<DOCUMENT> <TYPE>10-Q <SEQUENCE>1 <FILENAME>form10q-040330.txt <DESCRIPTION>FORM 10-Q <TEXT> UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 30, 2004, OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to __________. Commission File Number: 0-17072 WINDSWEPT ENVIRONMENTAL GROUP, INC. ----------------------------------- (Exact name of registrant as specified in its charter) Delaware 11-2844247 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 Sweeneydale Avenue, Bay Shore, New York 11706 ------------------------------------------------- (Address of principal executive offices) (Zip Code) (631) 434-1300 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes No X --- --- The number of shares of Common Stock, par value $.0001, outstanding on May 5, 2004 was 77,936,358. <PAGE> PART 1 - FINANCIAL INFORMATION ------------------------------ ITEM 1. FINANCIAL STATEMENTS WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED BALANCE SHEETS MARCH 30, 2004 AND JULY 1, 2003 <TABLE> <CAPTION> March 30, July 1, 2004 2003 -------------- -------------- (Unaudited) <S> <C> <C> ASSETS: CURRENT ASSETS: Cash $ 235,186 $ 130,096 Accounts receivable, net of allowance for doubtful accounts of $463,698 and $402,804, 8,159,175 5,881,603 respectively Inventory 165,083 215,466 Costs and estimated earnings in excess of billings on uncompleted contracts 436,287 871,753 Refundable income taxes 750,000 1,080,186 Prepaid expenses and other current assets 283,766 279,597 -------------- -------------- Total current assets 10,029,497 8,458,701 PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $5,553,586 and $5,111,516, respectively 2,752,582 2,497,435 OTHER ASSETS 186,657 98,127 -------------- -------------- TOTAL $ 12,968,736 $ 11,054,263 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY: CURRENT LIABILITIES: Accounts payable $ 1,855,809 $ 1,487,683 Accrued expenses 1,240,986 1,193,339 Short-term notes payable to related party 5,000,000 1,700,000 Billings in excess of cost and estimated earnings on uncompleted contracts 220,743 299,427 Accrued payroll and related fringe benefits 1,086,607 659,659 Current maturities of long-term debt 359,600 436,617 Other current liabilities 525,984 464,686 -------------- -------------- Total current liabilities 10,289,729 6,241,411 LONG-TERM DEBT 404,628 338,848 -------------- -------------- COMMITMENTS AND CONTINGENCIES REDEEMABLE COMMON STOCK AND STOCK OPTIONS 103,896 348,625 -------------- -------------- SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK, $.01 par value; 1,300,000 shares authorized; 1,300,000 shares outstanding at March 30, 2004 and July 1, 2003 1,300,000 1,300,000 -------------- -------------- STOCKHOLDERS' EQUITY: Series B preferred stock, $.01 par value; 50,000 shares authorized; 0 shares outstanding - - Nondesignated preferred stock, no par value; 8,650,000 shares authorized; 0 shares outstanding at March 30, 2004 and July 1, 2003 - - Common stock, $.0001 par value; 150,000,000 shares authorized; 77,936,358 shares outstanding at March 30, 2004 and July 1, 2003. 7,794 7,794 Additional paid-in-capital 33,941,517 34,000,017 Accumulated deficit (33,078,828) (31,182,432) -------------- -------------- Total stockholders' equity 870,483 2,825,379 -------------- -------------- TOTAL $ 12,968,736 $ 11,054,263 ============== ============== </TABLE> See notes to consolidated financial statements. 2 <PAGE> WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) <TABLE> <CAPTION> Thirteen Weeks Ended Thirty-Nine Weeks Ended -------------------------------- --------------------------------- March 30, April 1, March 30, April 1, 2004 2003 2004 2003 -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> Revenues $ 3,026,183 $ 3,648,548 $ 14,809,582 $ 14,105,571 Cost of revenues 4,650,312 3,204,889 13,489,965 11,314,559 -------------- -------------- -------------- -------------- Gross (loss) profit (1,624,129) 443,659 1,319,617 2,791,012 -------------- -------------- -------------- -------------- Operating expenses (income): Selling, general and administrative expenses 1,521,322 1,463,083 3,927,781 4,049,641 Expense (benefit) related to variable accounting treatment for officer options 103,896 (270,409) (244,729) (432,974) -------------- -------------- -------------- -------------- Total operating expenses 1,625,218 1,192,674 3,683,052 3,616,667 -------------- -------------- -------------- -------------- Loss from operations (3,249,347) (749,015) (2,363,435) (825,655) -------------- -------------- -------------- -------------- Other expense (income): Interest expense 252,681 16,100 312,328 51,290 Other, net (5,407) (116) (29,367) (23,425) -------------- -------------- -------------- -------------- Total other expense 247,274 15,984 282,961 27,865 -------------- -------------- -------------- -------------- Loss before benefit for income taxes (3,496,621) (764,999) (2,646,396) (853,520) Benefit for income taxes (928,637) (365,534) (750,000) (374,851) -------------- -------------- -------------- -------------- Net loss (2,567,984) (399,465) (1,896,396) (478,669) Dividends on preferred stock (19,500) (19,500) (58,500) (58,500) -------------- -------------- -------------- -------------- Net loss attributable to common shareholders $ (2,587,484) $ (418,965) $ (1,954,896) $ (537,169) ============== ============== ============== ============== Basic and diluted net loss per common share: Basic ($.03) ($.01) ($.03) ($.01) ====== ====== ====== ====== Diluted ($.03) ($.01) ($.03) ($.01) ====== ====== ====== ====== Weighted average number of common shares outstanding: Basic 77,936,358 77,936,358 77,936,358 77,936,358 ========== ========== ========== ========== Diluted 77,936,358 77,936,358 77,936,358 77,936,358 ========== ========== ========== ========== </TABLE> See notes to consolidated financial statements. 3 <PAGE> WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED) <TABLE> <CAPTION> Common Stock Addtional Number of Par Paid-in Accumulated Shares Value Capital Deficit Total ------ ----- ------- ------- ----- <S> <C> <C> <C> <C> <C> Balance at July 2, 2003 77,936,358 $7,794 $34,000,017 $(31,182,432) $2,825,379 Dividends on Series A preferred (58,500) (58,500) stock Net loss - - - (1,896,396) (1,896,396) ----------- ------- ------------ ------------- ----------- Balance at March 30, 2004 77,936,358 $7,794 $33,941,517 $(33,078,828) $ 870,483 =========== ======= ============ ============= =========== </TABLE> See notes to consolidated financial statements. 4 <PAGE> WINDSWEPT ENVIRONMENTAL GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Thirty-Nine Weeks Ended -------------------------------- March 30, April 1, 2004 2003 -------------- -------------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (1,896,396) $ (478,669) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 442,070 409,491 Provision for doubtful accounts, net 60,894 196,913 Benefit related to officer options and redeemable common stock (244,729) (432,974) Changes in operating assets and liabilities: Accounts receivable (2,338,466) 874,261 Inventory 50,383 56,542 Costs and estimated earnings in excess of billings on uncompleted contracts 435,466 30,347 Refundable income taxes 330,186 (380,947) Prepaid expenses and other current assets (4,169) (92,518) Other assets (88,530) (57,690) Accounts payable and accrued expenses 396,273 (170,818) Accrued payroll and related fringe benefits 426,948 165,013 Other current liabilities 78,781 (493,960) Billings in excess of costs and estimated earnings on uncompleted contracts (78,684) (8,735) -------------- -------------- NET CASH USED IN OPERATING ACTIVITIES (2,429,973) (383,744) -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (714,701) (1,078,497) -------------- -------------- NET CASH USED IN INVESTING ACTIVITIES (714,701) (1,078,497) -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments of long-term debt (323,769) (112,194) Proceeds from long-term debt 312,533 391,831 Repayment of convertible note to related party - (100,000) Payment of preferred stock dividends (39,000) (58,500) Proceeds from short-term notes payable to a related party 3,300,000 1,825,000 Repayments of short-term notes payable to a related party - (825,000) -------------- -------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 3,249,764 1,121,137 -------------- -------------- NET INCREASE (DECREASE) IN CASH 105,090 (341,104) CASH - BEGINNING OF PERIOD 130,096 399,679 -------------- -------------- CASH - END OF PERIOD $ 235,186 $ 58,575 ============== ============== Cash paid during the period for: Interest $34,168 $50,203 ======== ========= Income taxes $- $232,731 ======== ========= </TABLE> See notes to consolidated financial statements. 5 <PAGE> WINDSWEPT ENVIRONMENTAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS FOR PRESENTATION - The accompanying unaudited consolidated financial statements include the accounts of Windswept Environmental Group, Inc. (the "Company") and its wholly-owned subsidiaries. The unaudited consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America ("generally accepted accounting principles") for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of the Company, all adjustments (consisting of only normal and recurring accruals) considered necessary to present fairly the financial position of the Company and its subsidiaries on a consolidated basis as of March 30, 2004, the results of operations for the thirteen and thirty-nine weeks ended March 30, 2004 and April 1, 2003 and cash flows for the thirty-nine weeks ended March 30, 2004 and April 1, 2003, have been included. Certain prior period amounts have been reclassified to conform to the March 30, 2004 presentation. The results for the thirteen and thirty-nine weeks ended March 30, 2004 and April 1, 2003 are not necessarily indicative of the results for an entire year. These unaudited consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's Form 10-K for the fiscal year ended July 1, 2003. 2. STOCK OPTIONS - In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS)" No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure - an amendment of FASB Statement No. 123 (" SFAS 148"). SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and does not permit the use of the original SFAS No. 123 prospective method of transition in fiscal years beginning after December 15, 2003. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results, regardless of whether, when, or how an entity adopts the preferable, fair value based method of accounting. SFAS No. 148 improves the prominence and clarity of the pro forma disclosures required by SFAS No. 123 by prescribing a specific tabular format and by requiring disclosure in the "Summary of Significant Accounting Policies" or its equivalent and improves the timeliness of those disclosures by requiring their inclusion in financial reports for interim periods. The Company has adopted the disclosure requirements of SFAS No. 148. The Company will continue to account for stock-based employee compensation under APB Opinion No. 25 and its related interpretations. 6 <PAGE> The following table illustrates the effect on net income and net income per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation for all periods: <TABLE> <CAPTION> Thirteen Weeks Ended Thirty-Nine Weeks Ended -------------------------------- -------------------------------- March 30, April 1, March 30, April 1, 2004 2003 2004 2003 -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> Net loss attributable to common shareholders as reported $(2,587,484) $(418,965) $(1,954,896) $(537,169) Less: Stock-based employee compensation cost determined under the fair value method, net of related tax effects 41,433 59,780 124,116 179,341 -------------- -------------- -------------- -------------- Pro forma net loss attributable to common shareholders $ (2,628,917) $ (478,745) $ (2,079,012) $ (716,510) ============== ============== ============== ============== Net loss per share: Basic - as reported ($.03) ($.01) ($.03) ($.01) ====== ====== ====== ====== Basic - pro forma ($.03) ($.01) ($.03) ($.01) ====== ====== ====== ====== Diluted - as reported ($.03) ($.01) ($.03) ($.01) ====== ====== ====== ====== Diluted - pro forma ($.03) ($.01) ($.03) ($.01) ====== ====== ====== ====== </TABLE> 7 <PAGE> 3. NET LOSS PER COMMON SHARE -The calculation of basic and diluted net loss per common share was calculated for all periods in accordance with the requirements of Statement of Financial Accounting Standards No. 128, "Earnings per Share". The following table sets forth the computation of the basic and diluted net loss per share for the thirteen and thirty-nine weeks ended March 30, 2004 and April 1, 2003, respectively: <TABLE> <CAPTION> Thirteen Weeks Ended Thirty-Nine Weeks Ended ---------------------------------- -------------------------------- March 30, April 1, March 30, April 1, 2004 2003 2004 2003 -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> Numerator: Net loss attributable to common shareholders $(2,587,484) $(418,965) $(1,954,896) $(537,169) ============ ========== ============ ========== Denominator: Share reconciliation: Shares used for basic loss per share 77,936,358 77,936,358 77,936,358 77,936,358 Effect of dilutive items: Stock options - - - - Convertible securities - - - - -------------- -------------- -------------- -------------- Shares used for dilutive loss per share 77,936,358 77,936,358 77,936,358 77,936,358 ============== ============= ============== ============== Net loss per share: Basic ($.03) ($.01) ($.03) ($.01) Diluted ($.03) ($.01) ($.03) ($.01) </TABLE> The dilutive net loss per share computation for the thirteen week and thirty-nine week periods ended March 30, 2004 excludes 9,246,618 and 3,560,309 shares, respectively, related to stock options and warrants because the effect of including them would be anti-dilutive. The dilutive net loss per share computation for the thirteen and twenty-six week periods ended April 1, 2003 excludes approximately 4,369,000 and 4,680,000 shares, respectively, related to employee stock options and approximately 418,000 shares for the thirty-nine week period ended April 1, 2003 related to convertible notes because the effect of including them would be anti-dilutive. For all periods presented, 1,300,000 shares of common stock issuable upon the exercise of the Series A Redeemable Convertible Preferred Stock were excluded from diluted earnings per share because the effect of including them would be anti-dilutive. 4. BENEFIT FOR INCOME TAXES - The benefit for income taxes for the thirteen and thirty-nine weeks ended March 30, 2004 and April 1, 2003 consists of the following: <TABLE> <CAPTION> Thirteen Weeks Ended Thirty-Nine Weeks Ended -------------------------------- -------------------------------- March 30, April 1, March 30, April 1, 2004 2003 2004 2003 -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> Federal - current $(932,062) $(365,534) $(760,275) $(380,947) State - current 3,425 10,275 6,096 -------------- -------------- -------------- -------------- Total $(928,637) $(365,534) $(750,000) $(374,851) ============== ============== ============== ============== </TABLE> The effective rate for income taxes differs from the statutory rate primarily as a result of the 100% valuation allowance against deferred tax assets. The Company has a 100% valuation allowance against deferred tax assets because management believes that it is more likely than not that such deferred tax assets will not be realized. At March 30, 2004, the Company had approximately $1,022,000 in net operating loss carryforwards for tax purposes that expire at various dates through 2019. Due to the acquisition of greater than 50% ownership in October 1999 by Windswept Acquisition Corporation, a wholly-owned subsidiary of Spotless Plastics (USA), Inc. ("Spotless"), the Company is limited to 8 <PAGE> utilizing $68,000 of net operating loss carryforwards per annum. 5. CONTINGENCIES -The Company is a party to litigation matters and claims that are in the ordinary course of its operations, and while the results of such litigation and claims cannot be predicted with certainty, management believes that the final outcome of such matters will not have a material adverse effect on the Company's consolidated financial statements. 6. RELATED PARTY TRANSACTIONS - As of March 30, 2004, the Company owed Spotless $5,000,000, which bears interest at the rate of LIBOR (1.5% at March 30, 2004) plus 1% per annum and is payable on demand. The Company has increased its liquidity by entering into an Account Receivable Finance Agreement dated as of February 5, 2004 with Spotless pursuant to which Spotless may purchase certain of the Company's accounts receivable without recourse for cash, subject to certain terms and conditions. The Company accounts for its transfers of accounts receivable to Spotless as sales under Statement of Financial Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." Under the Account Receivable Finance Agreement, Spotless may, but is not obligated to, purchase one or more of the Company's accounts receivable, which are approved by Spotless, in its sole discretion, in respect of the particular debtor, invoices and related credit. As part of the agreement, Spotless may purchase any accounts receivable at a 15% discount to invoice prices, which the Company believes is at least as favorable to it as would be available from an unaffiliated third-party, based upon a good-faith estimate of an applicable discount negotiated at arm's length, as may be adjusted by Spotless in its sole discretion. In addition, the Company pays varying monthly discount fees on any purchased accounts receivable based upon invoice prices. All discounts and fees under the Account Receivable Finance Agreement are characterized as interest expense in the consolidated statements of operations. Further, the Company (a) manages any accounts receivable that it sells to Spotless while remitting to Spotless any proceeds received and (b) bears any related litigation costs. For both the thirteen-weeks and thirty-nine weeks ended March 30, 2004, the Company sold approximately $1,179,000 of accounts receivable to Spotless and incurred approximately $208,000 of discounts and fees associated with these sales. 7. OIL STORAGE TANK PROJECT- In April 2003, the Company commenced a remediation project in New York City for a local utility to remove sediment from an oil storage tank. During the course of the project, the sediment in the tank and was found to be substantiallly different than the sediment that the customer represented to be in the tank prior to the inception of the project. The Company continued to work on the project so as not to default on the terms which it understood to exist with the customer. The additional costs incurred to remove this matter, in the amount of approximately $1,600,000, were billed to the customer. However, the collectibility of such monies cannot be assured. Accordingly, the Company has not recognized the revenue associated with this claim. The project has been substantially completed and the customer has refused to acknowledge its liability for the additional charges billed by the Company. The Company has retained legal counsel to review its claim with the customer and believes that additional monies billed will be collected. As of March 30, 2004, the Company has recognized revenue of approximately $1,600,000 with respect to the original scope of this project, of which approximately $728,000 is still due to the Company. The Company believes that its claim for additional compensation has legal merit and, if negotiations with the customer do not yield satisfactory results, the Company intends to pursue legal action against the customer for the additional costs incurred plus a reasonable profit margin. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company, through its wholly-owned subsidiaries, provides a full array of emergency response, remediation and disaster restoration services to a broad range of clients. The Company has expertise in areas of hazardous materials remediation, microbial remediation, testing, toxicology, training, wetlands restoration, wildlife and natural resources rehabilitation, technical advisory, restoration and site renovation services. The Company's revenues are derived primarily from providing emergency response, remediation and disaster restoration services, and its cost of revenues consists primarily of labor and labor related costs, insurance, benefits, bonding and job-related insurance, repairs, maintenance, equipment rental, materials and supplies, disposal costs and depreciation of capital equipment. The Company's selling, general, and administrative 9 <PAGE> expenses primarily consist of expenses related to provisions for doubtful accounts, legal fees, sales salaries, marketing, consulting, insurance and travel and entertainment. In recent months, the Company has encountered slower collections of certain of its accounts receivable, and its liquidity has been severely adversely affected by its unrecouped costs incurred in connection with an oil storage tank project. Accordingly, the Company has needed to borrow increased amounts from Spotless. As a result of the additional borrowings, the amount outstanding was $5,000,000 as of March 30, 2004. The Company has considered various alternatives to increase its liquidity, including a preliminary proposal made by Spotless in January 2004 to convert a significant portion of its outstanding debt into shares of the Company's common stock, which could have allowed Spotless to loan additional funds to the Company and to increase its ownership of the Company's common stock to over 90% and, if it so desired and with the consent of the Company's Series A Redeemable Convertible Preferred Stockholders, (a) effect a short-form merger and (b) terminate the public registration of the Company's common stock with the SEC under the Securities Exchange Act of 1934 because the common stock would no longer be held by at least 300 stockholders of record. In this connection, the Company increased its liquidity by entering an Account Receivable Finance Agreement, dated as of February 5, 2004, with Spotless pursuant to which Spotless may purchase certain of the Company's accounts receivable without recourse for cash, subject to certain terms and conditions. Under the Account Receivable Finance Agreement, Spotless may, but is not obligated to, purchase one or more of the Company's accounts receivable, which are approved by Spotless, in its sole discretion, in respect of the particular debtor, invoices and related credit. As part of the agreement, Spotless may purchase any accounts receivable at a 15% discount to invoice prices, which the Company believes is at least as favorable to it as would be available from an unaffiliated third-party, based upon a good-faith estimate of an applicable discount negotiated at arm's length, as may be adjusted by Spotless in its sole discretion. In addition, the Company pays varying monthly discount fees on any purchased accounts receivable based upon invoice prices. All discounts and fees under the Account Receivable Finance Agreement are characterized as interest expense in the consolidated statements of operations. Further, the Company (a) manages any accounts receivable that it sells to Spotless while remitting to Spotless any proceeds received and (b) bears any related litigation costs. For both the thirteen-weeks and thirty-nine weeks ended March 30, 2004, the Company sold approximately $1,179,000 of accounts receivable to Spotless and incurred approximately $208,000 of discounts and fees associated with these sales. 10 <PAGE> CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of its financial position and results of operations are based upon the Company's unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these unaudited financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Management believes that the critical accounting policies and areas that require the most significant judgments and estimates to be used in the preparation of the unaudited financial statements are accounting for contracts, allowance for doubtful accounts and the valuation allowance against deferred tax assets. Contract Accounting - Revenue derived from services provided to customers over periods of less than one month is recognized at the completion of the related contracts. Revenue from firm fixed price contracts that extend over periods of one month or more is recognized using the percentage-of-completion method, measured by the percentage of costs incurred to date compared to estimated total costs for each contract. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, estimated profitability, the effect of contract penalty provisions and final contract settlements may result in revisions to estimates of costs and income and are recognized in the period in which the revisions are determined. Revenues from time and material contracts that extend over a period of more than one month are recognized as services are performed. Allowance for Doubtful Accounts - The Company maintains an allowance for doubtful trade accounts receivable for estimated losses resulting from the inability of its customers to make required payments. In determining collectibility, the Company reviews available customer financial information including public filings and credit reports and also consults legal counsel to assist in determining collectibility. When it is deemed probable that a specific customer account is uncollectible, that balance is included in the reserve calculation. Actual results could differ from these estimates under different assumptions. Deferred Tax Asset Valuation Allowance - The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. Due to the Company's prior history of losses, the Company has recorded a full valuation allowance against its net deferred tax assets as of March 30, 2004. The Company currently provides for income taxes only to the extent that it expects to pay cash taxes for current income. Should the Company be profitable in the future at levels which cause management to conclude that it is more likely than not that it will realize all or a portion of the deferred tax assets, the Company would record the estimated net realizable value of the deferred tax assets at that time and would then provide for income taxes at its combined federal and state effective rates. RESULTS OF OPERATIONS THIRTEEN WEEKS ENDED MARCH 30, 2004 AND APRIL 1, 2003 Revenue Total revenues for the thirteen weeks ended March 30, 2004 decreased by $622,365, or 17%, to $3,026,183 from $3,648,548 for the thirteen weeks ended April 1, 2003. This decrease was primarily attributable to decreases of approximately $252,000 related to a nonrecurring mold remediation project in Mexico and approximately $386,000 related to the loss of business from an insurance company. Cost of Revenues Cost of revenues increased $1,445,423 or 45% to $4,650,312 for the thirteen weeks ended March 30, 2004 as compared to $3,204,889 for the thirteen weeks ended April 1, 2003, primarily due to cost overruns incurred on an oil storage tank project (see Note 7). Gross profit decreased $2,067,788 to $(1,624,129) for the thirteen weeks ended March 30, 2004 from $443,659, for the thirteen weeks ended April 1, 2003, primarily due to costs incurred on the oil tank storage project. 11 <PAGE> Selling, General and Administrative Expenses Selling, general and administrative expenses increased by $58,239 or 4% to $1,521,322 for the thirteen weeks ended March 30, 2004 from $1,463,083 for the thirteen weeks ended April 1, 2003 and constituted approximately 50% and 40% of revenues in these periods, respectively. This increase was primarily attributable to increases in consulting expenses of approximately $97,000, marketing expenses of approximately $51,000, insurance expenses of approximately 49,000 and the provision for doubtful accounts of approximately $36,000, offset by decreases in legal expenses of approximately $127,000, sales salaries of approximately $37,000 and officers salaries of approximately $19,000. (Benefit) Expense Related to Variable Accounting Treatment for Officer Options Under the terms of an employment agreement with the Company and a separate agreement with Spotless, the Company's President and Chief Executive Officer may sell to the Company, or in certain circumstances to Spotless, all shares of common stock of the Company held by him and all shares of common stock underlying vested options to purchase shares of common stock of the Company held by him upon the occurrence of certain events. The expense related to variable accounting treatment for officer options was $103,896 for the thirteen weeks ended March 30, 2004 compared to a benefit of ($270,409) for the thirteen weeks ended April 1, 2003. The expense in the thirteen weeks ended March 30, 2004 was due to an increase in the market price of the Company's common stock and/or a change in the number of options outstanding that are vested. The benefit in the thirteen weeks ended April 1, 2003 was due to a decrease in the market price of the Company's common stock and/or a change in the number of options outstanding that are vested. Due to the terms of the options, changes in the market price of the Company's common stock, in either direction, result in a corresponding expense or benefit. Interest Expense Interest expense increased by $236,581 to $252,681 for the thirteen weeks ended March 30, 2004 from $16,100 for the thirteen weeks ended April 1, 2003. The increase in interest expense was primarily attributable to the discount recorded when Spotless purchased accounts receivable from the Company under the Account Receivable Finance Agreement and greater amounts of debt outstanding resulting from increased borrowings from Spotless for working capital. Benefit for Income Taxes The benefit for income taxes increased by $563,103 to $928,637 for the thirteen weeks ended March 30, 2004 from $365,534 for the thirteen weeks ended April 1, 2003. Net Loss Net loss increased by $2,168,519 to $2,567,984 for the thirteen weeks ended March 30, 2004 from $399,465 for the thirteen weeks ended April 1, 2003. The increase was the result of the factors discussed above. THIRTY-NINE WEEKS ENDED MARCH 30, 2004 AND APRIL 1, 2003 Revenue Total revenues for the thirty-nine weeks ended March 30, 2004 increased by $704,011, or 5%, to $14,809,582 from $14,105,571 for the thirty-nine weeks ended April 1, 2003. This increase was primarily attributable to increases of approximately $852,000 related to an oil tank cleaning project, approximately $1,850,000 related to several fire restoration projects, approximately $923,000 related to emergency response work performed in Virginia and Maryland resulting from Hurricane Isabel, approximately $338,000 related to a mold remediation project in Connecticut, approximately $537,000 related to several water emergency services, approximately $162,000 related to a monitoring project of water containments, approximately $100,000 in training revenue and approximately $1,110,000 related to projects from a new insurance company customer, which was partially offset by decreases of approximately $3,750,000 related to a nonrecurring mold remediation project in Hawaii and Mexico, approximately $1,115,000 related to the loss of business from an insurance company and approximately $406,000 related to fewer emergency response projects for a local utility company. 12 <PAGE> Cost of Revenues Cost of revenues increased $2,175,406 or 19% to $13,489,965 for the thirty-nine weeks ended March 30, 2004 as compared to $11,314,559 for the thirty-nine weeks ended April 1, 2003. Gross profit decreased $1,471,395 to $1,319,617, or 22% of total revenue, for the thirty-nine weeks ended March 30, 2004 from $2,791,012, or 20% of total revenue, for the thirty-nine weeks ended April 1, 2003, due primarily to cost overruns incurred on an oil storage tank project (see Note 7). Selling, General and Administrative Expenses Selling, general and administrative expenses decreased by $121,860 or 3% to $3,927,781 for the thirty-nine weeks ended March 30, 2004 from $4,049,641 for the thirty-nine weeks ended April 1, 2003 and constituted approximately 27% and 29% of revenues in these periods, respectively. This decrease was primarily attributable to decreases in the provision for doubtful accounts of approximately $97,000, legal expenses of approximately $297,000 and sales salaries of approximately $115,000, offset by increases in consulting expenses of approximately $247,000, insurance expenses of approximately $115,000 and miscellaneous expenses of approximately $60,000. Benefit Related to Variable Accounting Treatment for Officer Options Under the terms of an employment agreement with the Company and a separate agreement with Spotless, the Company's President and Chief Executive Officer may sell to the Company, or in certain circumstances to Spotless, all shares of common stock of the Company held by him and all shares of common stock underlying vested options to purchase shares of common stock of the Company held by him upon the occurrence of certain events. The benefit related to variable accounting treatment for officer options was $244,729 for the thirty-nine weeks ended March 30, 2004 compared to $432,974 for the thirty-nine weeks ended April 1, 2003. This benefit was due to a decrease in the market price of the Company's common stock and/or a change in the number of options outstanding that are vested. Due to the terms of the options, changes in the market price of the Company's common stock, in either direction, result in a corresponding expense or benefit. Interest Expense Interest expense increased by $261,038 to $312,328 for the thirty-nine weeks ended March 30, 2004 from $51,290 for the thirty-nine weeks ended April 1, 2003. The increase in interest expense was primarily attributable to the discount recorded when Spotless purchased accounts receivable from the Company under the Account Receivable Finance Agreement and greater amounts of debt outstanding resulting from increased borrowings from Spotless for working capital. Benefit for Income Taxes The benefit for income taxes increased by $375,149 to $750,000 for the thirty-nine weeks ended March 30, 2004 from $374,851 for the thirty-nine weeks ended April 1, 2003. Net Loss Net loss increased by $1,417,727 to $1,896,396 for the thirty-nine weeks ended March 30, 2004 from $478,669 for the thirty-nine weeks ended April 1, 2003. The decrease was the result of the factors discussed above. LIQUIDITY AND CAPITAL RESOURCES As of March 30, 2004, the Company had a cash balance of $235,186, working capital of $(260,232) and stockholders' equity of $870,483. As of July 1, 2003, the Company had cash balances of $130,096, working capital of $2,217,290 and stockholders' equity of $2,825,379. At July 2, 2002, the Company had cash balances of $399,679, working capital of $4,326,473 and stockholders' equity of $3,372,383. Historically, the Company has financed its operations primarily through issuance of debt and equity securities, through short-term borrowings from its majority shareholder, Spotless, and through cash generated from operations. In the opinion of management, the Company expects to have sufficient working capital to fund its current operations as long as 13 <PAGE> it does not encounter difficulty collecting its accounts receivable. However, market conditions and their effect on the Company's liquidity may restrict the Company's use of cash. In the event that sufficient positive cash flow from operations is not generated, the Company may need to seek additional financing from Spotless in addition to the financing contemplated by the Account Receivable Finance Agreement dated as of February 5, 2004, although Spotless is under no legal obligation to provide such additional funds. The Company currently has no credit facility for additional borrowing. Under the Account Receivable Finance Agreement, Spotless may, but is not obligated to, purchase one or more of the Company's accounts receivable, which are approved by Spotless, in its sole discretion, in respect of the particular debtor, invoices and related credit. As part of the agreement, Spotless may purchase any accounts receivable at a 15% discount to invoice prices, which the Company believes is at least as favorable to it as would be available from an unaffiliated third-party, based upon a good-faith estimate of an applicable discount negotiated at arm's length, as may be adjusted by Spotless in its sole discretion. In addition, the Company pays varying monthly discount fees on any purchased accounts receivable based upon invoice prices. All discounts and fees under the Account Receivable Finance Agreement are characterized as interest expense. As of March 30, 2004, the Company has incurred $208,000 of such discounts and fees. Further, the Company (a) manages any accounts receivable that it sells to Spotless while remitting to Spotless any proceeds received and (b) bears any related litigation costs. Net cash used in operating activities was $2,429,973 for the thirty-nine weeks ended March 30, 2004 as compared to $383,744 for the thirty-nine weeks ended April 1, 2003. Accounts receivable increased by $2,338,466 for the thirty-nine weeks ended March 30, 2004 as a result of increased sales and difficulties in cash collections. Accounts receivable decreased by $874,261 for the thirty-nine weeks ended April 1, 2003 due to increased collection activities. Accounts payable and accrued expenses increased by $396,273 for the thirty-nine weeks ended March 30, 2004 as a result of the Company's cash collections difficulties which resulted in slower payments to vendors. Accounts payable and accrued expenses decreased $170,818 for the thirty-nine weeks ended April 1, 2003 due to lower sales volume. Refundable income taxes decreased by $330,186 for the thirty-nine weeks ended March 30, 2004 as a result of collection of a federal income tax refund. Cash used for capital expenditures was $714,701 during the thirty-nine weeks ended March 30, 2004 as compared to $1,078,497 for the thirty-nine weeks ended April 1, 2003. Financing activities for the thirty-nine weeks ended March 30, 2004 provided net cash of $3,249,764. This amount includes repayments of long-term debt of $323,769, proceeds from long-term debt of $312,533, payment of preferred stock dividends of $39,000 and proceeds from short-term loans from Spotless of $3,300,000. Financing activities for the thirty-nine weeks ended April 1, 2003 provided net cash of $1,121,137. This amount included repayments of long-term debt of $112,194, proceeds from long-term debt of $391,831, repayment of a convertible note to a related party of $100,000, payment of preferred stock dividends of $58,500, proceeds from borrowings from Spotless of $1,825,000 and repayments of borrowings to Spotless of $825,000. As of March 30, 2004, the Company owed Spotless $5,000,000. All borrowings from Spotless bear interest at the London Interbank Offering Rate ("LIBOR") plus 1 percent, are secured by all of the Company's assets and are payable on demand. The Company's liquidity has been severely adversely affected by its unrecouped costs incurred in connection with an oil storage tank project. The Company believes that it will be successful in collecting for this project, but no assurance can be given as to the timing or amount of any such recovery. Management believes the Company will require positive cash flow from operations to meet its working capital needs over the next twelve months unless the Company increases its borrowings from Spotless or sufficiently utilizes its Accounts Receivable Finance Agreement with Spotless. In the event that positive cash flow from operations is not generated, the Company may be required to seek additional financing, from Spotless or otherwise, to meet its working capital needs. Management continues to pursue additional funding sources, but has been unable to attract debt or equity capital on terms more favorable than those available from Spotless. The Company anticipates continued revenue growth in new and existing service areas and continues to bid on large projects, though there can be no assurance that any of the Company's bids will be accepted. The Company is striving to improve its gross margin and control its selling, general and administrative expenses. There can be no assurance, however, that changes in the Company's plans or other events affecting the Company's operations will not result in accelerated or unexpected cash requirements, or that it will be successful in achieving positive cash flow from operations or obtaining additional financing. The Company's 14 <PAGE> future cash requirements are expected to depend on numerous factors, including, but not limited to: (a) the ability to obtain environmental or related construction contracts, (b) the ability to generate positive cash flow from operations, and the extent thereof, (c) the ability to raise additional capital or obtain additional financing, and (d) economic conditions. The table below summarizes contractual obligations and commitments as of March 30, 2004: <TABLE> <CAPTION> Total 1 Year 2-3 Years 4-5 Years ----- ------ --------- --------- <S> <C> <C> <C> <C> Operating leases $1,390,105 $439,887 $ 917,429 $ 32,789 Long-term debt 764,228 359,600 333,101 71,527 ----------- --------- ----------- ---------- $2,154,333 $799,487 $1,250,530 $ 104,316 =========== ========= =========== ========== </TABLE> OFF-BALANCE SHEET ARRANGEMENTS The Company does not have any off-balance sheet arrangements. INFLATION Inflation has not had a material impact on the Company's operations over the past three fiscal years or during the thirty-nine weeks ended March 30, 2004. SEASONALITY Since the Company and its subsidiaries are able to perform their services throughout the year, the business is not considered seasonal in nature. However, it is affected by the timing of large contracts in certain of its service areas, i.e., asbestos and mold abatement and construction, as well as the timing of catastrophes. FORWARD-LOOKING STATEMENTS Statements contained in this Form 10-Q include "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause the actual results, performance and achievements, whether expressed or implied by such forward-looking statements, not to occur or be realized. Such forward-looking statements generally are based upon the Company's best estimates of future results, performance or achievement, based upon current conditions and the most recent results of operations. Forward-looking statements may be identified by the use of forward-looking terminology such as "may," "will," "expect," "believe," "estimate," "anticipate," "continue" or similar terms, variations of those terms or the negative of those terms. Potential risks and uncertainties include, among other things, such factors as: o the market acceptance and amount of sales of the Company's services, o the Company's success in increasing revenues and reducing expenses, o the frequency and magnitude of environmental disasters or disruptions resulting in the need for the types of services the Company provides, o the extent of the enactment, enforcement and strict interpretations of laws relating to environmental remediation, o the competitive environment within the industries in which the Company operates, o the Company's ability to raise additional capital, o the Company's ability to attract and retain qualified personnel, and o the other factors and information disclosed and discussed in other sections of this Quarterly Report on Form 10-Q and in the Company's Report on Form 10-K for the fiscal year ended July 1, 2003. Investors should carefully consider such risks, uncertainties and other information, disclosures and discussions which contain cautionary statements identifying important factors that could cause actual results to differ materially from those provided in the forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 15 <PAGE> The foregoing discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company's results of operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing in Item 1 and with the consolidated financial statements included in the Company's annual report on Form 10-K. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to potential loss from market risks that may occur as a result of changes in the market price of the Company's common stock (with respect to the variable accounting treatment of a put option for shares of common stock and common stock options held by an officer of the Company) and as a result of changes in interest rates (primarily with respect to its debt obligations to Spotless). There have been no material changes to the nature of Company's market risks since the Company's Annual Report on Form 10-K for the period ended July 1, 2003. ITEM 4. CONTROLS AND PROCEDURES Our principal executive and financial officers have concluded, based on their evaluation of, the effectiveness of our "disclosure controls and procedures" as of the end of the period covered by this quarterly report on Form 10-Q (as defined under Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934) were effective as of such date to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and include controls and procedures designed to ensure that information we are required to disclose in such reports is accumulated and communicated to management, including our principal executive and officers, as appropriate to allow timely decisions regarding required disclosure. Subsequent to our evaluation, there were no significant changes in internal controls or other factors that could significantly affect these internal controls. PART 2 - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ----------------- Reference is hereby made to Note 5 to the Consolidated Financial Statements in Part I - Item 1 above and to Item 3 of the Company's Annual Report on Form 10-K for the year ended July 1, 2003 and to the references therein, for a discussion of all material pending legal proceedings to which the Company or any of its subsidiaries is party. ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES -------------------------------------------------------------- Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES ------------------------------- The Company is required to pay quarterly dividends on its Series A Convertible Preferred Stock, par value $.01 per share (the "Series A Preferred"), which dividends accrue from the initial date of issuance of the Series A Preferred, are cumulative and, if not paid when due, bear interest on the unpaid amount of the past due dividends at the prime rate published in The Wall Street Journal on the date the dividend was payable, plus 3%. The Company is currently in arrears on its Series A Preferred dividend payments and interest thereon in the aggregate amount of approximately $19,500 due to a lack of available cash. If the Company fails to make any four consecutive quarterly dividend payments on the Series A Preferred, the majority in interest of the holders of the Series A Preferred have the right to elect an additional director to the Company's Board of Directors, to serve as a director until such accrued and unpaid dividends have been paid in full. There can be no assurance when or if the Company will make any Series A Preferred dividend payments. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- Not applicable 16 <PAGE> ITEM 5. OTHER INFORMATION ----------------- Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits: 31.1 Certification of Chief Executive Officer pursuant to Sarbanes-Oxley Section 302(a) 31.2 Certification of Chief Financial Officer pursuant to Section 302(a) 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350. b. Reports on Form 8-K: None 17 <PAGE> SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WINDSWEPT ENVIRONMENTAL GROUP, INC. Date: May 19, 2004 By: /s/ Michael O'Reilly ------------------------------ MICHAEL O'REILLY, President and Chief Executive Officer (Principal Executive Officer) Date: May 19, 2004 By: /s/ Charles L. Kelly, Jr. ------------------------------ CHARLES L. KELLY, JR. Chief Financial Officer (Principal Financial Officer) 18 </TEXT> </DOCUMENT>