NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
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1.
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ORGANIZATION AND PRINCIPAL ACTIVITIES
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ORGANIZATION AND DESCRIPTION OF BUSINESS
Ultronics Corporation ( “the Company”) was incorporated in the state of Nevada on March 14, 1990 to serve as a vehicle to effect a merger, exchange of capital stock, asset acquisition or other business combination with a domestic or foreign private business. On February 14, 2005 the Company acquired all of the outstanding shares of General Environmental Management, Inc (“GEM”), a Delaware Corporation. The acquisition was accounted for as a reverse merger (recapitalization) with GEM deemed to be the accounting acquirer, and Ultronics Corporation the legal acquirer. Subsequent to the acquisition, the Company changed its name to General Environmental Management, Inc.
GEM previously operated as an environmental service firm structured to provide EHS compliance services, field services, transportation, off-site treatment, and on-site treatment services. On February 26, 2010, GEM completed the sale of this environmental service business. On November 13, 2009, the Company acquired California Living Waters, which owns all of the issued and outstanding capital stock of Santa Clara Waste Water Company (SCWW"). SCWW, located in Ventura County, California, is a waste water management company that operates a 12.7 mile pipeline from its facility to the City of Oxnard's water reclamation center. SCWW has been treating non-hazardous waste water for the oil and gas industry, industrial clients, and domestic waste generators for 50 years.
BASIS OF PRESENTATION
The condensed consolidated interim financial statements included herein have been prepared by the Company, pursuant to the rules and regulations of the Securities and Exchange Commission, in the opinion of management, include all adjustments which, except, as described elsewhere herein, are of a normal recurring nature, necessary for a fair presentation of the financial position, results of operations, and cash flows for the period presented. The financial statements presented herein should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission.
The results for the interim periods are not necessarily indicative of results for the entire year.
GOING CONCERN
The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company utilized cash in operations of $ 2,327,214 for the three months ended March 31, 2010, and as of March 31, 2010 the Company had current liabilities exceeding current assets by $14,476,019 and had a stockholders’ deficiency of $9,777,078. These matters raise substantial doubt about the Company’s ability to continue as a going concern.
Management is executing a plan to divest certain parts of the business in order to satisfy obligations of its senior lender. In conjunction with that strategy, the assets of GEM Mobile Treatment Services (GEM MTS) were sold on August 17, 2009 to MTS Acquisition Company, Inc., a holding company, and will be owned and operated by two former senior executives of GEM. Consideration for the sale was in the form of promissory notes in the aggregate amount of $5.6 million, the assignment of approximately $1.0 million of accounts payable and possible future royalties. The consideration was immediately assigned to CVC California, LLC, ("CVC") GEM's senior secured lender. As the notes are paid to CVC, GEM's indebtedness to CVC will be reduced (see Note 3).
On November 25, 2009, the Company entered into an Agreement with Luntz Acquisition (Delaware), LLC. (“Buyer”) pursuant to which the Company agreed to sell to Luntz all of the issued and outstanding stock of the Company's primary operating subsidiary, General Environmental Management, Inc. a Delaware corporation, ("GEM DE") for cash (the “Sale”). Luntz agreed to pay the Company $14 million for the purchased interests. On February 26, 2010, after approval of the transaction by the Company’s shareholders at a special meeting held on February 19, 2010, the Company completed the sale of the entities created out of GEM DE. The net cash proceeds from the transaction were used by the Company to retire senior debt and other obligations of the Company (see Note 4).
The Company will continue to operate in the environmental services sector after the Sale. However our primary focus and point for development will center on the SCWW treatment facility and the treatment of non-hazardous waste water. SCWW has been treating non-hazardous waste water for the oil and gas industry, industrial clients, and domestic waste generators for 50 years. Current clients that generate non-hazardous waste for SCWW also have a wider range of waste streams that SCWW currently services, including solids, tank bottoms and drilling muds, and hazardous waste streams. We will continue to provide the full range of services to SCWW’s clientele that SCWW currently offers.
The Company will also research technological opportunities in the waste-to-energy (W-T-E) marketplace as a further resource for our non-hazardous waste water treatment facilities. A W-T-E solution for managing the treating waste provides a significant advantage for generators of the waste, the environment, and the Company.
The Company will continue to develop SCWW as the foundation of our core business in the non-hazardous waste water treatment sector. We intend to do this through internal growth by offering SCWW’s integrated solution for generators of non-hazardous waste water and by making strategic acquisitions of non-hazardous waste water treatment companies.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation
The consolidated financial statements include the accounts of General Environmental Management, Inc., a Nevada corporation, and it’s wholly owned subsidiaries, General Environmental Management, Inc., a Delaware corporation, Island Environmental Services, Inc., a California corporation, General Environmental Management of Rancho Cordova, LLC and California Living Waters Inc. Inter-company accounts and transactions have been eliminated.
(b) Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company’s management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of the contingent assets and liabilities at the date of the financial statements. These estimates and assumptions will also affect the reported amounts of certain revenues and expenses during the reporting period. Actual results could differ materially based on any changes in the estimates and assumptions that the Company uses in the preparation of its financial statements that are reviewed no less than annually. Actual results could differ materially from these estimates and assumptions due to changes in environmental-related regulations or future operational plans, and the inherent imprecision associated with estimating such future matters.
(c) Revenue Recognition
The Company's business activities include providing wastewater treatment for companies and haulers in Ventura County, California, and in adjacent counties. The Company recognizes revenue at the time its customers unload untreated wastewater at the Company's facility. Concurrent with the recognition of revenue, the Company records the estimated costs to treat and dispose of the wastewater on hand.
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collection is reasonably assured.
(d) Concentrations of Credit Risks
The Company’s financial instruments that are exposed to concentrations of credit risk consist principally of cash and trade receivables. The Company places its cash in what it believes to be credit-worthy financial institutions. However, cash balances have exceeded FDIC insured levels at various times. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risk in cash.
The Company’s trade receivables result primarily from removal or transportation of waste, and the concentration of credit risk is limited to a broad customer base located throughout the Western United States.
During the three months ended March 31, 2010, one customer accounted for 21% of revenues.
(e) Fair Value of Financial Instruments
Fair Value Measurements are adopted by the Company based on the authoritative guidance provided by the Financial Accounting Standards Board , with the exception of the application of the statement to non-recurring, non-financial assets and liabilities as permitted. The adoption based on the authoritative guidance provided by the Financial Accounting Standards Board did not have a material impact on the Company's fair value measurements. Based on the authoritative guidance provided by the Financial Accounting Standards Board defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. FASB authoritative guidance establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:
Level 1- Quoted prices in active markets for identical assets or liabilities.
Level 2- Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly.
Level 3- Unobservable inputs based on the Company's assumptions.
FASB issued authoritative guidance that requires the use of observable market data if such data is available without undue cost and effort.
The following table presents certain investments and liabilities of the Company’s financial assets measured and recorded at fair value on the Company’s condensed consolidated balance sheets on a recurring basis and their level within the fair value hierarchy as of March 31,2010 and December 31, 2009:
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Level 1
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Level 2
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Level 3
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Total
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March 31, 2010
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|
|
|
|
|
|
|
|
|
|
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Fair value of warrants and embedded derivatives
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|
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-
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|
|
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-
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|
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$
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-
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|
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$
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-
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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December 31, 2009
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Fair value of warrants and embedded derivatives
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-
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|
|
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-
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$
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2,921,552
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|
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$
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2,921,552
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See Notes 7 and 10 for more information on these financial instruments.
(f) Stock Compensation Costs
The Company periodically issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing costs. Stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. Options vest and expire according to terms established at the grant date.
(g) Earnings per share
Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The diluted earnings per share calculation give effect to all potentially dilutive common shares outstanding during the period using the treasury stock method for warrants and options and the if-converted method for convertible debentures.
Warrants to purchase 10,411,426 shares of common stock and options to purchase 3,208,072 shares of common stock at various prices exceeding $0.19 per share were outstanding during the three months ended March 31, 2010 but were not included in the computation of diluted earnings per share for the period because the respective warrant and option exercise prices were greater than the average market price of the shares of common stock during the period and their effect would be anti-dilutive.
Warrants and options to purchase 16,686,288 shares of common stock have been excluded from the calculation of diluted net loss per share for the three months ended March 31, 2009. These potentially dilutive securities were not included in the calculation of loss per share for the three months ended March 31, 2009 because the Company incurred a loss during such period and thus their effect would have been anti-dilutive. Accordingly, basic and diluted income (loss) per share is the same for the three months ended March 31, 2010 and 2009.
(h) Recent Accounting Pronouncements
In October 2009, the FASB issued authoritative guidance on revenue recognition that will become effective for the Company beginning July 1, 2010, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. We believe adoption of this new guidance will not have a material impact on our financial statements.
In January 2010, the FASB issued guidance on improving disclosures about fair value measurements to add new disclosure requirements for significant transfers in and out of Level 1 and 2 measurements and to provide a gross presentation of the activities within the Level 3 roll-forward. The guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The disclosure requirements are effective for interim and annual reporting periods beginning after December 15, 2009, except for the requirement to present the Level 3 roll-forward on a gross basis, which is effective for fiscal years beginning after December 15, 2010. The adoption of this guidance was limited to the form and content of disclosures, and will not have a material impact on the Company’s results of operations or financial condition.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements
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3. ACQUISITIONS
On November 13, 2009, the Company entered into a Stock Purchase Agreement with United States Environmental Response, LLC, a California limited liability company pursuant to which we purchased all of the issued and outstanding capital stock of California Living Waters, Incorporated ("CLW"), a privately held company. CLW owns all of the issued and outstanding capital stock of Santa Clara Waste Water Company (SCWW") a California corporation. SCWW, located in Ventura County, California, is a waste water
management company that operates a 12.7 mile pipeline from its facility to the City of Oxnard' water reclamation center The Agreement was subject to a rescission if the Company did not pay certain indebtedness to its senior lender by close of business on March 12, 2010. On February 26, 2010 the Company paid its indebtedness to the senior lender and satisfied its obligations related to this rescission.
In consideration for the sale, GEM issued six promissory notes in the aggregate principal amount of $9,003,000, and warrants to purchase 425,000 shares of GEM's common stock valued at $146,678 based upon a Black Scholes valuation model. The Notes bear interest at 6.5 per cent per annum. Two of the Notes, totaling $3,778,000 are convertible into a total of 15% of GEM's common stock on a fully diluted basis upon the occurrence of certain future events (see Note 9). The acquisition was accounted for as a purchase. As
such, the results of SCWW operations have been included in the consolidated financial statements since November 13, 2009.
The following sets out the pro forma operating results for the three months ended March 31, 2009 for the Company had the acquisition occurred as of January 1, 2009:
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Three
months
ended
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March 31, 2009
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(Unaudited)
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Net sales
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$
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1,141,268
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Cost of sales
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868,831
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Gross profit
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272,437
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Operating expenses
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2,393,852
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|
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Operating loss
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(2,121,415
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)
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Other income (expense):
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Interest income
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467
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Interest expense and amortization of deferred financing costs
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(1,010,511
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)
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Gain on derivative liabilities
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552,512
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Other non-operating income
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8,265
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Net Loss
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$
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(2,570,682
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)
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Loss per weighted average share, basic and diluted
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$
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(.20
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)
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4. DISCONTINUED OPERATIONS
Sale of GEM Mobile Treatment
On August 17, 2009, the Company entered into a Stock Purchase Agreement ("Agreement") with MTS Acquisition Company ("MTS"), a privately held company, pursuant to which the Company sold all of the issued and outstanding common stock of GEM Mobile Treatment Services, Inc. (“GEM MTS”). GEM MTS is a provider of mobile wastewater treatment and vapor recovery services with locations in California and Texas.
GEM MTS was purchased by MTS, a corporation owned by two former senior executives of the Company. Consideration for the sale was in the form of a promissory note in the aggregate amount of $5.6 million, the assumption by MTS of approximately $1.0 million of accounts payable and possible future royalties. The consideration was immediately assigned by Company to CVC California, LLC, ("CVC") GEM's senior secured lender. As the notes are paid to CVC, GEM's indebtedness to CVC will be reduced. At the time of the sale, the net assets of MTS were $1,089,341.
The promissory note for $5,600,000 bears interest at 8%. On the first day of each calendar month commencing September 1, 2009 through and including August 1, 2010, accrued interest on the outstanding principal is due and payable. Thereafter, principal and interest under this Note is payable in thirty-six (36) consecutive equal monthly installments of principal and interest of $174,321.50 each, with the first installment due and payable on September 1, 2010, and with subsequent installments due and payable on the first day of each calendar month thereafter through and including August 1, 2013. All or any portion of the unpaid principal balance of this note, together with all accrued and unpaid interest on the principal amount being prepaid, may at the MTS’s option be prepaid in whole or in part, without premium or penalty. The Note is secured by liens on substantially all of assets and properties of MTS.
Concurrent with the closing of the sale of GEM MTS, the Company assigned with full recourse and full representation and warranty of title and ownership the promissory note to the Company’s senior lender (See Note 6). The Company also entered into a subordinated collateral agreement with GEM MTS in order to secure potential obligations related to indemnification payments it may hereafter become obligated to make to MTS in accordance with the Agreement.
The transaction resulted in the Company receiving $4,510,659 excess of consideration ($5.6 million note) over the $1,089,341 of net assets to be disposed. The Company analyzed the current accounting guidance and determined that the gain included in this transaction should not be recognized until the consideration is received. In making this decision the Company determined that the buyers initial investment did not qualify for recognition of profit by the full accrual method as the company did not receive sufficient cash proceeds upon the consummation of the transaction, and collection of the amounts due are uncertain. Under this method the note receivable has not been recorded, and no profit will be recognized until cash Payments by the buyer exceed the sellers cost of the assets. The transaction will be reassessed in the future to determine if it has met the criteria for the full accrual method, and at that time any unrecognized income will be recognized in the income statement. The Company reflected the $1,089,341 of net assets of MTS sold at the date of the transaction as due from buyer as of March 31, 2010 and December 31,2009 as no payment on the note have been received.
Sale of General Environmental Management Inc.
On November 25, 2009, General Environmental Management, Inc., a Nevada corporation (“Company”) entered into a Stock Purchase Agreement ("Purchase Agreement") with Luntz Acquisition (Delaware), LLC, ("Luntz") a subsidiary of PSC Environmental Services, LLC (“PSC”), pursuant to which the Company agreed to sell General Environmental Management, Inc. (DE) and its subsidiaries (“GEM Delaware”), which include five service centers, the TSDF of GEM Rancho Cordova LLC, and the Island Environmental Services business. PSC is a leading provider of industrial cleaning, environmental, remediation, and transportation services. GEM Delaware, a subsidiary of the Company, is a full-service hazardous waste management and environmental services firm with locations in the western United States On February 19, 2010, at a Special Meeting, stockholders approved the Purchase Agreement and on February 26, 2010, the Company completed the sale of GEM Delaware and its subsidiaries
Consideration for the sale was cash in the aggregate amount of $14 million,. As agreed, the final purchase price was adjusted by $2,477,400 based on the computation of net working capital at closing, resulting in net proceeds to the Company of $11,542,472 after closing costs. The net gain to the Company on the sale of DE after consideration of all closing costs was $8,687,132 (including a bonus of $765,000 to be paid to certain officers and directors). Luntz has retained $1.089 million for the one year period following the Closing, to assure payment of certain of the Company’s indemnification obligations, if any, arising under the Purchase Agreement and the related ancillary agreements.
A summary of the assets and liabilities of General Environmental Management Inc. as of
December 31, 2009 :
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December 31, 2009
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|
|
|
|
|
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Current assets
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$
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2,453,085
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Property and Equipment – net of accumulated depreciation
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4,901,641
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Goodwill and Intangibles
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612,615
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Other assets
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561,433
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TOTAL ASSETS
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8,528,774
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|
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|
|
|
|
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Current liabilities
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|
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4,928,153
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Long-term liabilities
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|
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677,982
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TOTAL LIABILITIES
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|
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5,606,135
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ASSETS OF GEM DELAWARE HELD FOR SALE
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$
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2,922,639
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The unaudited operating results of these discontinued operation for the three months ended March 31, 2010 and 2009 was as follows:
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|
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Three Months ended March 31,
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2010
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|
|
2009
|
|
|
|
|
|
|
|
|
|
|
Net sales
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$
|
1,806,747
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|
|
$
|
8,201,870
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|
|
|
|
|
|
|
|
|
|
|
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Cost of sales
|
|
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1,817,580
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|
|
|
7,196,715
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|
|
|
|
|
|
|
|
|
|
|
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Gross profit (Loss)
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|
|
(10,833)
|
|
|
|
1,005,155
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|
|
|
|
|
|
|
|
|
|
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Operating expenses
|
|
|
394,830
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
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Operating income (loss)
|
|
|
(405,663)
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|
|
|
1,005,155
|
|
|
|
|
|
|
|
|
|
|
|
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Other income (expense):
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|
|
|
|
|
|
|
|
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Interest expense and financing costs - net
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|
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(1,635)
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|
|
|
(106,041)
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|
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Gain (loss) from discontinued operations
|
|
$
|
(407,298)
|
|
|
$
|
899,114
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5. PROPERTY AND EQUIPMENT
Property and Equipment consists of the following as of March 31, 2010 and December 31, 2009:
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|
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March 31, 2010
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|
|
December 31, 2009
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
Land
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|
$
|
3,225,000
|
|
|
$
|
3,225,000
|
|
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Vehicles
|
|
|
90,776
|
|
|
|
90,776
|
|
|
Machinery and equipment
|
|
|
957,409
|
|
|
|
818,606
|
|
|
Land improvements
|
|
|
310,131
|
|
|
|
310,131
|
|
|
Plant and pipeline
|
|
|
8,435,914
|
|
|
|
8,308,929
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|
|
Construction in progress
|
|
|
62,500
|
|
|
|
62,500
|
|
|
|
|
|
13,081,730
|
|
|
|
12,815,942
|
|
|
Less accumulated depreciation and amortization
|
|
|
465,470
|
|
|
|
153,448
|
|
|
Property and equipment net of accumulated depreciation and amortization
|
|
$
|
12,616,260
|
|
|
$
|
12,662,494
|
|
The Company recorded depreciation expense of $312,022 for the three months ended March 31, 2010 . The Company recorded depreciation expense on the property and equipment related to its discontinued operations $152,862 and $1,370,960 which is in included in net loss from discontinued operations for the three months ending March 31, 2010.
6. RELATED PARTY TRANSACTIONS
|
Advances from Related Parties
|
|
During 2008, General Pacific Partners (“GPP”), a company operated by a prior member of the Board of Directors of the Company’s wholly owned subsidiary, General Environmental Management, Inc. of Delaware, made two unsecured advances to the Company totaling $472,500. The rate of interest on the advances was 10% per annum. As of December 31, 2009, $534,129 was outstanding under this advance (including accrued interest of $61,719). In 2008, GPP also provided certain financing services for which the Company agreed to pay GPP $250,000. The balance due to GPP for these services was $100,000 as of December 31, 2009. During the three month period ended March 31, 2010, General Pacific Partners agreed to convert $575,000 of the indebtedness to GPP into 1,437,500 shares of the Company’s common stock. The shares issued to GPP were valued at $273,125 based upon the trading price of the shares at the date of the agreement, resulting in a gain to the Company of $301,875. As of March 31, 2010, the remaining balance due to GPP was $69,226.
|
During the year ended December 31, 2009 a related individual made an unsecured advance with no formal terms of repayment to the Company totaling $115,000. The proceeds were used for working capital purposes. At March 31, 2010 and December 31, 2009 the balance due on the advance was $97,500 and $107,500, respectively.
|
Due to Officers and Directors
|
Commensurate with the closing of the sale to Luntz (see Note 4), certain officers and directors were granted a bonus $765,000 which is outstanding as of March 31, 2010.
|
7.
|
SECURED FINANCING AGREEMENTS
|
During the period 2008 through 2009, the Company entered into a series of financings with CVC California, LLC (“CVC”). The amounts due under these financings at March 31, 2010 and December 31, 2009 are as follows:
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured Notes from CVC California
|
|
$
|
6,777,027
|
|
|
$
|
14,658,365
|
|
|
Valuation Discount
|
|
|
-
|
|
|
|
(2,196,585
|
)
|
|
|
|
$
|
6,777,027
|
|
|
$
|
12,461,780
|
|
Note Agreements with CVC California
On September 4, 2009, the Company entered into a series of agreements with CVC that amended these agreements, including an Amended and Restated Revolving Credit and Term Loan Agreement, an Amended and Restated Revolving Credit Note, an Amended and Restated Convertible Term Note, a new Term Note, and Amended and Restated Warrants to purchase shares of the Company's common stock. Pursuant to the Amended and Restated Revolving Credit and Term Loan Agreement, (the "Amended Agreement") dated as of September 4, 2009 the Company issued to CVC:
(i) an Amended and Restated secured convertible term note (“ Convertible Note”) in the principal amount of $6,314,700. The principal amount of the Convertible Note bears an interest rate of fourteen percent, subject to adjustment, with interest payable monthly commencing November 1, 2009. The principal of the convertible Note is payable on demand or, in the absence of demand, (i) in seven (7) equal monthly installments of $138,000 each, due and payable on the first day of each calendar month commencing December 1, 2009 and continuing through and including June 1, 2010, and (ii) a final installment due and payable on June 30, 2010 in an amount equal to the entire remaining principal balance of this note. In the event of a prepayment of the Convertible Note, the Company must pay a prepayment premium in an amount equal to (
a
) two (2%) percent of the principal amount being prepaid if the prepayment is made on or prior to February 28, 2010, and (b) one (1%) percent of the principal amount being prepaid if such prepayment is made subsequent to February 28, 2010 and prior to August 1, 2011, unless the prepayment is made with the proceeds received from the sale of any business unit or units of the Company. The balance of the note outstanding at December 31, 2009 was $6,314,700. The note was paid in full on February 26, 2010 with the proceed from the sale of GEM Delaware (see Note 4).
The principal amount of the Convertible Note and accrued interest thereon due CVC was convertible into shares of the Company's common stock at a price of $0.60 per share, subject to certain adjustments. The convertible feature gave rise to a derivative liability that was valued at $896,542 at December 31, 2009. Concurrent with the extinguishment of the convertible note, the derivative liability was extinguished and a gain of $896,542 was recorded.
(ii) an Amended and Restated Secured Non-convertible Revolving Credit Note in the principal amount of up to $1.7 million (the " Revolving Note"). The principal amount of the Revolving Note bears interest at the rate of 10% per annum and is payable on demand (or, in the absence of demand, on August 31, 2011, or sooner by reason of an Event of Default or other mandatory prepayment event. The balance of the note outstanding at March 31, 2010 and December 31, 2009 was $1,177,027 and $1,700,000, respectively.
The Amended and restated Secured Non-convertible Revolving Credit Note was amended on November 25, 2009 with an Overadvance Note in the amount of $1,190,357.The principal amount of the Overadvance Note bears interest at the rate of 15% per annum and is payable on demand or, in the absence of demand, on August 31, 2011, or sooner by reason of an Event of Default or other mandatory prepayment event. The balance of the Overadvance Note outstanding at December 31, 2009 was $1,043,665. The overadvance note was paid in full with the proceeds from the sale of GEM Delaware (see Note 4).
In connection with the Convertible Note and the Amended and restated Secured Non-convertible Revolving Credit Note, the Company had granted to CVC a Warrant to purchase Two Million Seven Hundred Thousand (2,700,000) fully paid and non-assessable shares (the “Warrant Shares”) of the Company’s common stock, for cash at a price of $0.01 per share. The Company had previously determined that as the exercise price of the warrant contained reset provisions, the warrant was characterized as a derivative liability at December 31, 2009 in accordance with authorative guidance issued by FASB. Concurrent with the payoff of these notes, the warrant was converted to common shares and the derivative liability was extinguished (see Note 10).
(iii) a Term Note (“Term Note ”) in the principal amount of $5.6 million. The principal amount of the Term Note bears interest at the rate of 8% per annum and is payable as follows: on the first day of each calendar month commencing October 1, 2009 through and including August 1, 2010, accrued Interest on the outstanding principal shall be due and payable. Thereafter, principal and interest is payable in thirty-six (36) consecutive equal monthly installments of principal and interest of $174,321.50 each, with the first installment due and payable on September 1, 2010, and with subsequent installments due and payable on the first day of each calendar month thereafter through and including August 1, 2013. There is no pre-payment penalty in the event of a pre-payment. The balance of the Term Note outstanding at March 31, 2010 was $5,600,000.
On August 17, 2009, the Company had entered into a Stock Purchase Agreement with MTS Acquisition Company ("MTS"), pursuant to which the Company sold all of the issued and outstanding common stock of GEM Mobile Treatment Services, Inc. (“GEM MTS”). Consideration for the sale of GEM MTS was in the form of a promissory note (“the MTS Note") in the aggregate amount of $5.6 million, (payable on the same dates and terms as the Term Note), the assignment of approximately $1.0 million of accounts payable and possible future royalties. The consideration was immediately assigned to CVC. As the MTS Note is paid to CVC by MTS, the Company's indebtedness to CVC will be reduced.
Following the Closing of the sale of GEM Delware and the payoff of the notes to CVC, the Revolving Credit Note was amended and restated so as to provide for (a) the reduced principal balance (after giving effect to the payment described above), (b) the elimination of any right to further Advances; (c) interest on the principal balance from time to time to be paid monthly in arrears as currently provided in the Revolving Credit Note, and (d) principal to be payable (i) as, when and to the extent that payments are received by GEM under the Royalty Provisions, (ii) from amounts paid to or in respect of the Borrower under Section 10.12 of the GEM MTS Purchase Agreement or otherwise in respect of the $900,000 deposit in the Union Bank trust account, and (iii) to the extent not theretofore paid, any remaining balance of the amended and restated Revolving Credit Note shall be due and payable on demand (or, if no demand is earlier made, then on March 1, 2011). (Other than as stated herein, the Revolving Credit Note shall remain unchanged and shall remain in full force and effect.) In furtherance of the foregoing, immediately after the Closing, GEM gave irrevocable written instructions to MTS Acquisition Company, Inc. (“MTS”) to remit all payments on the Purchase Money Note and pursuant to the Royalty Provisions directly to CVC, until otherwise instructed in writing by the CVC, and (B) GEM gave irrevocable written instructions to PSC to remit all amounts payable under Section 10.12 of the Purchase Agreement directly to CVC; and GEM shall not agree to any amendment of Section 10.12 of the Purchase Agreement or waive any required performance there-under without the Lender’s prior written consent. To the extent that, at any time, CVC shall have received payment in full of the amended and restated Revolving Credit Note and all other Obligations pursuant to the direct payments contemplated in the preceding sentence or otherwise, then CVC shall promptly (x) remit any excess amounts collected to GEM, and (y) give written notice to MTS and/or PSC (as applicable) that payments that would otherwise thereafter be made to CVC as aforesaid shall instead be paid directly to GEM or whomever else shall be entitled thereto. The balance of the revolving credit note was $1,177,027 at March 31, 2010.
Valuation Discount and Modification of Debt
In connection with the CVC financing and subsequent modifications, the Company had recorded valuation discounts against the notes relating to closing fees paid, relative value of warrants issued and the conversion features of the notes. The note discount was $2,196,585 as of December 31, 2009. During the three months ended March 31, 2010, the Company amortized $382,646 of the note discount until February 26, 2010, and recorded a charge of $1,813,939 to remove the discount when the debt was retired.
8. ACQUISITION NOTES PAYABLE
On November 6, 2009, Company entered into a Stock Purchase Agreement ("CLW Agreement") with United States Environmental Response, LLC, a California limited liability company pursuant to which the Company has purchased all of the issued and outstanding capital stock of California Living Waters, Incorporated ("CLW"), a privately held company. In consideration for the sale, the Company issued six promissory notes (individually a "CLW Note" and collectively, the "CLW Notes") in the aggregate principal amount of $9,003,000. As of March 31, 2010 and December 31, 2009, aggregate amounts outstanding under these notes was $8,739,208 and $8,994,648 as follows:
$2,000,000 CLW the Seller's Note-- Payment of the outstanding principal of the CLW the Seller’s Note is due and payable in four (4) installments as follows: (A) Two Hundred Fifty Thousand Dollars ($250,000) in November, 2009, (B) Five Hundred Thousand Dollars ($500,000) and accrued interest on June 30 2010; (C) One Million Dollars ($1,000,000) and accrued interest on January 1, 2011 (D) the balance of all residual principal and accrued interest on March 31, 2011. The balance of the Note at March 31, 2010 and December 31, 2009 was $1,750,000 and $2,000,000, respectively.
$1,700,000 CLW Note One-- Payment of the outstanding principal of CLW Note One is due and payable in 120 installments commencing on December 1, 2009 and continuing on the first day of each calendar month through November 1, 2019. Installments are payable in the following amounts (subject to the other terms of this Note): (A) the amount of principal and accrued interest payable in the first one hundred nineteen (119) Installments shall be equal Installments of principal and interest, calculated on the basis of a 30-year amortization of this Note and (B) the one hundred twentieth (120th) Installment shall be a final, “balloon” payment. The balance of the Note at March 31, 2010 and December 31, 2009 was $1,693,803 and $1,696,917, respectively.
$1,100,000 CLW Note Two-- Payment of the outstanding principal of this CLW Note Two is due and payable in sixty (60) installments commencing on December 1, 2009 and continuing on the first day of each calendar month through November 1, 2014. Installments are payable in the following amounts (subject to the other terms of this Note): (A) the amount of principal and accrued interest payable in the first fifty-nine (59) Installments shall be equal Installments of principal and interest, calculated on the basis of a 30-year amortization of this Note; and (B) the final, “balloon” payment on November 1, 2014. The balance of the Note at March 31, 2010 and December 31, 2009 was $1,090,955 and $1,095,501, respectively.
$425,000 CLW Note Three-- Payment of the outstanding principal of the CLW Note is due and payable in 120 installments commencing on December 1, 2009 and continuing on the first day of each calendar month through November 1, 2019. Installments are payable in the following amounts (subject to the other terms of this Note): (A) the amount of principal and accrued interest payable in the first one hundred nineteen (119) Installments shall be equal Installments of principal and interest, calculated on the basis of a 30-year amortization of this Note and (B) the one hundred twentieth (120th) Installment shall be a final, “balloon”. CLW Note Three is convertible at any time in full or in part (but if in part, then only in principal increments of $100,000 or an integral multiple thereof) into shares of common stock of Company at the conversion rate of Four Dollars ($4.00) per share, subject to adjustment. The balance of the Note at March 31, 2010 and December 31, 2009 was $423,451 and $424,230, respectively.
$1,600,000 CLW Note Four-- Payment of the outstanding principal of the CLW Note Four is due and payable in 41 installments commencing on July 1, 2010 and continuing on the first day of each calendar month through November 1, 2013. Installments are payable in the following amounts (subject to the other terms of this Note): (A) the amount of principal and accrued interest payable in the first forty Installments shall be equal Installments of principal and interest, calculated on the basis of a 30-year amortization of this Note,
provided that
the first Installment shall also include all interest accrued during the first seven months from the date of this Note; Four and (B) the final, “balloon”, Installment shall be in the amount of all then-outstanding principal, interest and other amounts then outstanding. Note Four is convertible into 5% of the common stock of Company on a fully diluted basis until Company achieves a Capital Restructuring Goal. Capital Restructuring Goal means the concurrent fulfillment of each of the following events: (i) the CLW Seller’s Note shall have been fully paid on the terms thereof as to all theretofore outstanding principal, interest, costs and expenses; (ii) Company shall have available, as properly reflected in Company’s books one million dollars ($1,000,000) in uncommitted working capital (not including any working capital lines of credit); and (iii) Company shall have invested into SCWW capital of at least one million dollars $1,000,000. The balance of the Note at March 31, 2010 and December 31, 2009 was $1,600,000 and $1,600,000, respectively.
$2,178,000 CLW Note Five-- Payment of the outstanding principal of the CLW Note Five is due and payable in 41 installments commencing on July 1, 2010 and continuing on the first day of each calendar month through November 1, 2013. Installments are payable in the following amounts (subject to the other terms of this Note): (A) the amount of principal and accrued interest payable in the first forty Installments shall be equal Installments of principal and interest, calculated on the basis of a 30-year amortization of this Note,
provided that
the first Installment shall also include all interest accrued during the first seven months from the date of this Note; Four and (B) the final, “balloon”, Installment shall be in the amount of all then-outstanding principal, interest and other amounts then outstanding. Note Four is convertible into 10% of the common stock of Company on a fully diluted basis until Company achieves the Capital Restructuring Goal. The balance at March 31, 2010 and December 31, 2009 was $2,178,000 and $ 2,178,000, respectively.
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
$
|
8,736,208
|
|
|
$
|
8,994,648
|
|
|
Current portion
|
|
|
(564,534
|
)
|
|
|
(1,072,974
|
)
|
|
Long Term portion
|
|
$
|
8,171,674
|
|
|
$
|
7,921,674
|
|
9. LONG TERM OBLIGATIONS
Long term obligations consist of the following at March 31, 2010 and December 31, 2009:
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
(a) Notes Payable, National Bank of California
|
|
$
|
3,970,545
|
|
|
$
|
4,175,187
|
|
|
(b) Notes Payable, Island Acquisition
|
|
|
1,250,000
|
|
|
|
1,250,000
|
|
|
(c) Notes Payable, Investors
|
|
|
521,251
|
|
|
|
521,251
|
|
|
(d) Note payable, Wiker Trust
|
|
|
270,986
|
|
|
|
279,306
|
|
|
(e) Note payable, Agua de Oro 2
|
|
|
29,900
|
|
|
|
47,969
|
|
|
(f) Equipment Note payable, OMNI Bank
|
|
|
14,531
|
|
|
|
19,442
|
|
|
(g) Note payable, Individual
|
|
|
26,400
|
|
|
|
27,900
|
|
|
(h) Subordinated notes payable
|
|
|
1,800,000
|
|
|
|
1,800,000
|
|
|
Total Notes Payable
|
|
|
7,883,613
|
|
|
|
8,121,055
|
|
|
Less Note discount
|
|
|
50,458
|
|
|
|
59,916
|
|
|
Less current portion
|
|
|
4,049,236
|
|
|
|
4,822,719
|
|
|
Notes payable, net of current portion
|
|
$
|
3,783,919
|
|
|
$
|
3,238,420
|
|
|
(a)
|
Notes payable to National Bank of California consists of the following at March 31, 2010 and December 31, 2009 :
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
(i) Notes Payable, National Bank of California 1
|
|
$
|
1,769,257
|
|
|
$
|
1,779,060
|
|
|
(ii) Notes Payable, National Bank of California 2
|
|
|
1,685,997
|
|
|
|
1,701,137
|
|
|
(iii) Notes Payable, National Bank of California 3
|
|
|
46,331
|
|
|
|
58,741
|
|
|
(iv) Notes Payable, National Bank of California 4
|
|
|
132,939
|
|
|
|
145,982
|
|
|
(v) Notes Payable, National Bank of California 5
|
|
|
336,021
|
|
|
|
490,267
|
|
|
Total
|
|
$
|
3,970,545
|
|
|
$
|
4,175,187
|
|
(i) Note payable to National Bank of California, 80% guaranteed by the USDA and various related parties of the Company, bears interest at Prime plus 1%, and is payable over 20 years. (i) Note payable to National Bank of California, 80% guaranteed by the USDA and various related parties of the Company, bears interest at Prime plus 1%, and is payable over 20 years. The loan is secured by a first lien on all assets and commercial real estate of the Company, including the pipeline, and is due in 2026.
(ii) Note payable National Bank of California, 80% guaranteed by the USDA and various related parties of the Company, bears interest at Prime plus 1%, and is payable over 20 years. The loan is secured by a first lien on all assets and commercial real estate of the Company’s California Living Water Subsidiary, including the pipeline, and is due in 2026.
(iii) Note payable to National Bank of California, 80% guaranteed by the USDA and various insiders of the Company, bears interest at Prime plus 1%, and is payable over 5 years. The loan is secured by a first lien on all assets and commercial real estate of the Company’s California Living Water Subsidiary, and is due in 2011.
(iv) Note payable to National Bank of California, guaranteed by various related parties of the Company, interest at Prime plus 2%, payable over five years. This loan is secured by equipment and is cross collateralized to all other notes with National Bank of California.
(v) Note payable to National Bank of California, secured primarily by accounts receivable, bearing interest at Prime plus 2%. The note was due on March 5, 2010 and has been extended until June 2010.
The above loans are subject to certain covenants with the senior lender, National Bank of California. The affirmative covenants apply to the financial results of the Company’s subsidiary, SCWW, and include certain ratio requirements such as current ratio, Debt / Worth ratio and debt service. At December 31, 2009, SCWW was not in compliance with certain of these covenants, and as such, the notes are in default. The company is currently in discussions to resolve the default, and has classified the notes as current in the accompanying March 31, 2010 balance sheet.
(b) On August 31, 2008, the Company entered into a stock purchase agreement with Island Environmental. As part of the consideration for the purchase, the Company issued two three year promissory notes totaling $1.25 million. The first note is payable to the former owners in the amount of $1,062,500. The second note is payable to NCF Charitable Trust in the amount of $187,500. The notes bear interest at eight percent (8%) with the entire balance of interest and principal payable August 31, 2011. In conjunction with the revision to the agreements with CVC described in Note 7 an amendment to these notes was executed that all interest payments and principal payments due pursuant to the notes were deferred until August 31, 2011.
(c) During the period March 4, 2004 through June 22, 2004, the Company entered into a Loan and Security Agreement with several investors to provide the funding necessary for the purchase of the Transfer Storage Disposal Facility (TSDF) located in Rancho Cordova, California. The notes were secured by the TSDF, carried an interest rate of eight percent (8%) per annum, and principal and interest are convertible at $30.00 per share into common stock. In addition, the note holders were issued warrants to purchase common stock. The notes were initially due June 30, 2009, but were extended to September 30, 2011. As of December 31, 2008, notes payable of $422,500 plus accrued interest of $67,105 remained outstanding.
On July 1, 2009 three note holders entered into new promissory note agreements that replaced in full the principal of the Loan and Security Agreement dated June 1, 2004. The notes are unsecured and carry an interest rate of ten percent (10%) per annum. The principal of the notes is due December 31, 2010.
On August 1, 2009 accrued interest of $168,528 was converted into 485,150 shares of common stock. As an incentive to convert the accrued interest into shares of the Company's common stock, the Board of Directors awarded 663,814 fully vested warrants to purchase common stock of the Company to the three convertible note holders. The warrants are exercisable at $0.52 per share and have a forty (40) month term. The value of these warrants was calculated at $231,140 and included in the statement of operations for the year ending December 31, 2009 as a cost to induce conversion. For the Black Scholes calculation, the Company assumed no dividend yield, a risk free interest rate of 1.72 % and expected volatility of 104.54 %.
As of December 31, 2009, notes payable of $500,000 and accrued interest of $21,252 remained outstanding.
(d) The Wiker Trust obligation is interest only, bearing interest at 7.75% per annum, due August 1, 2012. This is an unsecured note that is subordinated to the National Bank of California notes.
(e) An unsecured four-year note, bearing interest at 15%, payable in monthly installments of $6,130, including interest. This note is subordinated to the National Bank of California notes.
(f) Note payable relating to the purchase of equipment. The note bears interest at 10.88% per annum, payable in 36 monthly installments of principal and interest at $2,456. This obligation is subordinated at the National Bank of California notes.
(g) An unsecured four-year note, bearing interest at 15%, payable in monthly installments of $6,130, including interest. This note is subordinated to the National Bank of California notes.
(h) The Company has two notes payable that are subordinated to the notes payable to National Bank of California. The subordinated Notes Payable consists of the following at March 31, 2010:
|
(i) Note payable, Wiker Trust
|
|
$
|
800,000
|
|
|
(ii) Note payable, US Environmental Response
|
|
|
1,000,000
|
|
|
Total
|
|
$
|
1,800,000
|
|
(i) The Wiker Trust obligation is interest only, bearing interest at 7.75% per annum, due August 1, 2012. This is an unsecured note that is subordinated to the National Bank of California notes. The Wiker Trust is a charitable remainder trust who made the initial loan to the Company in order to fund the acquisition of SCWW in 2004. The CEO of SCWW is a trustee of the Wiker Trust.
(ii) The United States Environmental Response (“USER”) note, formerly held by Aqua de Oro, is a four year note, bearing interest at 7.75%, payable in monthly installments of $6,458 for 7 years, with all remaining principal and interest due on July 31, 2011. The CEO of SCWW is the President of USER. The balance due represents funds paid by Company to the court appointed disbursing agent for the benefit of approved creditors. This is an unsecured note that is subordinated to the National Bank of California notes and all debts allowed in the Company's bankruptcy reorganization.
10. DERIVATIVE LIABILITIES
In 2009, the Company adopted the FASB’s guidance on “Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock.” This guidance requires that instruments which do not have fixed settlement provisions are deemed to be derivative instruments. The conversion feature of the Company’s Secured Financing and the related warrants, do not have fixed settlement provisions because their conversion and exercise prices, respectively, may be lowered if the Company issues securities at lower prices in the future. The Company was required to include the reset provisions in order to protect the note holders from the potential dilution associated with future financings. In accordance with current guidance, the conversion feature of the notes was separated from the host contract (i.e., the notes) and recognized as an embedded derivative instrument at December 31, 2009. During the three months ended March 31, 2010, the Company eliminated these derivative liabilities.
The derivative liabilities were valued as of March 31, 2010 and December 31, 2009 using a probability weighted Black-Scholes-Merton valuation technique with the following weighted average assumptions:
|
|
|
March
31,
2010
|
|
|
December
31,
2009
|
|
|
Conversion feature:
|
|
|
|
|
|
|
|
Risk-free interest rate
|
|
|
-
|
|
|
|
.40%
|
|
|
Expected volatility
|
|
|
-
|
|
|
|
137.57%
|
|
|
Expected life (in years)
|
|
|
-
|
|
|
|
0.75
|
|
|
Expected dividend yield
|
|
|
-
|
|
|
|
0.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants:
|
|
|
|
|
|
|
|
|
|
Risk-free interest rate
|
|
|
-
|
|
|
|
-
|
|
|
Expected volatility
|
|
|
-
|
|
|
|
-
|
|
|
Expected life (in years)
|
|
|
-
|
|
|
|
-
|
|
|
Expected dividend yield
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value:
|
|
|
|
|
|
|
|
|
|
Conversion feature
|
|
|
-
|
|
|
$
|
896,542
|
|
|
Warrants
|
|
|
-
|
|
|
|
2,025,000
|
|
|
|
|
$
|
-
|
|
|
$
|
2,921,542
|
|
The risk-free interest rate was based on rates established by the Federal Reserve. The expected volatility was based on the Company’s historical volatility for its common stock. The expected life of the conversion feature of the notes was based on the term of the notes and the expected life of the warrants was determined by the expiration date of the warrants. The expected dividend yield was based on the fact that the Company has not paid dividends to common shareholders in the past and does not expect to pay dividends to common shareholders in the future.
Warrant Liability
In connection with the CVC financings described in Note 7, the Company had granted to CVC an Amended and Restated Warrant to purchase Two Million Seven Hundred Thousand (2,700,000) fully paid and non-assessable shares (the “Warrant Shares”) of the Company’s common stock, for cash at a price of $0.01 per share at any time and from time to time from and after the date hereof and until 5:00 p.m. (Pacific time) on August 31, 2014. CVC also had the right and option, exercisable effective at any time upon or after the consummation of a Sale of the Company’s revenue-generating business units, or upon and after the occurrence and during the continuance of an Event of Default or any other event or circumstance which causes, effects or requires any payment in full under the Loan Agreement and until the Expiration Date, to require the Company to redeem and purchase any or all Warrant Shares or rights to purchase Warrant Shares hereunder, for a cash purchase price of $0.75 per Warrant Share or per right to purchase a Warrant Share hereunder, such option purchase price to be subject to adjustment from time to time in respect of certain events. The total value of the put if all shares are redeemed was $2,025,000, and was recorded as a derivative liability at December 31, 2009. In conjunction with the closing and the Amended and Restated Warrant to Purchase Shares of Common Stock, CVC of California exercised its put option related to its warrant for 2,700,000 shares for a cash purchase price of $0.75 per Warrant Share or $2,000,000. At closing, CVC was paid $500,000 and issued 3,750,000 shares of the Company’s common stock valued at $712,500 to satisfy the put option, resulting in a gain on extinguishment of the derivative liability of $812,500 in the accompanying March 31, 2010 statement of operations.
Conversion feature
The principal amount of the Convertible Note and accrued interest thereon due CVC was convertible into shares of the Company's common stock at a price of $0.60 per share, subject to certain adjustments. The convertible feature gave rise to a derivative liability that was valued at $896,542 at December 31, 2009. Concurrent with the extinguishment of the convertible note during 2010, the derivative liability was extinguished and a gain of $896,542 was recorded in the accompanying March 31, 2010 statement of operations.
11. STOCK OPTIONS AND WARRANTS
On March 28, 2007 the Board of Directors approved and implemented the 2007 Stock Option Plan (the “Plan”). The plan authorized option grants to employees and other persons closely associated with the Company for the purchase of up to 5,500,000 shares.
No options were issued during the quarter ended March 31, 2010.
|
|
|
Weighted Avg.
|
|
|
Weighted Avg.
|
|
|
Weighted Avg.
|
|
|
|
|
Options
|
|
|
Exercise Price
|
|
|
Life in Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding, January 1, 2010
|
|
|
3,400,155
|
|
|
|
1.54
|
|
|
|
7.58
|
|
|
Options granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Options exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Options cancelled
|
|
|
(192,083
|
)
|
|
|
1.60
|
|
|
|
-
|
|
|
Options outstanding, March 31, 2010
|
|
|
3,208,072
|
|
|
|
1.53
|
|
|
|
7.30
|
|
|
Options exercisable, March 31, 2010
|
|
|
2,985,563
|
|
|
|
1.58
|
|
|
|
7.20
|
|
The options had no intrinsic value at March 31, 2010.
For the three months ended March 31, 2010 and 2009, the fair value of options vesting during the period was $119,677 and $261,734 respectively, and has been reflected as compensation cost. As of March 31, 2010, the Company has unvested options valued at $151,287 which will be reflected as compensation cost over the estimated remaining vesting period of 24 months.
Warrants
A summary of the warrant activity during the period is as follows:
|
|
|
|
|
|
Range of exercise prices
|
|
|
Weighted Avg. in Years
|
|
|
Warrants outstanding, January 1, 2010
|
|
|
10,411,426
|
|
|
$
|
0.52-$37.50
|
|
|
|
4.19
|
|
|
Warrants granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Warrants exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Warrants expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Warrants outstanding, March 31, 2010
|
|
|
10,411,426
|
|
|
$
|
0.52-$37.50
|
|
|
|
3.92
|
|
The warrants had no intrinsic value at March 31, 2010.
12. COMMITMENTS AND CONTINGENCIES
Legal Proceeding
On July 5, 2007, a lawsuit was instituted by Romic Environmental Technologies Corp. (“RET”) against the Company and four of its senior executives, all of whom were formerly employed by RET. The lawsuit was brought in the Superior Court of the State of California, County of Los Angeles. The lawsuit was settled by the Company in February 2010 with the majority of the settlement payment funded by insurance.
The Company is subject to legal proceedings and claims that arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters will not have material adverse effect on its financial position, results of operations or liquidity.
13. INCOME TAXES
The Company's net deferred tax assets consisted of the following at March 31, 2010 and
December 31, 2009:
|
|
|
March 31,
2010
|
|
|
December 31,
2009
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax asset, net operating loss
|
|
$
|
9,263,441
|
|
|
$
|
19,411,281
|
|
|
Less valuation allowance
|
|
|
(9,263,441
|
)
|
|
|
(19,411,281
|
)
|
|
Net deferred tax asset
|
|
$
|
-
|
|
|
$
|
-
|
|
As of March 31, 2010, the Company had federal net operating loss carry forwards of approximately $27,245,415 expiring in various years through 2025, which can be used to offset future taxable income, if any. No deferred asset benefit for these operating losses has been recognized in the financial statements due to the uncertainty as to their realizability in future periods.
As of March 31, 2010, the Company recorded a gain on the sale of General Environmental Management, Inc. (DE) and its subsidiaries (“GEM Delaware”), which include five service centers, the TSDF of GEM Rancho Cordova LLC, and the Island Environmental Services business (See Note 4). Due to the State of California disallowing the use of NOL carryforwards for the calendar year 2010, the Company recorded a state tax provision of $325,000. Due to the affect of the Federal Alternative Minimum Tax on the gain transaction, the Company recorded a $100,000 federal tax provision.
Reconciliation of the effective income tax rate to the United States statutory income tax rate for the three months ended March 31, 2010 and 2009 is as follows:
|
|
|
Three months ended
March 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
Tax expense at U.S. statutory income tax rate
|
|
|
(34.0
|
) %
|
|
|
(34.0
|
) %
|
|
Increase in the valuation allowance
|
|
|
34.0
|
|
|
|
34.0
|
|
|
Effective rate
|
|
|
-
|
|
|
|
-
|
|
Effective January 1, 2007, the Company adopted a new accounting requirement to Account for Uncertainty
in Income Taxes. The interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under the new accounting requirements, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. The new requirements also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of March 31, 2010, the Company did not have a liability for unrecognized tax uncertainties.
The Company files income tax returns in the U.S. federal jurisdiction and various states. The Company is subject to U.S. federal or state income tax examinations by tax authorities for years after 2002. During the periods open to examination, the Company has net operating loss and tax credit carry forwards for U.S. federal and state tax purposes that have attributes from closed periods. Since these NOLs and tax credit carry forwards may be utilized in future periods, they remain subject to examination.
The Company’s policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of March 31, 2010 the Company has no accrued interest or penalties related to uncertain tax positions.
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
In addition to historical information, this Quarterly Report contains forward-looking statements, which are generally identifiable by use of the words “believes”, “expects”, “intends”, “anticipates”, “plans to”, “estimates”, “ projects”, or similar expressions. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Factors That May Affect Future Results”. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in other documents the company files from time to time with the Securities and Exchange Commission ( the “SEC”), including the Quarterly Reports on form 10-Q filed by us in the fiscal year 2009.
Statements made in this Form 10-Q (the “Quarterly Report”) that are not historical or current facts are “forward-looking statements” made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the “Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend that such forward-looking statements be subject to the safe harbors for such statements. We wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. Any forward-looking statements represent management’s best judgment as to what may occur in the future. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Quarterly Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We disclaim any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statement or to reflect the occurrence of anticipated or unanticipated events.
The words “we,” “us,” “our,” and the “Company,” refer to General Environmental Management, Inc. The words or phrases “may,” “will,” “expect,” “believe,” “anticipate,” “estimate,” “approximate,” or “continue,” “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions, or the negative thereof, are intended to identify “forward-looking statements.” Actual results could differ materially from those projected in the forward looking statements as a result of a number of risks and uncertainties, including but not limited to: (a) our failure to implement our business plan within the time period we originally planned to accomplish; and (b) other risks that are discussed in this Quarterly Report or included in our previous filings with the Securities and Exchange Commission (“SEC”).
OVERVIEW
Ultronics Corporation (Ultronics) was a non-operating company formed for the purpose of evaluating opportunities to acquire an operating company. On February 14, 2005 Ultronics acquired General Environmental Management, Inc. through a reverse merger between Ultronics Acquisition Corp., a wholly owned subsidiary of Ultronics and General Environmental Management, Inc., whereby General Environmental Management, Inc. (GEM) was the surviving entity.
The acquisition was accounted for as a reverse merger (recapitalization) with GEM deemed to be the accounting acquirer, and Ultronics Corporation the legal acquirer. Accordingly, the historical financial information presented in the financial statements is that of GEM as adjusted to give effect to any difference in the par value of the issuer’s and the accounting acquirer stock with an offset to capital in excess of par value. The basis of the assets, liabilities and retained earnings of GEM, the accounting acquirer, have been carried over in the recapitalization. Subsequent to the acquisition, the Company changed its name to General Environmental Management, Inc. GEM is a fully integrated environmental service firm structured to provide EHS compliance services, field services, transportation, off-site treatment, and on-site treatment services. Through its services GEM assists clients in meeting regulatory requirements for the disposal of hazardous and non-hazardous waste. GEM provides its clients with access to GEMWare, an internet based software program that allows clients to maintain oversight of their waste from the time it leaves their physical control until final disposition by recycling, destruction, or landfill. The GEM business model is to grow both organically and through acquisitions.
During 2003 and 2004 GEM acquired the assets of Envectra, Inc., Prime Environmental Services, Inc. (Prime) and 100% of the membership interest in Pollution Control Industries of California, LLC, now named General Environmental Management of Rancho Cordova, LLC. The assets of Envectra, Inc. included an internet based integrated environmental management software now marketed by the Company as GEMWare. The acquisition of the assets of Prime resulted in a significant increase in the revenue stream of the company and a presence in the Washington State and Alaska markets through Prime’s Seattle office. All Prime services are now offered under the GEM name. The primary asset of Pollution Control Industries of California, LLC was a fully permitted Part B Treatment Storage Disposal Facility (TSDF) in Rancho Cordova, California. The facility provides waste management services to field service companies and allows the Company to bulk and consolidate waste into larger more cost effective containers for outbound disposal.
During 2006, the Company entered into a stock purchase agreement with K2M Mobile Treatment Services, Inc. of Long Beach, California ("K2M"), a privately held company, pursuant to which the Company acquired all of the issued and outstanding common stock of K2M. K2M is a California-based provider of mobile wastewater treatment and vapor recovery services. Subsequent to the acquisition in March 2006, the Company opened a vapor recovery service division in Houston, Texas and will be looking to expand its operations in the Gulf coast area.
On August 31, 2008, the Company entered into a stock purchase agreement with Island Environmental Services, Inc. of Pomona, California ("Island"), a privately held company, pursuant to which the Company acquired all of the issued and outstanding common stock of Island, a California-based provider of hazardous and non-hazardous waste removal and remediation services to a variety of private and public sector establishments.
On August 17, 2009, the Company divested the assets of GEM Mobile Treatment Services (GEM MTS). GEM MTS was sold to MTS Acquisition Company, Inc., a holding company, and will be owned and operated by two former senior executives of GEM. Consideration of the sale was in the form of promissory notes in the aggregate amount of $5.6 million, the assignment of approximately $1.0 million of accounts payable and possible future royalties. The consideration was immediately assigned to CVC California, LLC, (“CVC”) GEM’s senior secured lender. As the notes are paid to CVC, GEM’s indebtedness to CVC will be reduced. Total reduction in indebtedness to CVC could amount to more than $7million.
On November 13, 2009, Company entered into a Stock Purchase Agreement ("Agreement") with United States Environmental Response, LLC, a California limited liability company (“Seller”) pursuant to which the Company has purchased all of the issued and outstanding capital stock of California Living Waters, Incorporated ("CLW"), a privately held company. CLW owns all of the issued and outstanding capital stock of Santa Clara Waste Water Company (SCWW") a California corporation. CLW's only operating subsidiary is SCWW. SCWW had unaudited revenues of $4,581,722 and $7,609,636 in 2007 and 2008 respectively and had revenues of $4,344,749 for the first 8 months of 2009.
SCWW, located in Ventura County, California, is a waste water management company that operates a 12.7 mile pipeline from its facility to the City of Oxnard water reclamation center. In consideration for the sale, GEM issued six promissory notes (individually a "Note" and collectively, the "Notes") in the aggregate principal amount of $9,003,000, and warrants to purchase 425,000 shares of GEM's common stock. The Notes bear interest at 6.5 per cent per annum. Two of the Notes, totaling $3,778,000 are convertible into a total of 15% of GEM's common stock on a fully diluted basis.
Three Months Ended March 31, 2010
Discontinued Operations
On February 26, 2010, the Company completed the sale of GEM DE and its operating subsidiaries. On August 17, 2009, GEM DE divested the assets of GEM Mobile Treatment Services, Inc. Based on the completion of this divestiture subsequent to year end, the revenues and expenses of all of the GEM DE entities have been classified as discontinued operations and the assets and liabilities of GEM DE also have been classified as discontinued. The revenues and expenses in the accompanying financial statements reflect only the operations of CLW (and its operating subsidiary SCWW) and the operations of GEM Nevada, the corporate parent, for the three months ended March 31, 2010.
Revenues
Total revenues are presented in the income statement for only the continuing business (i.e., CLW and its only operating subsidiary SCWW) for the three months ended March 31, 2010. Total revenues for 2010 were $1,458,706. Revenues for the three months were approximately 25% above the 2009 levels for the same period.
Cost of Revenues
Cost of revenues are presented in the income statement for only the continuing business (i.e., CLW and its only operating subsidiary SCWW) for the three months ended March 31, 2010. Cost of revenues for 2010 were $1,285,937or 88% of revenue for the three months. It is anticipated that in a normal year that cost of sales will be approximately 65% of revenue (which represents the historical average for the latest 24 month period for SCWW).
Operating Expenses
Operating expenses for only the continuing business (i.e., CLW and its only operating subsidiary SCWW) for the three months ended March 31, 2010 were $209,814 or 14.4% of revenue. It is anticipated that in a normal year operating expenses will be approximately 25% of revenue (which represents the historical average for the latest 24 month period for SCWW). Operating expenses for GEM Nevada were $1,668,729 for the three months ended March 31, 2010. Total operating expense for the three months ended March 31, 2010 were $2,588,949 or 177.5% of revenue.
Depreciation and amortization expenses are included in operating expenses, and represent only the expenses of CLW (and its only operating subsidiary SCWW) for the three months ended March 31, 2010. Depreciation and amortization for 2010 was $312,022 or 21.4% of revenue.
Interest and Financing Costs
Interest and financing costs for the three months ended March 31, 2010 were $868,880, or 59.6% of revenue. Interest costs are primarily attributable to: a) interest on the remaining CVC term borrowings of $1,177,077;
b) interest on the SCWW acquisition notes of $8,986,208.
Other Non-operating Income
The Company did not have other non-operating income for the three months ended March 31, 2010.
Net Income
The net income for the three months ended March 31, 2010 was $4,477,955 or 307% of revenue. The net loss from continuing operations of $3,376,879 was primarily attributable to the operating and interest expenses detailed above. Net income included a gain on the sale of Gem Delaware of $8,687,132 (see Note 4).
LIQUIDITY AND CAPITAL RESOURCES
Cash
Our primary source of liquidity is cash provided by operating, investing, and financing activities. Net cash used in operations for the three months ended March 31, 2010 was $2,327,214 as compared to $1,195,653 for the same period in 2009.
Liquidity
The accompanying consolidated financial statements have been prepared assuming that the company will continue as a going concern. The Company incurred a net income of $4,477,955 and used cash in operations and discontinued operations of $2,327,214 during the quarter ended March 31, 2010. Continuing operations used cash of $2,734,512 and discontinued operations provided cash of $407,298. As of March 31, 2010 the Company had current liabilities exceeding current assets by $14,476,019 primarily because of the reclassification of long term debt to current resulting from covenant provisions under the ComVest notes and had a stockholders’ deficiency of $9,777,078. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management completed a plan in February 2010 to divest certain parts of the business in order to satisfy obligations of its senior lender. In conjunction with that strategy, the
assets of GEM MobileTreatment Services (GEM MTS) were sold on August 17, 2009. GEM MTS was sold to MTS Acquisition Company, Inc., a holding company, and will be owned and operated by two former senior executives of GEM. Consideration for the sale was in the form of promissory notes in the aggregate amount of $5.6 million, the assignment of approximately $1.0 million of accounts payable and possible future royalties. The consideration was immediately assigned to CVC California, LLC, ("CVC") GEM's
senior secured lender. As the notes are paid to CVC, GEM's indebtedness to CVC will be reduced. In conjunction with this transaction, all sources of cash from this entity have been classified in discontinued operations.
On November 25, 2009, the Company entered into an Agreement with Luntz Acquisition (Delaware), LLC. (“Buyer”) pursuant to which the Company has agreed to sell to Luntz all of the issued and outstanding stock of the Company's primary operating subsidiary, General Environmental Management, Inc. a Delaware corporation, ("GEM DE") for cash (the “Sale”).Luntz agreed to pay the Company $14 million for the purchased interests. On February 26, 2010, after approval of the transaction by the Company’s shareholders
at a special meeting held on February 19, 2010, the Company completed the sale of the entities created out of GEM DE. The net cash proceeds from the transaction were used by the Company to retire senior debt and other obligations of the Company (see Note 4).
On November 13, 2009, the Company entered into a Stock Purchase Agreement with United States Environmental Response, LLC, a California limited liability company pursuant to which we purchased all of the issued and outstanding capital stock of California Living Waters, Incorporated ("CLW"), a privately held company. CLW owns all of the issued and outstanding capital stock of Santa Clara Waste Water Company (SCWW") a California corporation. SCWW, located in Ventura County, California, is a waste water
management company that operates a 12.7 mile pipeline from its facility to the City of Oxnard' water reclamation center.
The Company’s current source of cash is earnings from the CLW operation and proceeds from the sale of its previous operating entities. The Company will continue to explore other sources of capital to expand and fund its current operations.
Cash Flows for the Three Months Ended March 31, 2010.
Operating activities for the three months ended March 31, 2010 produced $2,327,214 in cash. Accounts receivable, net of allowances for bad debts, were increased by $79,084 as of March 31, 2010 and accounts payable were decreased by $61,663. Depreciation and amortization for the three months ended March 31, 2010 totaled $358,474. The net income of $4,477,955 included a number of non-cash items incurred by the Company including expenses of $119,677 representing the fair value of vested options, $388,602 representing amortization of discount on notes, $427,500 representing warrants issued for services, $1,512,064 representing debt modification, $272,459 representing accrued interest on notes payable, $1,709,052 representing a gain on extinguishment of derivative liabilities and a gain of $8,687,131 on sale from discontinued operations. Prepaid expenses increased by $111,530 and accrued expenses decreased by $223,085.
The Company provided cash for investment in plant, property and equipment and deposits totaling approximately $11,276,685 for the three months ended March 31, 2010. Financing activities used $9,175,123 for the three months ended March 31, 20 to reduce notes payable and make payments on capital leases.
These activities resulted in a $225,652 reduction in cash balances for the three months ended March 31, 2010.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our consolidated financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses. The following are the areas that we believe require the greatest amount of estimates in the preparation of our financial statements: allowances for doubtful accounts, impairment testing and accruals for disposal costs for waste received at our TSDF.
(a) Allowance for doubtful accounts
We establish an allowance for doubtful accounts to provide for accounts receivable that may not be collectible. In establishing the allowance for doubtful accounts, we analyze specific past due accounts and analyze historical trends in bad debts. In addition, we take into account current economic conditions. Actual accounts receivable written off in subsequent periods can differ materially from the allowance for doubtful accounts provided.
(b) Impairment of Long-Lived Assets
Accounting for the Impairment or Disposal of Long-Lived Assets establishes guidelines regarding when impairment losses on long-lived assets, which include property and equipment, should be recognized and how impairment losses should be measured. This statement also provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. The Company periodically reviews, at least annually, such assets for possible impairment and expected losses. If any losses are determined to exist they are recorded in the period when such impairment is determined.
(c) Revenue Recognition
The Company's business activities include providing wastewater treatment for companies and haulers in Ventura County, California, and in adjacent counties. The Company recognizes revenue at the time its customers unload untreated wastewater at the Company's facility. Concurrent with the recognition of revenue, the Company records the estimated costs to treat and dispose of the wastewater on hand.
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collection is reasonably assured.
(d) Derivative Financial Instruments
The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the condensed consolidated statements of operations. For stock-based derivative financial instruments, the Company uses the Black-Scholes option pricing model to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.
Recent Accounting Pronouncements
In October 2009, the FASB issued authoritative guidance on revenue recognition that will become effective for the Company beginning July 1, 2010, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. We believe adoption of this new guidance will not have a material impact on our financial statements.
In January 2010, the FASB issued guidance on improving disclosures about fair value measurements to add new disclosure requirements for significant transfers in and out of Level 1 and 2 measurements and to provide a gross presentation of the activities within the Level 3 roll-forward. The guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The disclosure requirements are effective for interim and annual reporting periods beginning after December 15, 2009, except for the requirement to present the Level 3 roll-forward on a gross basis, which is effective for fiscal years beginning after December 15, 2010. The adoption of this guidance was limited to the form and content of disclosures, and will not have a material impact on the Company’s results of operations or financial condition.