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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, 2002.
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 0-25552
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DUALSTAR TECHNOLOGIES CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 13-3776834
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11-30 47TH AVENUE, LONG ISLAND CITY, NY 11101
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(Address, including zip code of principal executive offices)
(718) 340-6655
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address and former fiscal year,
if changed since last report)
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 __.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's common stock,
as of the latest practicable date.
COMMON STOCK, $.01 PAR VALUE --- 16,501,568 SHARES AS OF NOVEMBER 11, 2002
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INDEX
DUALSTAR TECHNOLOGIES CORPORATION
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets - September 30, 2002 (Unaudited) and
June 30, 2002
Unaudited consolidated statements of operations - Three months ended
September 30, 2002 and 2001
Unaudited consolidated statements of cash flows - Three months ended
September 30, 2002 and 2001
Notes to consolidated financial statements (Unaudited) - September
30, 2002
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 3. Defaults Upon Senior Securities
Item 6. Exhibits and Reports on Form 8-K
Signatures
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, JUNE 30,
2002 2002
----------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash $5,098,405 $2,535,419
Accounts receivable - net of allowance for doubtful accounts 20,641,905 26,249,507
Retainage receivable 3,348,769 3,473,970
Costs and estimated earnings in excess of billings on uncompleted
contracts 564,323 1,299,615
Prepaid expenses and other current assets 268,525 210,997
----------- -----------
Total current assets 29,921,927 33,769,508
Property and equipment - net of accumulated depreciation and amortization 2,693,755 3,158,890
Other 494,627 511,303
----------- -----------
Total assets $33,110,309 $37,439,701
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable $7,753,171 $12,250,161
Senior secured promissory note payable 15,334,606 14,850,300
Billings in excess of costs and estimated earnings on uncompleted
contracts 6,837,089 5,707,947
Accrued expenses and other current liabilities 3,088,660 3,540,799
Mortgage payable 1,687,891 1,693,885
----------- -----------
Total current liabilities 34,701,417 38,043,092
----------- -----------
Total liabilities 34,701,417 38,043,092
----------- -----------
Commitments and contingencies
Shareholders' deficit:
Common stock 165,016 165,016
Additional paid-in capital 41,575,421 41,575,421
Accumulated deficit (43,331,545) (42,343,828)
----------- -----------
Total shareholders' deficit (1,591,108) (603,391)
----------- -----------
Total liabilities and shareholders' deficit $33,110,309 $37,439,701
=========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
2002 2001
------------ ------------
Revenues earned $ 14,548,491 $ 17,556,079
Costs of revenues earned, excluding depreciation and amortization 12,501,523 15,063,500
------------ ------------
Gross profit 2,046,968 2,492,579
Operating expenses:
General and administrative expenses, excluding depreciation and
amortization 2,354,937 3,132,954
Depreciation and amortization 261,504 561,262
------------ ------------
Operating loss (569,473) (1,201,637)
------------ ------------
Other (income) expense:
Interest income (3,665) (91,189)
Interest expense 476,194 407,155
Gain on sale of communications assets (74,545) --
------------ ------------
Other expense - net 397,984 315,966
------------ ------------
Loss before provision for income taxes (967,457) (1,517,603)
Provision for income taxes 20,260 --
------------ ------------
Net loss ($987,717) ($1,517,603)
============ ============
Basic and diluted loss per share ($0.06) ($0.09)
Weighted average shares outstanding 16,501,568 16,501,568
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
2002 2001
----------- -----------
Net cash provided by (used in) operating activities $ 2,343,674 ($1,230,324)
----------- -----------
Cash flows from investing activities:
Acquisition of property and equipment (70,112) (228,447)
Proceeds from sale of communications assets 295,418 --
----------- -----------
Net cash provided by (used in) investing activities 225,306 (228,447)
----------- -----------
Cash flows from financing activities:
Principal payments on capital lease obligations -- (38,524)
Principal payments on mortgage (5,994) (5,518)
----------- -----------
Net cash used in financing activities (5,994) (44,042)
----------- -----------
Net increase (decrease) in cash 2,562,986 (1,502,813)
Cash at beginning of period 2,535,419 3,711,287
----------- -----------
Cash at end of period $ 5,098,405 $ 2,208,474
=========== ===========
NON-CASH TRANSACTION:
During the three months ended September 30, 2002, accrued interest of $427,377
was capitalized to the senior secured promissory note payable.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
DualStar Technologies Corporation ("DualStar" or the "Company"), through its
wholly owned subsidiaries, operates two separate lines of business: (a)
construction and (b) communications.
In fiscal year 2002, the Company continued to limit its communications business
and resources to the Internet and subscription video businesses in the New York
City metropolitan area and in Florida. The Company's communications segment
informed its telephone customers and the FCC in April 2002 that telephone
services would be phased out starting June 2002. Telephone service was
completely discontinued in August 2002.
In addition, the Company decided to sell certain communications assets in
locations outside of the New York City metropolitan area and Florida. In April
2002, the Company sold certain communications assets for $0.4 million. The
transaction resulted in a loss of $0.5 million. In August 2002, the Company sold
certain access agreements on properties located in the Los Angeles area and the
communications assets located in the properties for $0.4 million. The
transaction resulted in a gain of $0.1 million.
Due to the Company's continuing re-focus of its communications business efforts
and resources, a $2.5 million charge for the impairment of certain remaining
communications assets was recorded in fiscal year 2002.
The Company incurred significant losses in the last several fiscal years,
primarily in the communications segment, and it expects that the communications
segment, even significantly limited, will continue to incur losses going forward
and will require additional capital to fund those losses. The Company has
implemented and will continue to implement cost reductions designed to minimize
such losses. There can be no assurance that these efforts will be successful or
that the construction segment will sustain profitability or positive cash flow
from future operations or that positive cash flow, if any, will be sufficient to
offset continued losses from the communications segment. Given the current U.S.
economic climate and market conditions and the financial condition of the
Company, there is a substantial likelihood that the Company will be unable to
raise additional funds on terms satisfactory to it, if at all, to fund the
expected operating losses. Moreover, the Company presently owes Madeleine L.L.C.
("Madeleine") over $15 million and is in default under the loan (described
below). Madeleine may call the loan due and payable at any time, and, if it is
not paid, foreclose on significant assets of the Company's subsidiaries that
secure such loan. If the Company cannot raise additional funds or if Madeleine
demands payment on its loan, the Company will likely be forced to cease
operations. Accordingly, there is substantial doubt about the Company's ability
to continue as a going concern.
In November 2000, the Company consummated a $12.5 million senior secured loan
transaction with Madeleine, an affiliate of Blackacre Capital Management L.L.C.
("Blackacre"). The loan, which is due and payable in November 2007, bears
interest at a fixed rate of 11% per annum. The loan is a senior secured
obligation of the Company and is guaranteed by certain subsidiaries of the
Company, including OnTera, Inc., which have pledged substantially all of their
respective
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
assets to collateralize such guarantee. In connection with the loan, the Company
issued warrants to purchase 3,125,000 shares of common stock at an exercise
price of $4.00 per share, subject to antidilution provisions, expiring in
December 2007, to an affiliate of Madeleine. A portion of the $12.5 million loan
proceeds was used to retire existing indebtedness of the Company in the
principal amount of $7 million owed to Madeleine and to pay expenses of
obtaining the loan.
The remaining proceeds were used for the Company's working capital purposes. No
value was allocated to the warrants because the value was deemed immaterial.
The Company has not made any payments to Madeleine pursuant to the $12.5 million
loan agreement. The de-listing of the Company's common shares from the Nasdaq
National Market has also created a default under the loan agreement. In August
2002, the Company, Blackacre and Madeleine began negotiating, with a view, to
eliminate the loan by selling certain of the Company's communications assets to
Blackacre at fair market value and by converting the remaining loan balance to
stock of the Company. On November 8, 2002, the Company announced that it entered
into a letter of intent with Madeleine under which Madeleine or its designee
would purchase substantially all the assets of ParaComm Inc. The assets to be
acquired are ParaComm's private cable television systems and associated assets
related to its principal properties in the State of Florida. The purchase price
will be $3,000,000, paid through the reduction of principal and accrued interest
on the outstanding secured indebtedness previously extended by Madeleine to the
Company. The Company has the right until January 7, 2003 to actively solicit
higher cash offers for the stock or assets of ParaComm. The ParaComm sale to
Madeleine is conditioned upon the approval of the transaction by the Company's
Board of Directors, as well as receipt of a favorable fairness opinion from an
independent financial advisor. In addition, the acquisition is subject to the
execution of a definitive purchase agreement. There is no assurance that the
Company, Blackacre and Madeleine will be able to reach agreement on valuation
issues, or that they will reach final agreement to further eliminate or reduce
the loan. The Company presently owes Madeleine over $15 million and is in
default under the loan agreement. Madeleine has the right to call the loan due
and payable at any time. If Madeleine were to demand payment, the Company would
be unable to make such payment. In such an event, Madeleine would have the right
to foreclose on significant assets of the Company that collateralize the loan.
Such foreclosure would result in the Company being unable to continue in
business.
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include certain information and
disclosures required by accounting principles generally accepted in the United
States of America for complete consolidated financial statements. In the opinion
of management, all adjustments considered necessary for a fair presentation have
been included and are of a normal and recurring nature. Operating results for
the three-month period ended September 30, 2002 are not necessarily indicative
of the results that may be expected for the fiscal year ending June 30, 2003.
The interim statements should be read in conjunction with the financial
statements and notes, thereto included in the Company's Annual Report on Form
10-K for the fiscal year ended June 30, 2002.
NOTE B - PER SHARE DATA
The computation of basic and diluted net loss per share is based on the weighted
average number of shares of common stock outstanding. For diluted net loss and
income per share, when
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE B (CONTINUED)
dilutive, stock options and warrants are included as share equivalents using the
treasury stock method, and shares available for conversion under the convertible
note are included as if converted at the date of issuance. For the three months
ended September 30, 2002 and 2001, stock options and warrants have been excluded
from the calculation of diluted loss per share as their effect would have been
antidilutive.
NOTE C - CONTINGENCIES
(a) Until 1995, Centrifugal was a partner with DAK Electric Contracting Corp.
("DAK") in a joint venture that performed mechanical and electrical services for
a general contractor on a construction project in Manhattan known as the Lincoln
Square project. Centrifugal was responsible for the mechanical portion of the
contract, and its co-venturer, DAK, was responsible for the electrical portion.
In 1995, DAK became insolvent, thereby obligating Centrifugal to complete the
work on this project. As a result, in fiscal 1996 the Company wrote off
approximately $3.7 million with respect to accounts receivable, loans
receivable, claims and other costs that the Company incurred on behalf of DAK in
fulfillment of DAK's obligations under the contract on the Lincoln Square
project.
As of June 30, 1996, all of the known claims and liens of subcontractors of the
joint venture were settled and discharged, and all of the vendor lawsuits which
arose out of these claims were also settled with the exception of the following:
The joint venture's bonding companies have claims over for indemnity against
Centrifugal and under a guarantee agreement against the Company in the event
that a judgment is rendered against the bonding companies in a suit brought by
an employee benefit fund for DAK's employees' union seeking contributions to the
fund which the fund claims were due but not paid by DAK. The complaint alleges
several causes of action against several defendants in connection with several
projects and seeks a total of approximately $450,000 in damages on all of these
causes against the named defendants; however, only one of the several causes of
action, which seeks an unspecified portion of the total damages demanded,
relates to the Company. The Company has been informed that plaintiff will assert
that more than half of the total sums it seeks is due under the bond which the
Company provided, with the remainder of the sums demanded due on the claims
unrelated to the Company. The Company may also be exposed for interest.
Additionally, it may be exposed to such legal fees and other expenses as the
Company's bonding company may incur in its defense against plaintiff's claims;
however, many years into this matter, no demand for any of these sums has been
made. The bonding companies, Centrifugal and the Company have asserted, among
other defenses, that such contributions were not guaranteed under the terms of
the joint venture's bonds.
(b) In August 2001, OnTera signed a promissory note and security agreement with
Nokia to finance the purchase of various network equipment totaling
approximately $668,000. The note bears interest at a rate of 11% per annum and
requires eighteen monthly installments effective April 1, 2001. The note is
secured by the network equipment financed by the note. OnTera has not made
monthly installments since June 2001, therefore the Company is in default of the
agreement. As such, the remaining balance at September 30, 2002 of $564,370 is
included in Accrued expenses and other current liabilities. In August 2002,
Nokia filed suit in the District Court of Dallas County, Texas, claiming damages
of approximately $607,000 plus interest, costs and attorneys on the promissory
note.
(c) In 1999, ParaComm purchased from Golden Sky Systems (GSS) GSS's contract
with DirecTV which authorized it to be a DirecTV Master Systems Operator (MSO).
Along with the
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C (CONTINUED)
contract so purchased, ParaComm acquired a GSS contract with one of its System
Operators, Cable America, Inc. In May, 2002 Cable America, Inc. filed suit in
the Circuit Court of Cook County, Illinois against ParaComm, OnTera, DirecTV,
GSS and Pegasus Communications Inc., which had subsequently acquired GSS. The
suit claims damages for allegedly unpaid commissions in the claimed amount of
$339,000 and also seeks an accounting.
(d) In July 2002, plaintiff Harvey Wayne, as an alleged shareholder of the
Company, filed a verified shareholders' derivative complaint against directors
and officers of the Company, various other entities and the Company as a nominal
defendant, in the United States District Court for the Eastern District of New
York. The complaint alleges breach of fiduciary duties and seeks to compel the
Company to hold a shareholders meeting for the election of directors. The
complaint seeks injunctive relief and unspecified damages. The Company has not
yet moved or filed an answer in this matter.
(e) In the ordinary course of business, the Company is involved in claims
concerning personal injuries and property damage, all of which the Company
refers to its insurance carriers. The Company believes that the claims are
covered under its liability policies and that no loss to the Company is
probable. No provision for such claims has been made in the accompanying
financial statements.
NOTE D - SEGMENT INFORMATION
The Company has the following two reportable segments: construction and
communications. The construction segment primarily engages in electrical and
mechanical contracting services in the New York Metropolitan area. The
communications segment primarily installs communication systems and provides
Internet, cable television and other services to buildings in New York City and
Florida.
The accounting policies used to develop segment information correspond to those
disclosed in the Company's Annual Report on Form 10-K for the fiscal year ended
June 30, 2002. The Company does not allocate certain corporate expenses incurred
by the parent company to its segments. Segment profit (loss) is based on profit
(loss) from operations before income taxes (benefits) and does not include those
corporate expenses incurred by the parent company. Sales and transfers between
segments are accounted for at cost. The reportable segments are distinct
business units operating in different industries. They are separately managed,
with separate marketing systems.
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE D (CONTINUED)
REPORTABLE SEGMENT INFORMATION CONSTRUCTION COMMUNICATIONS TOTALS
- ---------------------------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002
Revenues from external customers $14,097,095 $451,396 $14,548,491
Segment profit (loss) 329,293 (649,952) (320,659)
Segment assets at September 30, 2002 29,881,375 2,014,649 31,896,024
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001
Revenues from external customers $16,689,807 $866,272 $17,556,079
Intersegment revenues -- 6,250 6,250
Segment profit (loss) 653,558 (1,385,839) (732,281)
Segment assets at June 30, 2002 33,658,903 2,768,592 36,427,495
RECONCILIATION TO CONSOLIDATED AMOUNTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------
2002 2001
LOSS
Total loss for reportable segments ($320,659) ($732,281)
Unallocated amounts:
Corporate (667,058) (785,322)
-----------------------------------------
Total consolidated net loss ($987,717) ($1,517,603)
=========================================
NOTE E - DEBT
Senior Secured Promissory Note
In November 2000, the Company consummated a $12.5 million senior secured loan
transaction with Madeleine, an affiliate of Blackacre. The loan, which is due
and payable in November 2007, bears interest at a fixed rate of 11% per annum.
The loan is a senior secured obligation of the Company and is guaranteed by
certain subsidiaries of the Company, including OnTera, which have pledged
substantially all of their respective assets to collateralize such guarantee. In
connection with the loan, the Company issued warrants to purchase 3,125,000
shares of common stock at an exercise price of $4.00 per share, subject to
antidilution provisions, expiring in December 2007, to an affiliate of
Madeleine. A portion of the $12.5 million loan proceeds was used to retire
existing indebtedness of the Company in the principal amount of $7 million owed
to Madeleine and to pay expenses of obtaining the loan. The remaining proceeds
were used for the Company's working capital purposes. No value was allocated to
the warrants because the value was deemed immaterial.
The Company has not made any payments to Madeleine pursuant to the $12.5 million
loan agreement. The de-listing of the Company's common shares from the Nasdaq
National Market has also created a default under the loan agreement. In August
2002, the Company, Blackacre and Madeleine began negotiating, with a view, to
eliminate the loan by selling certain of the Company's
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE E (CONTINUED)
communications assets to Blackacre at fair market value and by converting the
remaining loan balance to stock of the Company. On November 8, 2002, the Company
announced that it entered into a letter of intent with Madeleine under which
Madeleine or its designee would purchase substantially all the assets of
ParaComm Inc. The assets to be acquired are ParaComm's private cable television
systems and associated assets related to its principal properties in the State
of Florida. The purchase price will be $3,000,000, paid through the reduction of
principal and accrued interest on the outstanding secured indebtedness
previously extended by Madeleine to the Company. The Company has the right until
January 7, 2003 to actively solicit higher cash offers for the stock or assets
of ParaComm. The ParaComm sale to Madeleine is conditioned upon the approval of
the transaction by the Company's Board of Directors, as well as receipt of a
favorable fairness opinion from an independent financial advisor. In addition,
the acquisition is subject to the execution of a definitive purchase agreement.
There is no assurance that the Company, Blackacre and Madeleine will be able to
reach agreement on valuation issues, or that they will reach final agreement to
further eliminate or reduce the loan.
The Company presently owes Madeleine over $15 million and is in default under
the loan agreement. Madeleine has the right to call the loan due and payable at
any time. If Blackacre were to demand payment, the Company would be unable to
make such payment. In such an event, Madeleine would have the right to foreclose
on significant assets of the Company that collateralize the loan. Such
foreclosure would result in the Company being unable to continue in business.
Mortgage Payable
In November 1999, the Company refinanced its mortgage loan, borrowing an
additional $1.0 million, thereby increasing the loan balance to $1.75 million.
The new mortgage loan will expire on December 1, 2004 and can be renewed for an
additional five years. The mortgage loan bears interest at a fixed rate of 8.5%
per annum for five years, and is secured by the related building. Interest
during the renewal term will be paid at a fixed rate per annum equal to the
prime rate in effect on November 1, 2004. Principal of the loan is amortized on
a 25-year basis. The mortgage loan agreement requires the Company to comply with
certain covenants, including maintaining certain net working capital and
tangible net worth amounts. If the Company fails to meet any of the
requirements, the loan shall become immediately due and payable. At September
30, 2002, the Company failed to maintain the tangible net worth and working
capital requirements. Accordingly, the mortgage payable of $1.7 million was
reclassified as a current liability. The Company has not been notified of any
intention by the bank to accelerate such repayments. The Company is current with
its monthly payment obligations.
NOTE F - NEW ACCOUNTING STANDARDS ADOPTED
The Company adopted SFAS 142, "Goodwill and Intangible Assets." The Company does
not have any unamortized goodwill and therefore this adoption has no effect on
the financial statements.
DUALSTAR TECHNOLOGIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - NEW ACCOUNTING STANDARDS NOT YET ADOPTED
In June 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated with
Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullified
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)." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. A fundamental conclusion reached by the FASB in
this statement is that an entity's commitment to a plan, by itself, does not
create a present obligation to others that meets the definition of a liability.
SFAS No. 146 also establishes that fair value is the objective for initial
measurement of the liability. The provisions of this statement are effective for
exit or disposal activities that are initiated after December 31, 2002, with
early application encouraged. The Company has not yet determined the impact of
SFAS No.146 on its financial position and results of operations, if any.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
DualStar Technologies Corporation ("DualStar" or the "Company"), through its
wholly owned subsidiaries, operates two separate lines of business: (a)
construction businesses; and (b) communications businesses. For a description of
the Company's businesses and operations, see Item 1 of the Company's Annual
Report on Form 10-K, for the fiscal year ended June 30, 2002.
The statements contained in this Quarterly Report on Form 10-Q, including the
exhibits hereto, relating to operations of DualStar Technologies Corporation and
its subsidiaries (DualStar or the Company) may constitute forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended. Please note that the words intends, expects, plans, estimates,
projects, believes, anticipates and similar expressions are intended to identify
forward-looking statements. Actual results of the Company may differ materially
from those in the forward-looking statements and may be affected by a number of
factors including the Company's ability to continue operations, including if
Madeleine L.L.C. were to call its loan, the ability of OnTera, Inc., a wholly
owned subsidiary of the Company, to continue to implement its cost reduction
plan, the ability of the Company to raise and provide the capital resources to
fund the continuing communications operating losses, the Company's ability to
continue to obtain insurance and suretyship coverage, regulatory or legislative
changes, the Company's dependence on key personnel, and the Company's ability to
manage growth, in addition to those risk factors, set forth in the section
captioned "Risk Factors" and the assumptions, risks and uncertainties set forth
below in the other sections of the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 2002 as well as in DualStar's other filings with the
SEC. The Company can give no assurance that its plans, intentions, and
expectations will be achieved and actual results could differ materially from
forecasts and estimates.
CAPITAL RESOURCES AND LIQUIDITY
Cash balances at September 30, and June 30, 2002 were $5.1 million and $2.5
million, respectively. The Company was provided with $2.3 million of cash in the
three months ended September 30, 2002 by operating activities. The net provision
of cash was primarily due to decrease in receivables of the construction
businesses. In the three months ended September 30, 2001, the Company used net
cash of $1.2 million in operating activities to fund operating loss incurred by
the communications segment. The Company's operating cash flows are primarily
generated from the construction segment. Due to the relatively high dollar value
of each construction contract, generally ranging from $5 million to $10 million,
should the collection of contract receivables be delayed, it may have a material
adverse effect on the Company's operations.
The Company incurred significant losses in the last several fiscal years,
primarily in the communications segment, and it expects that the communications
segment will continue to incur losses going forward and will require additional
capital to fund those losses. The Company has implemented and will continue to
implement cost reductions designed to minimize such losses. There can be no
assurance that these efforts will be successful or that the construction segment
will sustain profitability or positive cash flow from future operations or that
any positive cash flow will be sufficient to offset continued losses from the
communications segment. Given the current U.S. economic climate and market
conditions and the financial condition of the Company, there is a substantial
likelihood that the Company will be unable to raise additional funds on terms
satisfactory to it, if at all, to fund the expected operating losses. Moreover,
the Company presently owes Madeleine L.L.C. ("Madeleine") over $15 million and
is in default under the loan. Madeleine may call the loan due and payable at any
time, and, if it is not paid, foreclose on significant assets of the Company's
subsidiaries that secure such loan. If the
Company cannot raise additional funds or if Madeleine demands payment on its
loan, the Company will likely be forced to cease operations. Accordingly, there
is substantial doubt about the Company's ability to continue as a going concern.
In the three months ended September 30, 2002 and 2001, the Company acquired
capital assets of $0.1 million and $0.2 million, respectively, primarily for
investment in communications infrastructure systems for high-rise buildings to
enable the Company to provide Internet, video and other services to the
buildings' residents.
Senior Secured Promissory Note
In November 2000, the Company consummated a $12.5 million senior secured loan
transaction with Madeleine, an affiliate of Blackacre. The loan, which is due
and payable in November 2007, bears interest at a fixed rate of 11% per annum.
The loan is a senior secured obligation of the Company and is guaranteed by
certain subsidiaries of the Company, including OnTera, which have pledged
substantially all of their respective assets to collateralize such guarantee. In
connection with the loan, the Company issued warrants to purchase 3,125,000
shares of common stock at an exercise price of $4.00 per share, subject to
antidilution provisions, expiring in December 2007, to an affiliate of
Madeleine. A portion of the $12.5 million loan proceeds was used to retire
existing indebtedness of the Company in the principal amount of $7 million owed
to Madeleine and to pay expenses of obtaining the loan. The remaining proceeds
were used for the Company's working capital purposes. No value was allocated to
the warrants because the value was deemed immaterial.
The Company has not made any payments to Madeleine pursuant to the $12.5 million
loan agreement. The de-listing of the Company's common shares from the Nasdaq
National Market has also created a default under the loan agreement. In August
2002, the Company, Blackacre and Madeleine began negotiating, with a view, to
eliminate the loan by selling certain of the Company's communications assets to
Blackacre at fair market value and by converting the remaining loan balance to
stock of the Company. On November 8, 2002, the Company announced that it entered
into a letter of intent with Madeleine under which Madeleine or its designee
would purchase substantially all the assets of ParaComm Inc. The assets to be
acquired are ParaComm's private cable television systems and associated assets
related to its principal properties in the State of Florida. The purchase price
will be $3,000,000, paid through the reduction of principal and accrued interest
on the outstanding secured indebtedness previously extended by Madeleine to the
Company. The Company has the right until January 7, 2003 to actively solicit
higher cash offers for the stock or assets of ParaComm. The ParaComm sale to
Madeleine is conditioned upon the approval of the transaction by the Company's
Board of Directors, as well as receipt of a favorable fairness opinion from an
independent financial advisor. In addition, the acquisition is subject to the
execution of a definitive purchase agreement. There is no assurance that the
Company, Blackacre and Madeleine will be able to reach agreement on valuation
issues, or that they will reach final agreement to further eliminate or reduce
the loan.
The Company presently owes Madeleine over $15 million and is in default under
the loan agreement. Madeleine has the right to call the loan due and payable at
any time. If Blackacre were to demand payment, the Company would be unable to
make such payment. In such an event, Madeleine would have the right to foreclose
on significant assets of the Company that collateralize the loan. Such
foreclosure would result in the Company being unable to continue in business.
Mortgage payable
In November 1999, the Company refinanced its mortgage loan, borrowing an
additional $1 million, thereby increasing the loan balance to $1.75 million. The
new mortgage loan will expire
on December 1, 2004 and can be renewed for an additional five years. The
mortgage loan bears interest at a fixed rate of 8.5% per annum for five years,
and is secured by the related building. Interest during the renewal term will be
paid at a fixed rate per annum equal to the prime rate in effect on November 1,
2004. Principal of the loan is amortized on a 25-year basis. The mortgage loan
agreement requires the Company to comply with certain covenants, including
maintaining certain net working capital and tangible net worth amounts. If the
Company fails to meet any of the requirements, the loan shall become immediately
due and payable. At September 30, 2002, the Company failed to maintain the
tangible net worth and working capital requirements. Accordingly, the mortgage
payable of $1.7 million has been classified as a current liability. The Company
has not been notified of any intention by the bank to accelerate such
repayments. The Company is current with monthly payment obligations.
RESULTS OF OPERATIONS
NET REVENUES BY SEGMENT
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
2002 2001
Segments ($ million) % of Total ($ million) % of Total
------------------------------------------------------------
Construction 14.1 96.6 16.7 94.9
Communications 0.5 3.4 0.9 5.1
------------------------------------------------------------
Total revenues 14.6 100.0 17.6 100.0
============================================================
OPERATING (LOSS) INCOME BY SEGMENT
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
2002 2001
Segments ($ million) % of Total ($ million) % of Total
------------------------------------------------------------
Construction 0.3 (100.0) 0.7 (100.0)
Communications (0.6) 200.0 (1.4) 200.0
------------------------------------------------------------
Total operating (loss) income (0.3) 100.0 (0.7) 100.0
============================================================
Construction revenue decreased $2.6 million or 15.6% from $16.7 million in
the three months ended September 30, 2001 to $14.1 million in the three months
ended September 30, 2002. The decrease was primarily due to fewer construction
contracts started in 2002.
Cost of construction revenue decreased $2.3 million or 15.8% from $14.6
million in the three months end September 30, 2001 to $12.3 million in the three
months ended September 30, 2002. The decrease was primarily due to the decrease
in construction revenue. Gross profit percentages were 12.7% and 12.6% in the
three months ended September 30, 2002 and 2001, respectively. The improvement in
gross profit percentage was due primarily to a higher gross margin percentage in
the new contracts started in 2002.
Construction operating income decreased $0.4 million or 57.0% from $0.7
million in the three months ended September 30, 2001 to $0.3 million for the
three months ended September 30, 2002. The decrease was due primarily to a
decrease in construction revenue.
Communications revenue decreased $0.4 million or 44.0% from $0.9 million in
the three months ended September 30, 2001 to $0.5 million in the three months
ended September 30, 2002. The decrease was primarily due to the Company's
decision to discontinue telephone services in New York City starting June 2002.
Cost of communications revenue decreased $0.3 million or 60.0% from $0.5
million in the three months ended September 30, 2001 to $0.2 million in the
three months ended September 30, 2002. The decrease was primarily due to the
decrease in revenue. Gross profit percentage increased to 55.6% in the three
months ended September 30, 2002 from 44.4% in the three months ended September
30, 2001. The improvement in gross profit percentage was primarily due to
the termination of telephone service.
Operating loss of the communications segment decreased $0.8 million or 57.1%
from ($1.4) million in three months ended September 30, 2001 to ($0.6) million
in the three months ended September 30, 2002. The improvement was due primarily
to the Company's decision to further limit its communications business efforts
and resources to the Internet and subscription video businesses in the New York
City metropolitan area and in Florida. The Company's communications segment
informed its telephone customers and the FCC in April 2002 that telephone
services would be phased out starting June 2002. Telephone service was
completely discontinued in August 2002. There can be no assurance that the
Company will be able to raise and provide the capital resources to fund the
expected communications operating losses. In addition, in the event that
additional working capital becomes necessary to fund communications operations,
there can be no assurance that the Company will be able to obtain financing on
terms satisfactory to it.
In August 2002, OnTera, Inc. sold certain access agreements on properties
located in the Los Angeles area and the communications assets located in the
properties for $0.4 million. The transaction resulted in a gain of $0.1 million.
As a result of a restructuring of the communications businesses commenced
in fiscal 2001, on a consolidated basis, the general and administrative expenses
decreased $0.7 million or 22.6% from $3.1 million in the three months ended
September 30, 2001 to $2.4 million in the three months ended September 30, 2002.
The decrease in general and administrative expenses included a $0.4 million
decrease in payroll and related costs, and a $0.3 million decrease in
professional fees.
Depreciation and amortization decreased $0.3 million or 50.0% from $0.6
million in the three months ended September 30, 2001 to $0.3 million in the
three months ended September 30, 2002. The decrease was primarily due to charges
of impairment of communications assets recorded in the previous fiscal year, as
well as the sale of communications assets.
Interest income was insignificant in the three months ended September 30,
2002 compared to $0.1 million in the three months ended September 30, 2001. The
decrease was due to a decrease in investment of the Company's excess cash, which
was used instead to fund the operating loss of the communications businesses.
Interest expense increased $0.1 million or 25.0% from $0.4 million in the
three months ended September 30, 2001 to $0.5 million in the three months ended
September 30, 2002. The increase was due primarily to the Company's senior
secured promissory note to Madeleine, in which, unpaid interest was capitalized
and added to the principal due to the proposed amendment to the promissory note.
NEW ACCOUNTING STANDARDS ADOPTED
The Company adopted SFAS 142, "Goodwill and Intangible Assets". The Company does
not have any unamortized goodwill and therefore this adoption has no effect on
the financial statements.
NEW ACCOUNTING STANDARDS NOT YET ADOPTED
In June 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated with
Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullified
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)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. A fundamental conclusion
reached by the FASB in this statement is that an entity's commitment to a plan,
by itself, does not create a present obligation to others that meets the
definition of a liability. SFAS No. 146 also establishes that fair value is the
objective for initial measurement of the liability. The provisions of this
statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. The Company has not yet
determined the impact of SFAS No.146 on its financial position and results of
operations, if any.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("SEC") recently issued proposed guidance
for disclosure of critical accounting policies. The SEC defines "critical
accounting policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effects of matters that are inherently uncertain and
may change in subsequent periods. To the extent that final SEC rules on this
subject may require disclosures in addition to those the Company already makes,
the Company intends to adopt such additional disclosure requirements once the
final rules required are adopted.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates. As of
September 30, 2002, the Company had debt of $17.0 million with various fixed
interest rates from 8.5% to 11.0%. The fixed rate debt may have its fair value
adversely affected if interest rates decline; however, the amount is not
expected to be material. The Company does not have any derivative financial
instruments as of September 30, 2002. The Company believes that the interest
rate risk associated with its investments is not material to the results of
operations of the Company.
ITEM 4 -- CONTROLS AND PROCEDURES
The Company's principal executive officer and principal financial officer have
concluded that the Company's disclosure controls and procedures are effective,
based on their evaluation of these controls and procedures as of November 14,
2002. There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect these controls subsequent to
the date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
In July 2002, plaintiff Harvey Wayne, as an alleged shareholder of the Company,
filed a verified shareholders' derivative complaint against directors and
officers of the Company, various other entities and the Company as a nominal
defendant, in the United States District Court for the Eastern District of New
York. The complaint alleges breach of fiduciary duties and seeks to compel the
Company to hold a shareholders meeting for the election of directors. The
complaint seeks injunctive relief and unspecified damages. The Company has not
yet moved or filed an answer in this matter.
ITEM 3 - DEFAULT UPON SENIOR SECURITIES
(a) As provided in full in Part I, Item 2 of this Report, the Company is in
default under the terms of the Madeleine loan agreement by reason of its being
delisted from Nasdaq and for nonpayment of interest. As of the date of the
filing of this Report, the Company is in default in the amount of $ 15.6
million.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
In the three months ended September 30, 2002, no Current Report on Form 8-K was
filed.
Signatures
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.
DualStar Technologies Corporation
Date: November 14, 2002 By: /s/ GREGORY CUNEO
----------------- --------------------------
Gregory Cuneo
President and Chief Executive Officer
Date: November 14, 2002 By: /s/ ROBERT BIRNBACH
----------------- --------------------------
Robert Birnbach
Executive Vice President and Chief
Financial Officer
Date: November 14, 2002 By: /s/ MICHAEL GIAMBRA
----------------- --------------------------
Michael Giambra
Corporate Controller
CERTIFICATIONS UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Gregory Cuneo, President and Chief Executive Officer of DualStar
Technologies Corporation, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of DualStar Technologies
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 this Quarterly Report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this Quarterly Report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this Quarterly Report is being
prepared;
b) evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
Quarterly Report (the "Evaluation Date"); and
c) presented in this Quarterly Report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of
Company's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data and have identified for the
Company's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal controls;
and
6. The Company's other certifying officers and I have indicated in this
Quarterly Report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Gregory Cuneo
------------------------------
Gregory Cuneo
President and Chief Executive Officer
I, Robert Birnbach, Executive Vice President and Chief Financial Officer of
DualStar Technologies Corporation, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of DualStar Technologies
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 this Quarterly Report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this Quarterly Report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this Quarterly Report is being
prepared;
b) evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
Quarterly Report (the "Evaluation Date"); and
c) presented in this Quarterly Report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of
Company's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data and have identified for the
Company's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal controls;
and
6. The Company's other certifying officers and I have indicated in this
Quarterly Report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Robert Birnbach
---------------------------------
Robert Birnbach
Executive Vice President and Chief Financial Officer
CERTIFICATIONS UNDER SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Gregory Cuneo, President and Chief Executive Officer of DualStar Technologies
Corporation (the "Company"), do hereby certify in accordance with 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
- -- The Quarterly Report on Form 10-Q of the Company for the period ending
September 30, 2002 (the "Quarterly Report") fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of
1934 (15 U.S.C. 78m or 78o(d)), and
- -- The information contained in the Quarterly Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: November 14, 2002
/s/ Gregory Cuneo
-------------------------------------
Gregory Cuneo
President and Chief Executive Officer
I, Robert Birnbach, Executive Vice President and Chief Financial Officer of
DualStar Technologies Corporation (the "Company"), do hereby certify in
accordance with 18 U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
- -- The Quarterly Report on Form 10-Q of the Company for the period ending
September 30, 2002 (the "Quarterly Report") fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of
1934 (15 U.S.C. 78m or 78o(d)), and
- -- The information contained in the Quarterly Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: November 14, 2002
/s/ Robert Birnbach
-------------------------------------
Robert Birnbach
Executive Vice President and Chief
Financial Officer