Form 10QSB for NANNACO INC
Item 2 - Management's Discussion and Analysis of Financial Condition and
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The following is a discussion of our financial condition, results of operations,liquidity and capital resources. This discussion should be read in conjunctionwith our audited financial statements and the notes thereto included elsewherein this Form 10-QSB and with our annual report on Form 10-KSB for the year endedSeptember 30, 2003.
Some of the statements under "Description of Business," "Risk Factors,""Management's Discussion and Analysis or Plan of Operation," and elsewhere inthis Report and in the Company's periodic filings with the Securities andExchange Commission constitute forward-looking statements. These statementsinvolve known and unknown risks, significant uncertainties and other factorswhat may cause actual results, levels of activity, performance or achievementsto be materially different from any future results, levels of activity,performance or achievements expressed or implied by such forward- lookingstatements. Such factors include, among other things, those listed under "RiskFactors" and elsewhere in this Report.
In some cases, you can identify forward-looking statements by terminology suchas "may," "will," "should," "could," "intends," "expects," "plans,""anticipates," "believes," "estimates," "predicts," "potential" or "continue" orthe negative of such terms or other comparable terminology.
The forward-looking statements herein are based on current expectations thatinvolve a number of risks and uncertainties. Such forward-looking statements arebased on assumptions that the Company will obtain or have access to adequatefinancing for each successive phase of its growth, that there will be nomaterial adverse competitive or technological change in condition of theCompany's business, that the Company's President and other significant employeeswill remain employed as such by the Company, and that there will be no materialadverse change in the Company's operations, business or governmental regulationaffecting the Company. The foregoing assumptions are based on judgments withrespect to, among other things, further economic, competitive and marketconditions, and future business decisions, all of which are difficult orimpossible to predict accurately and many of which are beyond the Company'scontrol.
Although management believes that the expectations reflected in theforward-looking statements are reasonable, management cannot guarantee futureresults, levels of activity, performance or achievements. Moreover, neithermanagement nor any other persons assumes responsibility for the accuracy andcompleteness of such statements.
Nannaco, Inc. ("Nannaco" or the "Company") is a reporting company under thefederal securities laws and its shares of common stock are publicly traded onthe Over The Counter Electronic Bulletin Board ("OTCBB") under the symbol"NNCO". The Company was incorporated under the laws of the State of Texas onOctober 20, 1998, and immediately thereafter began operations. The Company'sshares began trading on September 5, 2002 on the OTCBB. The Company providedsurface cleaning, surface protection, surface restoration, and other services tocommercial businesses, as well to the owners of historical buildings. TheCompany has operated under the trade name of Surface Pro in order to relate tothe principal business activity, since the Nannaco name does not indicate thetype of business.
Until September 30, 2003, Nannaco focused on surface cleaning, surfaceprotection and restoration. However, sales from these products were notsufficient to enable the company to continue operations and the Company changedits strategy due to poor operating conditions and their operating resultscoupled with difficulties in raising capital through debt and equity sources. Asof September 30, 2003, the Company ceased all operating activities under thesurface cleaning, surface protection and restoration business and disposed ofmost of its assets while formulating a plan to improve it financial position andis treated as a development stage company, effective October 1, 2003. TheCompany adopted a new strategy during the fourth quarter of 2003 that committedto the disposal of its current business and to seek a merger/acquisitiontransaction with a Company having better financial resources. In December 2003and January 2004, the Company issued several announcements related to the changein business. The Company initially moved to a new line of business as aconsultant and advisor to customers but has abandoned this strategy and isactively seeking a merger-acquisition candidate.
In January 2004, the Company formed a new wholly owned subsidiary named AmericanQualified Financial Services, Inc. ("AQFS"). AQFS is a Texas Corporation and thecompany planned to utilize AQFS to market the reinsurance of debt securitiesprimarily to qualified benefit plans. However, this plan has been abandoned.
OVERVIEW OF COMPANY.
Since its inception, the Company has suffered recurring losses from operationsand has been dependent on existing stockholders and new investors to provide thecash resources to sustain its operations. We have substantial currentobligations. As of March 31, 2004, we had no assets and $854,894 of liabilities.Of the $854,894 outstanding at March 31, 2004, $246,427 is for unpaid federalpayroll taxes, interest and penalties. The Company has received correspondencefrom the Internal Revenue Service ("IRS") detailing the obligation and remediesthat the IRS may pursue if not paid. The remaining current obligations (whichare all past due) include accounts payable of $124,468, judgment payable of$50,995, sales tax payable of $40,801, bank loans of $59,336, loanpayable-related party of $42,700 and convertible debentures of $175,000. TheCompany does not have sufficient cash resources to pay these obligations.
The Company's long-term viability as a going concern is dependent on certain keyfactors, as follows:
- The Company's ability to continue to obtain sources of outside financing to support near term operations and to allow the Company to continue to make investments
- The Company's ability to increase profitability and sustain a cash flow level that will ensure support for continuing operations.
In March 2004, the Company announced they had signed a letter of intent toacquire Red Alert Group, Inc., a company specializing in homeland and globalsecurity. The Company anticipates that upon the successful completion of theannounced acquisition, the name of the Company will be changed to Red AlertGroup, Inc. and will apply to obtain a new stock ticker symbol.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The methods, estimates and judgment we use in applying our most criticalaccounting policies have a significant impact on the results we report in ourfinancial statements. The Securities and Exchange Commission has defined themost critical accounting policies as the ones that are most important to theportrayal of our financial condition and results, and require us to make ourmost difficult and subjective judgments, often as a result of the need to makeestimates of matters that are inherently uncertain. Based upon this definition,our most critical estimates include going concern and the valuation of non-cashissuances of common stock. We also have other key accounting estimates andpolicies, but we believe that these other policies either do not generallyrequire us to make estimates and judgments that are as difficult or assubjective, or it is less likely that they would have a material impact on ourreported results of operations for a given period. For additional informationsee Note 3 "Summary of Significant Accounting Policies" in the notes to ourunaudited financial statements contained in our quarterly report on Form 10-QSBfor the three months ended December 31, 2003. Although we believe that ourestimates and assumptions are reasonable, they are based upon informationpresently available. Actual results may differ significantly from theseestimates.
The independent auditors' reports to our financial statements for the year endedSeptember 30, 2003 and September 30, 2002, include an emphasis paragraph inaddition to their audit opinion stating that our recurring losses fromoperations, working capital deficiency and default on our convertible debenturesraise substantial doubt about our ability to continue as a going concern. Ourfinancial statements do not include any adjustments to reflect the possibleeffects on recoverability and classification of assets or the amounts andclassification of liabilities that may result from our inability to continue asa going concern.
VALUATION OF NON-CASH ISSUANCES OF COMMON STOCK
The Company issued common stock to several parties in non-cash transactionsduring the six months ended March 31, 2004. For these issuances, valuation wasdetermined based upon the stock closing price on the date of grant.
RESULTS OF OPERATIONS
FINANCIAL ANALYSIS OF THE THREE AN SIX MONTHS ENDED MARCH 31, 2004 AND 2003
Six Months Ended Three Months Ended March 31, March 31, 2004 2003 2004 2003 --------------------------------------------------------------REVENUES $ 15,577 $ 34,225 $ -- $ 30,903COST OF REVENUES 16,848 17,613 3,715 9,079 ----------------------------------------------------------------------------GROSS LOSS (1,271) 16,612 (3,715) 21,824
Selling, general and administrative 15,217 26,228 (1,994) 16,272Compensation and payroll taxes 1,983,397 25,000 1,637,032 12,500Consulting 1,946,042 700 1,857,543 700Penalties 31,062 3 --Legal and professional 984,894 18,810 769,594 16,810Debenture liquidated damages 24,500 -- 3,500 --Rent 1,495 3,648 -- 2,931Travel and entertainment 3,726 215 2,445 200Bad debt expense 1,171 -- 1,171 --Depreciation 15,600 -- 7,800 ----------------------------------------------------------------------------TOTAL OPERATING EXPENSES 4,960,445 91,263 4,269,295 57,213 ----------------------------------------------------------------------------
LOSS FROM OPERATIONS (4,961,716) (74,651) (4,273,009) (35,389)
Interest expense, net (12,467) (4,432) (6,234) (2,164) ----------------------------------------------------------------------------
TOTAL OTHER EXPENSE (12,467) (4,432) (6,234) (2,164) ----------------------------------------------------------------------------
NET LOSS $ (4,974,183) $ (79,083) $ (4,279,244) $ (37,553) ===================================== ======================================
Operating revenue decreased $30,903, or 100%, to zero for the three months endedMarch 31, 2004 from $30,903 for the three months ended March 31, 2003. Thedecrease is due to the result of the Company making the decision to exit thesurface cleaning, surface protection and restoration business and to focus onbeing a consultant and advisor to customers. No revenue was generated fromconsulting services and the company ceased this activity in February 2004.
Operating revenue decreased $18,648, or 54%, to $15,577 for the six months endedMarch 31, 2004 from $34,225 for the six months ended March 31, 2003. Thedecrease is due to the result of the Company making the decision to exit thesurface cleaning, surface protection and restoration business and to focus onbeing a consultant and advisor to customers. However, no revenue was generatedfrom consulting services and the Company ceased this activity ion February 2004.
Cost of Sales:
Cost of sales decreased $5,364, or 59%, to $3,715 for the three months endedMarch 31, 2004 from $9,079 for the three months ended March 31, 2003. 15,577 forthe six months ended March 31, 2004 from $34,225 for the six months ended March31, 2003. The decrease is due to the result of the Company making the decision
to exit the surface cleaning, surface protection and restoration business and tofocus on being a consultant and advisor to customers.
Cost of sales decreased $765, or 4%, to $16,848 for the six months ended March31, 2004 from $17,613 for the six months ended March 31, 2003. The decrease isdue to the result of the Company making the decision to exit the surfacecleaning, surface protection and restoration business and to focus on being aconsultant and advisor to customers.
Operating expenses increased $4,212,082, or 7,362%, to $4,269,295 for the threemonths ended March 31, 2004 from $57,213 for the three months ended March 31,2003. The increase was primarily the result of a $1,624,532 increase incompensation, a $1,856,843 increase in consulting, and a $752,784 increase inlegal and professional. The increase in compensation, consulting and legal andprofessional was primarily the result of the issuance of common stock forcompensation and services.
Operating expenses increased $4,869,182, or 5,335%, to $4,960,445 for the sixmonths ended March 31, 2004 from $91,263 for the six months ended March 31,2003. The increase was primarily the result of a $1,958,397 increase incompensation, a $1,945,342 increase in consulting, and a $966,084 increase inlegal and professional. The increase in compensation, consulting and legal andprofessional was primarily the result of the issuance of common stock forcompensation and services.
Other expense increased $4,070, or 188% to $6,234 for the three months endedMarch 31, 2004 from $2,164 for the three months ended March 31, 2003. Theincrease was primarily due to accrued interest for indebtedness.
Other expense increased $8,035, or 181% to $12,467 for the six months endedMarch 31, 2004 from $4,432 for the six months ended March 31, 2003. The increasewas primarily due to accrued interest for indebtedness.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $0 at March 31, 2004 as compared to $0 atSeptember 30, 2003, and working capital deficit was $854,894 at March 31, 2004as compared to $726,139 at September 30, 2003. The increase in the workingcapital deficit is primarily due to the fact of increases in accounts payable,accrued interest, other current liabilities, payroll taxes payable and judgmentpayable. Additionally, the Company has no assets at March 31, 2004.
Operating Activities: Net cash provided by operating activities was $0 for thesix months ended March 31, 2004 while cash that was used in operating activitieswas $61,906 for the six months ended March 31, 2003. The increase in cashprovided by operations resulted primarily due to the fact of increases inaccrued interest, other current liabilities, accounts payable, payroll taxespayable and judgment payable.
Investing Activities: There were no investing cash flow activities for the sixmonths ended March 31, 2004 while cash that was provided by investing activitieswas $45,425 for the six months ended March 31, 2003. The decrease in cashprovided from investing activities was the result of the Company receiving$50,000 in cash advances from shareholders and $4,575 for the purchase ofproperty and equipment in 2003 with no such amounts for 2004.
Financing Activities There were no financing cash flow activities for the sixmonths ended March 31, 2004 while cash provide by financing activities was$104,750. The decrease in cash provided by operations was the result of theCompany receiving $104,750 of proceeds from the issuance of convertibledebentures in 2003 with no such amount in 2004.
We are highly leveraged. At March 31, 2004, we have no assets and have currentliabilities of $854,894, our stockholders' deficiency is $854,894, we have anaccumulated deficit of $5,048,764 from previous business operations and we had adeficit accumulated during the development stage for our new business operationsof $4,974,183. The following table is a summary of our short-term debt as ofMarch 31, 2004:
BALANCE AT MARCH 31, 2004Bank Loans
$35,000 bank installment loan, dated Feb. 19, 2000, bearing interest at 10% per annum, 60 monthly payments of principal and interest.............................. $25,350$35,000 bank line of credit, bearing interest at prime plus 1.25% per annum, interest payable monthly and line of credit due July 15, 2002........................ 33,986
On February 19, 2000, we obtained a bank installment loan in the amount of$35,000, of which $25,350 is outstanding at March 31, September 30, 2003. Theinterest rate is 10% per annum and sixty monthly payments of principal andinterest in the amount of $745 are required. This note is secured by thepersonal guaranty of the Company's former President.
At March 31, 2004, we had a bank line of credit, which provides for borrowingsof up to $35,000, of which $33,986 was outstanding. The interest rate is Primeplus 1.25% per annum and monthly interest payments were required. The line ofcredit matured on July 15, 2002 but the bank has not exercised its rights ofdefault and the facility was on a month to month basis. The line of credit issecured by a personal guaranty of the Company's former President.
Loan Payable - Related Party
Loan payable, dated January through July of 2001, bearing interest at 10% per annum and due in July of 2002....................................................... $ 42,700
Beginning in January of 2001 and through July of 2001, Mark Triesch, a directorOf the Company, loaned $43,700 to the Company in the form of a promissory note.The note bears interest at ten percent (10%) per annum and the principal andaccrued interest was due one year from each of the investments. As of July 2002,the entire amount was due and payable. In April 2003, the Company repaid $1,000of principal resulting in the current balance due of $42,700.
$175,000 Convertible Debentures, dated March and April of 2003, bearing interest at 6% per annum and due in March and April of 2006....................... $175,000
========TOTAL SHORT-TERM DEBT $277,036
Pursuant to Securities Purchase Agreements, Convertible Debentures and relatedcontracts, in March of 2003, the Company issued $155,000 of six percent (6%)convertible debentures due in March of 2006 and in April issued another $20,000of the debentures due in April 2006. The Company received $122,100 of cashproceeds, net of $52,900 of cash offering costs. The debenture holder has theoption of converting the principal and accrued interest into the Company'scommon stock at a conversion price equal to seventy-five percent (75%) of thelowest closing bid price per share for the twenty (20) trading days immediatelypreceding the conversion. The Company has the option to redeem all or part of
the debentures prior to the maturity date at a price equal to one hundred thirtypercent (130%) of the principal amount plus accrued interest.
In March and April of 2003, the Company recognized an immediate $58,333 interestexpense and paid-in capital relating to a beneficial conversion feature inherentin the debentures since the debentures were immediately convertible. Inconnection with the offering, in addition to cash offering costs of $52,900, theCompany issued 500,000 of its common shares to the investment bankers. Theshares were valued on the issuance date at the trading price of $0.03 per shareor $12,500. The total offering costs of $65,400 were initially deferred to beamortized over the term of the debentures, however due to a default provisionwhich changed the debentures maturity to due on demand (see below), the $65,400was fully expensed as of September 30, 2003.
Under a related Registration Rights Agreement, the Company is subject to a 2%monthly liquidated damages penalty for not filing a registration statement withthe Securities and Exchange Commission, within a stipulated timeframe, toregister the common shares underlying the convertible debentures and another 2%monthly liquidated damages penalty relating to that registration statement notbecoming effective within a stipulated timeframe. The liquidated damages penaltystarted accruing at 2% or $3,500 per month at June 1, 2003 and at another 2% or$3,500 per month starting September 1, 2003. The penalties for June and July2003 were satisfied with the issuance of 350,000 of the Company's common sharesto the debenture investors and remaining accrued liquidated damages were $10,500at September 30, 2003. The Company recognized a $1,750 gain on the settlement of$7,000 of accrued liquidated damages in June and July 2003 based on the $0.015trading price of the common stock on the settlement date. For the three monthperiod ended December 31, 2003, the Company recorded $21,000 of liquidateddamages expense and recorded an additional $3,500 of liquidated damages expensefor the three months ended March 31, 2004, resulting in an accrued balance of$35,000. In March 2004, the Company reached an agreement with the debentureinvestors and all outstanding penalties in the amount of $35,000 were satisfiedwith the issuance of 1,750,000 of the Company's common shares based on a $0.02trading price of the common stock on the settlement date. Accordingly, at March31, 2004, there is no remaining accrued liquidated damages balance in theaccompanying balance sheet.
Due to the default under the Registration Rights Agreement, the debentures wentinto default as of June 1, 2003. Accordingly, the debentures became due ondemand at that date and are presented as current liabilities at March 31, 2004.
To continue with our business plan, we will require additional short-termworking capital and we have not had generating sufficient cash from operationsto fund our operating activities through the end of fiscal 2004. Presently, wehave no source of revenues and are seeking a merger-acquisition candidate Wecannot assure you that the new business concept will provide sufficientproceeds, if any, and borrowings under any interim financing we are able tosecure will be sufficient to meet our projected cash flow needs.
Our ability to obtain additional financing depends on many factors beyond ourcontrol, including the state of the capital markets, the market price of ourcommon stock, the prospects for our business and the approval by ourstockholders of an amendment to our certificate of incorporation increasing thenumber of shares of common stock we are authorized to issue. The necessaryadditional financing may not be available to us or may be available only onterms that would result in further dilution to the current owners of our commonstock. Failure to obtain commitments for financing would have a material adverseeffect on our business, results of operations and financial condition. If thefinancing we require to sustain our working capital needs is unavailable orinsufficient or we do not receive the necessary financing, we may be unable tocontinue as a going concern.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table highlights, as of March 31, 2004, our contractualobligations and commitments by type and period:
PAYMENTS DUE BY PERIOD LESS THAN 1 CONTRACTUAL OBLIGATIONS TOTAL YEAR 1-3 YEARS 4-5 YEARS AFTER 5 YEARS-------------------------- -------- -------- ---------- --------- -------------Short-Term Debt: -- -- -- -- --Bank Loans 59,336 59,336 -- -- --Loan Payable-Related Party 42,700 42,700 -- -- --Convertible Debentures 175,000 175,000 -- -- -- -------- -------- ---------- --------- -------------
Total Short-Term Debt $277,036 $277,036 $ -- ======== ======== ========== ========= =============
RECENT ACCOUNTING DEVELOPMENTS
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),"Consolidation of Variable Interest Entities, an interpretation of ARB No. 51,"which as an interpretation defines when and who consolidates a "variableinterest entity," or "VIE." This new consolidation model applies to entities (i)where the equity investors (if any) do not have a controlling financialinterest, or (ii) whose equity investment at risk is insufficient to financethat entity's activities without receiving additional subordinated financialsupport from other parties and requires additional disclosures for allenterprises involved with the VIE. FIN 46 is effective during 2003 depending onwhen the VIE is created. We do not believe that the adoption of FIN 46 will havea significant impact on our financial position and results of operations.
In May 2003, the FASB issued SFAS No. 149; Amendment of Statement 133 onDerivative Instruments and Hedging Activities ("SFAS 149") which provides forcertain changes in the accounting treatment of derivative contracts. SFAS 149 iseffective for contracts entered into or modified after June 30, 2003, except forcertain provisions that relate to SFAS No. 133 Implementation Issues that havebeen effective for fiscal quarters that began prior to June 15, 2003, whichshould continue to be applied in accordance with their respective effectivedates. The guidance should be applied prospectively. The adoption of SFAS 149did not have a material impact on the Company's financial position, results ofoperations or liquidity.
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150 (SFAS150), "Accounting for Certain Financial Instruments with Characteristics of BothLiabilities and Equity." It establishes standards for how an issuer classifiesand measures certain financial instruments with characteristics of bothliabilities and equity. This standard is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003. Theadoption of FAS 150 did not have a significant impact on our financial positionand results of operations.
The ability to invest further will be heavily dependent on securing additionalcapital from investors or debt. There is no assurance that additional equity ordebt financing will be available on terms acceptable to Management.