses directly related to a derivative action filed by a stockholder. See
Part II Item 1 "Legal Proceedings" for further discussion.
As a result of the foregoing factors, the Company recorded an operating
loss of $647,000 for the nine months ended September 30, 2003 compared to
operating income of $37,000 for the nine months ended September 30, 2002, an
increase in the loss of approximately $684,000.
Net nonoperating expense increased by $184,000 to a net nonoperating
expense of $164,000 for the nine months ended September 30, 2003 from net
nonoperating income of $20,000 for the nine months ended September 30, 2002.
The increase was primarily due to an increase in interest expense of $105,000
and a decrease of income of $41,000 in the equity of a joint venture, to a loss
of $29,000 in 2003 from income of $12,000 in 2002. The Company also recorded a
decrease in interest and dividend income of $30,000 from 2002, to $2,800.
The Company recorded a net loss of $811,000 for the nine months ended
September 30, 2003 compared to net income of $57,000 for the same period ended
in 2002, an increase in the loss of approximately $868,000.
For the nine months ended September 30, 2003 and 2002, the Company has not
fully recognized the tax benefit of the losses incurred in prior periods.
Accordingly, the effective tax rate for each period was zero.
LIQUIDITY AND CAPITAL RESOURCES
The Company had a working capital deficit of $1,467,000 at September 30,
2003, compared to a working capital deficit of $847,000 at December 31, 2002, a
decrease in working capital of $620,000. Current assets at September 30, 2003
included cash and investments of $32,000, which is a decrease of $373,000 from
December 31, 2002. This decrease in cash and investments was the result of the
Company closing on an $845,000 credit facility with a local bank, and redeeming
its $400,000 certificate of deposit in the transaction to pay off current debt.
The decrease in working capital was principally due to the Credit Facility
obtained which assisted in refinancing existing short-term debt to long-term,
but offset by the operating loss for the nine month period.
In the first nine months of 2003 the Company's cash flow provided from
operations was $29,000, a decrease of approximately $158,000 from the same
period in 2002. In the third quarter of 2003, the Company determined it had
under billed a customer for certain services which resulted in an understatement
of revenue totaling approximately $214,000, or gross profit of approximately
$194,000 over a two year period beginning with the third quarter of 2000 and
ending in the fourth quarter of 2002.
In February 2003 the Company closed on an $845,000 credit facility with a
local bank. This senior debt credit facility is comprised of a $295,000 four
year term note at 7.5% and a line of credit up to $550,000 at Prime plus 1.5%
and secured by a first lien on all assets of the Company. The Company used the
funds to refinance its prior debt and to provide working capital. Previously,
the Company had a $750,000 line of credit with another financial institution,
secured by a $400,000 restricted Certificate of Deposit, required and held by
this financial institution. Effectively, the former line of credit provided
only $350,000 of additional working capital. The effective increase in the line
provides the Company with additional working capital, and the debt refinance
provides lower cost and longer term debt, improving cash flow. To secure the
credit facility, the Company was required by the financial institution to obtain
additional collateral of $100,000 (the "Additional Collateral") from a real
estate mortgage from a third party. Messrs. J. Patrick Nicholson, the former
Chairman of the Board and Consultant to the Company; Michael G. Nicholson, the
Company's Chief Operating Officer and a Director; Robert F. Nicholson, a Company
employee, and Timothy J. Nicholson, a Company employee, ("the Nicholsons")
collectively provided the $100,000 Additional Collateral. In exchange for their
commitment, the Company has agreed to provide the Nicholsons the following: (1)
an annual fee in an amount equal to $2,000 per annum; (2) interest at an annual
rate of 5% of the $100,000 value of the Additional Collateral beginning on the
first anniversary date of the closing of the credit facility, and (3) a warrant
to acquire in the aggregate, 50,000 shares of the Company's voting common stock
at a purchase price of $0.90 per share, which was the closing market price of
the Company's common stock on the prior business day to the closing of the
Credit Facility. The warrant is exercisable, in whole or in part, at any time
and from time to time until February, 2006. In addition, the Company granted to
the Nicholsons a lien upon the Company's inventory and accounts receivable.
This lien is subordinated to both existing liens on the Company's assets and all
liens granted by the Company in favor of the financial institution providing the
Credit Facility. The warrants are exercisable during the period from February
26, 2003 to February 28, 2006.
The Company was in violation of financial covenants governing the credit
facility, concerning the maintenance of both a tangible net worth amount and
positive debt service coverage ratio for the period, of which requires positive
earnings. The Company's bank (the "Bank") waived this violation in light of the
Company's net loss for the nine months ended September 30, 2003, but required
additional consideration in exchange for this waiver. The Company obtained a
certificate of deposit in the amount of $75,000 with the Bank, and transferred
custodianship of its treasury stock to the Bank. At September 30, 2003, the
Company had $131,777 of borrowing capacity under the Credit Facility.
The normal collection period for accounts receivable are approximately
30-60 days for the majority of customers. This is a result of the nature of the
license contracts, type of customer and the amount of time required to obtain
the information to prepare the billing. The Company did not change its reserve
for bad debts during the first nine months of 2003.
The Company is currently pursuing sale of its investment in Florida N-Viro,
LP, which may provide, in management's opinion, additional funds to finance the
Company's cash requirements. Because these efforts are still in progress, there
can be no assurance the Company will successfully complete these negotiations.
During 2002, the Company paid certain amounts due to Hydropress
Environmental Services, Inc. ("Hydropress") under a Settlement Agreement dated
December 14, 2001 and pursuant to the terms of a promissory note (the
"Hydropress Note"). The original principal amount of the Hydropress Note was
$204,587, was non-interest bearing and matured on October 15, 2002 with a
balloon payment of $144,587. At September 30, 2002, the outstanding principal
balance on the Hydropress Note was $144,587, which was paid in full to
Hydropress in October 2002. In conjunction with the final discharge of the
Hydropress Note, the Company arranged an unsecured loan from a third-party
licensee for $144,587, with monthly payments of $13,966 due for one year through
October 15, 2003. This unsecured loan was paid in full in August 2003.
The Company is currently in discussions with several companies in the
cement and fuel industries for the development and commercialization of the
patented N-Viro fuel technology. Because these discussions are still in
progress, there can be no assurance they will be successful.
The Company continues to focus on the development of regional biosolids
processing facilities. Currently the Company is in negotiations with several
privatization firms to permit and develop independent, regional facilities.
Because these discussions are still in progress, there can be no assurance they
will be successful.
The national public attack on Class B levels of sludge treatment is rapidly
moving the market to Class A technologies, of which the Company's patented
N-Viro processes are very cost competitive and well established in the market
place. The development and patenting of new technologies for animal manure
treatment, bio-fuel and nematode control have the potential to expand the
Company's revenue base over the next five years and beyond.
RISK FACTORS AND FORWARD LOOKING STATEMENTS
THE COMPANY'S LICENSEES ARE SUBJECT TO EXTENSIVE AND INCREASINGLY STRICT
FEDERAL, STATE AND LOCAL ENVIRONMENTAL REGULATION AND PERMITTING
The Company's licensees and their operations are subject to increasingly
strict environmental laws and regulations, including laws and regulations
governing the emission, discharge, disposal and transportation of certain
substances and related odor. Wastewater treatment plants and other plants at
which our biosolids products or processes may be implemented are usually
required to have permits, registrations and/or approvals from state and/or local
governments for the operation of such facilities. Some of our licensee's
facilities require air, wastewater, storm water, biosolids processing, use or
siting permits, registrations or approvals. These licensees may not be able to
maintain or renew their current permits or registrations or to obtain new
permits or registrations. The process of obtaining a required permit or
registration can be lengthy and expensive. They may not be able to meet
applicable regulatory or permit requirements, and therefore may be subject to
related legal or judicial proceedings that could have a materially adverse
effect on our income derived from these licensees.
Any of the permits, registrations or approvals noted above, or related
applications may be subject to denial, revocation or modification, or challenge
by a third party, under various circumstances. In addition, if new
environmental legislation or regulations are enacted or existing legislation or
regulations are amended or are enforced differently, these licensees may be
required to obtain additional, or modify existing, operating permits,
registrations or approvals.
Maintaining, modifying or renewing current permits or registrations or
obtaining new permits or registrations after new environmental legislation or
regulations are enacted or existing legislation or regulations are amended or
enforced differently may be subject to public opposition or challenge. Much of
this public opposition and challenge, as well as related complaints, relates to
odor issues, even when our licensees are in compliance with odor requirements
and even though the licensees have worked hard to minimize odor from their
operations. Public misperceptions about the business and any related odor could
influence the governmental process for issuing such permits or registrations or
for responding to any such public opposition or challenge. Community groups
could pressure local municipalities or state governments to implement laws and
regulations which could increase our licensees' costs of their operations that
in turn could have a material and adverse effect on the Company's business and
financial condition.
THE ABILITY TO GROW MAY BE LIMITED BY COMPETITION
The Company provides a variety of technology and services relating to the
treatment of wastewater residuals. The Company is in direct and indirect
competition with other businesses that provide some or all of the same services
including regional residuals management companies and national and international
water and wastewater operations/privatization companies, technology suppliers,
municipal solid waste companies and farming operations. Many of these
competitors are larger and have significantly greater capital resources.
The Company derives a substantial portion of its revenue from services
provided under municipal contracts, and many of these are subject to competitive
bidding. The Company also intends to bid on additional municipal contracts,
however, and may not be the successful bidder. In addition, some of its
contracts will expire in the future and those contracts may not be renewed or
may be renewed on less attractive terms. If the Company is not able to replace
revenues from contracts lost through competitive bidding or from the
renegotiation of existing contracts with other revenues within a reasonable time
period, the lost revenue could have a material and adverse effect on its
business, financial condition and results of operation.
THE COMPANY'S CUSTOMER CONTRACTS MAY BE TERMINATED PRIOR TO THE EXPIRATION OF
THEIR TERM.
A substantial portion of the Company's revenue is derived from services
provided under contracts and agreements with existing licensees. Some of these
contracts, especially those contracts with large municipalities, provide for
termination of the contract by the customer after giving relative short notice
(in some cases as little as ten days). In addition, some of these contracts
contain liquidated damages clauses, which may or may not be enforceable in the
event of early termination of the contracts. If one or more of these contracts
are terminated prior to the expiration of its term, and we are not able to
replace revenues from the terminated contract or receive liquidated damages
pursuant to the terms of the contract, the lost revenue could have a material
and adverse effect on our business, financial condition and results of
operations.
A SIGNIFICANT AMOUNT OF THE COMPANY'S BUSINESS COMES FROM A LIMITED NUMBER OF
CUSTOMERS AND OUR REVENUE AND PROFITS COULD DECREASE SIGNIFICANTLY IF WE LOST
ONE OR MORE OF THEM AS CUSTOMERS.
The Company's business depends on provision of services to a limited number
of customers. One or more of these customers may stop contracting for services
from us or may substantially reduce the amount of services we provide them. Any
cancellation, deferral or significant reduction in the services we provide these
principal customers or a significant number of smaller customers could seriously
harm our business and financial condition. For the quarter and nine months
ended September 30, 2003, our single largest customer accounted for
approximately 40 percent and 38 percent, respectively, of our revenues and our
top three customers accounted for approximately 75 percent and 72 percent,
respectively, of our revenues.
THE COMPANY IS AFFECTED BY UNUSUALLY ADVERSE WEATHER CONDITIONS
The Company's business is adversely affected by unusual weather conditions
and unseasonably heavy rainfall which can temporarily reduce the availability of
land application sites in close proximity to our operations. In addition,
revenues and operational results are adversely affected during months of
inclement weather which limits the level of land application that can be
performed. Long periods of adverse weather could have a material negative
effect on the Company's business and financial condition.
FUEL COST VARIATION COULD AFFECT OPERATING RESULTS AND EXPENSES
The price and supply of fuel is unpredictable and fluctuates based on
events outside our control, including demand for oil and gas, actions by OPEC
and other oil and gas producers, and war in oil producing countries. Because
fuel is needed for the trucks that transport the processing materials and
supplies for our customers, price escalations or reductions in the supply of
fuel could increase operating expenses and have a negative impact on the results
of operations. The Company is not always able to pass through all or part of
the increased fuel costs due to the terms of certain customers' contracts and
the inability to negotiate such pass through costs in a timely manner.
THE COMPANY IS DEPENDENT ON THE MEMBERS OF ITS MANAGEMENT TEAM
The Company is highly dependent on the services of its management team, the
loss of any of whom may have a material adverse effect on its business and
financial condition.
The Company has entered into employment agreements with certain members of
its management team, which contain non-compete and other provisions. The laws
of each state differ concerning the enforceability of non-competition
agreements. The Company cannot predict with certainty whether or not a court
will enforce a non-compete covenant in any given situation based on the facts
and circumstances at that time. If one of its key executive officers were to
leave and the courts refused to enforce the non-compete covenant, the Company
might be subject to increased competition, which could have a material and
adverse effect on its business and financial condition.
THE COMPANY'S INTELLECTUAL PROPERTY MAY BE MISAPPROPRIATED OR SUBJECT TO CLAIMS
OF INFRINGEMENT
The Company attempts to protect our intellectual property rights through a
combination of patent, trademark, and trade secret laws, as well as licensing
agreements. The Company's failure to obtain or maintain adequate protection of
our intellectual property rights for any reason could have a material adverse
effect on our business and financial condition.
The Company's competitors, many of whom have substantially greater
resources and have made substantial investments in competing technologies, may
have applied for or obtained, or may in the future apply for and obtain, patents
that will prevent, limit or otherwise interfere with the Company's ability to
offer services. The Company has not conducted an independent review of patents
issued to third parties.
The Company also relies on unpatented proprietary technology. It is
possible that others will independently develop the same or similar technology
or otherwise obtain access to its unpatented technology. If the Company is
unable to maintain the proprietary nature of its technologies, it could be
materially adversely affected.
The Company cautions that words used in this document such as "expects,"
"anticipates," "believes," "may," and "optimistic," as well as similar words and
expressions used herein, identify and refer to statements describing events that
may or may not occur in the future. These forward-looking statements and the
matters to which they refer are subject to considerable uncertainty that may
cause actual results to be materially different from those described herein.
Some, but not all, of the factors that could cause actual results to be
different than those anticipated or predicted by the Company include: (i) a
deterioration in economic conditions in general; (ii) a decrease in demand for
the Company's products or services in particular; (iii) the Company's loss of a
key employee or employees; (iv) regulatory changes, including changes in
environmental regulations, that may have an adverse affect on the demand for the
Company's products or services; (v) increases in the Company's operating
expenses resulting from increased costs of labor and/or consulting services; and
(vi) a failure to collect upon or otherwise secure the benefits of existing
contractual commitments with third parties, including customers of the Company.
For example, while the Company anticipates obtaining the permits and approvals
necessary for the Bio-Fuel pilot program to commence operations within the next
twelve months, such program may not begin until after that period or ever.
Delay or cancellation with respect to this project could result from (1) a
failure to achieve acceptable air quality levels in preliminary testing, (2)
costs associated with the use of Bio-Fuel significantly exceeding current
estimates, or (3) competing technologies rendering the Bio-Fuel process less
attractive.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to credit risk from its customers. Credit limits
are closely monitored, as are collections of accounts receivable. The Company
generally does not require collateral from its customers. Historically, losses
from bad debt have been within management's expectations.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of our management, including the chief executive officer and chief
financial officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of September 30, 2003. Based on that
evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures were effective as of September 30,
2003. There were no significant changes in our internal controls or in other
factors during the quarter ended September 30, 2003 that significantly affected
or are reasonably likely to materially effect, our internal controls.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 11, 2003, Strategic Asset Management, Inc. ("SAMI"), the beneficial
owner of 464,372 shares of the voting, common stock of the Company or 17.63% of
the total number of issued and outstanding shares of voting, common stock, filed
a stockholder's derivative action in Delaware Chancery Court("the Court")against
the Company and its Board of Directors, seeking, among other things, to enjoin
the Company from modifying the terms and conditions contained in a consulting
agreement dated December 2, 1999, effective as of July 20, 2002 (the "Consulting
Agreement") by and between the Company and J. Patrick Nicholson, the Chairman of
the Board and a consultant to the Company. R. Francis DiPrete, the president and
a member of the board of directors of SAMI, is a member of the Board of
Directors of the Company. As reported by the Company in a Form 8-K filed on
August 29, 2003, the Company and SAMI have reached agreement on the settlement
of this lawsuit, pending approval of the Court. The specific terms and
conditions of the settlement, including a complete copy of the settlement
agreement, were included in the Company's filing. As reported by the Company in
a Form 8-K filed on October 22, 2003, the Company has been notified by the Court
that a date of December 15, 2003 has been set to hold a hearing on the proposed
settlement.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In the three months ended September 30, 2003 the Company issued one share
of non-convertible Series A Redeemable Preferred Stock, $0.01 per value, to J.
Patrick Nicholson, in connection with the Settlement Agreement described in Part
II, Item 1 of this filing. The issuance was exempt from registration pursuant to
Section 4(2) of the Securities Act or Regulation D promulgated thereunder, as a
transaction not involving a public offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 31.1 - Certification of CEO Pursuant to Section 302 of the Sarbanes
- - Oxley Act of 2002.
Exhibit 31.2 - Certification of CFO Pursuant to Section 302 of the Sarbanes
- - Oxley Act of 2002.
Exhibit 32.1 - Certification of CEO Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 32.2 - Certification of CFO Pursuant to Section 906 of the Sarbanes
- -Oxley Act of 2002.
(b) Reports on Form 8-K:
The Company filed a report on Form 8-K dated August 5, 2003, to
announce a change to the date of the 2003 Annual Stockholders Meeting.
The Company filed a report on Form 8-K dated August 29, 2003 to
announce it had reached an agreement with the Chairman of the Board of
Directors, and also reached a settlement of a derivative action filed on behalf
of a stockholder.
N-VIRO INTERNATIONAL CORPORATION
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
N-VIRO INTERNATIONAL CORPORATION
Date: November 30, 2003 /s/ Terry J. Logan
------------------- ---------------------
Terry J. Logan
Chief Executive Officer and President
(Principal Executive Officer)
Date: November 30, 2003 /s/ James K. McHugh
------------------- ----------------------
James K. McHugh
Chief Financial Officer, Secretary and Treasurer
(Principal Financial & Accounting Officer)
Exhibit 31.1
------------
N-Viro International Corporation
Certifications
I, Terry J. Logan, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of N-Viro International
Corporation;
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 the 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting;
and
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 the 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 control 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: November 30, 2003 /s/ Terry J. Logan
---------------------
President and Chief Executive Officer
Exhibit 31.2
------------
N-Viro International Corporation
Certifications
I, James K. McHugh, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of N-Viro International
Corporation;
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 the 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting;
and
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 the 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 control 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: November 30, 2003 /s/ James K. McHugh
----------------------
Chief Financial Officer
Exhibit32.1
-----------
CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Terry J. Logan, the Chief Executive Officer of N-Viro International
Corporation, certify that (i) the Form 10-Q fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (ii) the
information contained in the Form 10-Q fairly presents, in all material
respects, the financial condition and results of operations of N-Viro
International Corporation.
/s/ Terry J. Logan
- ---------------------
Terry J. Logan, Chief Executive Officer
November 30, 2003
Exhibit 32.2
------------
CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, James K. McHugh, the Chief Financial Officer of N-Viro International
Corporation, certify that (i) the Form 10-Q fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (ii) the
information contained in the Form 10-Q fairly presents, in all material
respects, the financial condition and results of operations of N-Viro
International Corporation.
/s/ James K. McHugh
- ----------------------
James K. McHugh, Chief Financial Officer
November 30, 2003