10-Q 1 b313319_10q.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001. [ ] TRANSITIONAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to ______________ Commission file number: 33-29942-NY ---------------------------- NATIONS FLOORING, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 11-2925673 -------------------------------------------------------------------------------- (State or other (IRS Employer jurisdiction of incorporation) Identification Number) 100 Maiden Lane, New York, New York 10038 -------------------------------------------------------------------------------- (Address of principal executive offices) (212) 898-8855 -------------------------------------------------------------------------------- (Issuer's telephone number) -------------------------------------------------------------------------------- (Former name, former address or former fiscal year, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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. X Yes No --- --- State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 3,729,779 shares of Common Stock, par value $.001 per share, were outstanding at August 14, 2001. 1 INDEX Page ---- Part I - Financial Information Item 1. Financial Statements Consolidated balance sheets 3 Consolidated statements of operations 4-5 Consolidated statements of cash flows 6-7 Notes to consolidated financial statements 8-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-16 Item 3. Quantitative and Qualitative Disclosures about Market Risk 16 Part II - Other Information Item 1. Legal Proceedings 16 Item 4. Submission of Matters to a Vote of Security Holders 16 Item 6. Exhibits and Reports on Form 8-K 16 Signatures 17 2 NATIONS FLOORING, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Unaudited)

See Notes to Consolidated Financial Statements 3 NATIONS FLOORING, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Six Months Ended June 30,

See Notes to Consolidated Financial Statements. 4 NATIONS FLOORING, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) Three Months Ended June 30,

See Notes to Consolidated Financial Statements. 5 NATIONS FLOORING, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Six Months ended June 30,

See Notes to Consolidated Financial Statements. 6 NATIONS FLOORING, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (unaudited) Six Months ended June 30,

See Notes to Consolidated Financial Statements. 7 NATIONS FLOORING, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Significant Accounting Policies Nature of business Nations Flooring, Inc. (Nations or Company) was organized under the laws of the State of Delaware. The Company sells floorcoverings and related products through its residential contract, residential replacement and commercial operating segments in Nevada, Utah, Idaho, metropolitan Washington, D.C. and Myrtle Beach, S.C. The Company believes that the economic and other characteristics of its three operating segments meet the aggregation criteria outlined in Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information. Accordingly, segment information is not presented since the Company's operating segments are aggregated for reporting purposes. The Company grants credit principally to new homebuilders. A summary of the Company's significant accounting policies follows. Principles of consolidation The consolidated financial statements include the accounts of the Company and its subsidiary, Carpet Barn, Inc. (CBI). All material intercompany accounts and transactions are eliminated in consolidation. Preferred stock The holders of the 12% cumulative preferred stock of Nations have an aggregate of 16% of the votes of the outstanding shares of the common stock of Nations. In the event the Company is liquidated, no distributions shall be made to the holders of shares of stock ranking junior to the preferred stock, unless, prior thereto, the holders of shares of preferred stock shall have received a liquidation preference payment of $1,000 per share plus all accrued and unpaid dividends through the date of such payment. Also, until all accrued and unpaid dividends and distributions on preferred stock have been paid in full, the Company shall not declare or pay dividends on, make any other distributions on, or redeem, purchase or otherwise acquire for consideration any shares of stock ranking junior to the preferred stock. The preferred stock may be redeemed at the option of the Board of Directors at a call price per share equal to its liquidation value plus any accrued and unpaid dividends through the date of redemption. If no call has been made, the Company is required to call the preferred stock for redemption at the call price on a date not later than seven days after the closing of an underwritten public offering. Basis of presentation The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information 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 accounting principles generally accepted in the United States of America for complete financial statements. In management's opinion, the accompanying consolidated financial statements reflect all material adjustments (consisting only of normal recurring accruals) necessary for a fair statement of the results for the interim periods presented. The results for the interim periods are not necessarily indicative of the results which will be reported for the entire year. Use of estimates in the preparation of financial statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash During the periods presented, the Company maintained cash balances which, at times, were in excess of federally insured limits. The Company has experienced no losses in such accounts. At December 31, 2000 and June 30, 2001 the Company's cash balances were maintained at financial institutions in Nevada, Illinois, South Carolina, Idaho and Virginia. 8 NATIONS FLOORING, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Significant Accounting Policies (continued) Inventory Inventory consists primarily of carpet and vinyl and is stated at the lower of cost (first-in, first-out method) or market. Included in inventory is work-in-process of $461,079 and $498,692 at December 31, 2000 and June 30, 2001, respectively. Property and equipment Building, furniture and equipment, autos and trucks and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation is provided on the straight-line and accelerated methods for financial reporting purposes. Amortization is provided on the straight-line basis over the shorter of the economic life of the asset or the lease term. Property and equipment consist of the following:

The Company assesses the impairment of long-lived assets, identifiable intangibles and costs in excess of net assets of business' acquired (goodwill), by comparison to the projected undiscounted cash flows to be derived from the related assets. The Company has concluded that no impairment in the carrying amount of long-lived assets, identifiable intangibles and goodwill existed at June 30, 2001. Intangible assets Intangible assets consist of the following:

Goodwill is being amortized by the straight-line method over fifteen to twenty-five years. The Company incurred financing costs related to bank financing (see Note 3). These costs are being amortized on the effective interest method over the term of the debt. The Company has also entered into covenants not-to-compete in connection with certain business acquisitions. The covenants are being amortized on the straight-line method over the five-year terms of the agreements. 9 NATIONS FLOORING, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Significant Accounting Policies (continued) Income taxes The Company provides for deferred taxes on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. Vendor cooperative marketing and purchase discounts The Company participates in various advertising and marketing programs with suppliers. Certain of the Company's costs incurred in connection with these programs are reimbursed. The Company records these reimbursements when earned. The Company also records accounts payable net of anticipated purchase discounts. Basic and dilutive net loss per common share Basic and dilutive net loss per common share is computed based on net loss applicable to common stockholders and the following weighted average number of common shares outstanding:

Dilutive net loss per share for the six and three months ended June 30, 2000 and 2001 is the same as the basic net loss per share as the inclusion of incremental shares for outstanding stock options would have been anti-dilutive. Dividends on preferred stock, which totaled $309,600 for both the six months ended June 30, 2000, and 2001 and $154,800 for both the three months ended June 30, 2000 and 2001, reduced the earnings available to common stockholders in the computation of earnings per share Revenue recognition Revenue is recorded for sales of commercial and retail floorcovering and related products upon completion of installation. Advertising All costs related to marketing and advertising the Company's products are expensed in the period incurred. Advertising expense, net of cooperative advertising earned, was $663,282 and $734,017 for the six months ended June 30, 2000, and 2001, respectively. Self Insurance The Company is self-insured for its employee health insurance plan. The Company is reinsured for claims in excess of $20,000 per individual per year. 10 NATIONS FLOORING, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Significant Accounting Policies (continued) Accounting for Stock-Based Compensation The Company measures compensation expense related to the grant of stock options and stock-based awards to employees and directors in accordance with the provisions of Accounting Principles Board Opinion (APB) No. 25, under which compensation expense, if any, is based on the difference between the exercise price of an option, or the amount paid for an award, and the market price or fair value of the underlying common stock at the date of the award or grant or at the measurement date for variable awards. Stock-based compensation arrangements involving non-employees are accounted for under Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation, (SFAS 123) under which such arrangements are accounted for based on the fair value of the option or award. Fair value of financial instruments The carrying amounts of financial instruments including cash, accounts receivable, accounts payable, accrued expenses and customer deposits approximate their fair values because of their short maturities. The carrying amounts of note payable, long-term debt and the note payable-principal stockholder approximate their fair values because the interest rates on these instruments are at market rates. Although management expects a substantial portion of the note payable-principal stockholder to be paid in the near term, it is not practicable to estimate the fair value of these amounts, as they have no stated repayment terms. Management does not believe fair value of such amounts, if determined, would differ materially from their recorded amounts. Note 2. Note Payable- Principal Stockholder The Company has an unsecured note payable totaling $2,851,248 to Branin Investments, Inc. (Branin), which is 100% owned by Philip A. Herman, who until his resignation on August 18, 2000 was the Chairman of the Board and President of Nations. Prior to his resignation, this note payable consisted of interest and non-interest bearing advances. The note bears interest at 13% per annum, payable monthly and is due at the earlier of May 2003 or the date on which the Company completes a public offering of its equity securities or a refinancing of its bank debt owed pursuant to the Credit Facility with Fleet as described in Note 3. In addition, Branin has agreed to subordinate its rights to receive principal and interest payments to the obligation under the Credit Facility. In light of these terms the entire note has been classified as long term at December 31, 2000 and June 30, 2001. Total interest expense of $97,500 and $167,514 relating to the amounts owed to Branin has been reflected in the accompanying consolidated statements of operations for the six months ended June 30, 2000 and 2001, respectively. Accrued interest of $241,676 and $361,067 is included in the balance of the Note Payable-Principal Stockholder at December 31, 2000 and June 30, 2001. The Company had an oral consulting agreement with Branin for certain management advisor services. The agreement called for monthly payments of $20,000. Effective May 31, 2001, the agreement was mutually terminated. Note 3. Note Payable and Long-Term Debt The Company, through its subsidiary CBI, has a credit agreement (the "Credit Facility") with Fleet Capital Corporation ("Fleet"), consisting of a $5,000,000 term loan and a $5,000,000 revolving line of credit. Advances on the revolving line of credit are further limited by CBI's levels of eligible accounts receivable and inventory. The term loan requires quarterly payments of $175,000. CBI has pledged substantially all of its assets to secure the Credit Facility and Nations has pledged all of the common stock of CBI to secure its guarantee of the Credit Facility. The term and revolving portions of the Credit Facility are due on May 18, 2003. All borrowings under the Credit Facility bear interest, payable monthly, at the base rate per annum announced from time to time by Fleet (4.36% at June 30, 2001) plus 2.75% and 3.25% per annum, in connection with advances under the revolving line and term loan, respectively. (During the period from April 1 through June 30, 2001, because of the covenant violations discussed below, interest on the revolving line and term loan accrued interest at the stated default rates, which were 4.75% and 5.25% over the base rate, respectively.) The Credit Facility also contains provisions that excess cash flow of CBI over certain defined levels will be used to repay principal under the term loan. The Credit Facility contains financial covenants which, among others, requires CBI to maintain minimum levels of tangible net worth and debt coverage. In connection with this Credit Facility, Branin has agreed that the note payable to Branin (see Note 2) will be subject to certain subordination and payment limitation requirements. 11 NATIONS FLOORING, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 3. Note Payable and Long-Term Debt (continued) At December 31, 2000, CBI was in violation of certain financial covenants related to the Credit Facility. The Company is currently in discussions with Fleet concerning the waiver of these violations as well as the amendment of certain of the covenants to levels where the Company believes it can be in compliance prospectively, however there can be no assurance such negotiations will be successful. Because the covenants have not been revised on a going forward basis, and future compliance under the current terms is unlikely, the portions of the term note due beyond June 30, 2002 totaling $2,200,000 have been reflected as currently due. Amounts outstanding under the Credit Facility are as follows: December 31, June 30, 2000 2001 --------------- ---------------- Revolving line of credit $ 4,532,156 $ 4,629,380 Term loan $ 3,250,000 $ 2,900,000 At June 30, 2001, the Company had no availability under the term loan and approximately $25,000 available under the revolving line of credit. The Company has a mortgage note payable with a financial institution secured by the Company's land and building of $432,572 and $417,619 outstanding at December 31, 2000 and June 30, 2001, respectively. The note bears interest at 9% and is due in monthly payments of principal and interest totaling $5,690 with the balance due May 2003. CBI also has long-term obligations including capital leases of $178,085 and $142,922 outstanding at December 31, 2000 and June 30, 2001, respectively. The obligations bear interest at an approximate average of 13% and mature between August 2001 and September 2005. The Company is actively seeking a credit relationship to replace the Fleet Credit Facility, and provide the Company additional working capital. In addition, the Company plans to raise equity funds to further its acquisition strategy. On March 22, 2001, the Company signed an agreement with an underwriter to use its best efforts in a proposed $1,000,000 private placement of convertible debt, to be followed by a public offering with expected gross proceeds of approximately $15,000,000. There can be no assurance that such contemplated replacement financing or equity offering will be completed or that the funds raised will be sufficient to execute the Company's strategy. Note 4. Pronouncements Issued Not Yet Adopted In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 addresses financial accounting and reporting for business combinations and is effective for all business combinations after June 30, 2001. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and is effective for fiscal years beginning after December 15, 2001. The Company is in the process of determining the expected impact on earnings and existing goodwill and other intangibles upon adoption, which will include the elimination of goodwill amortization and may include the reclassification other intangible assets to goodwill and additional goodwill impairment. As of June 30, 2001, goodwill totaled approximately $14 million and is being amortized over fifteen to twenty-five years. 12 Item 2. Management's discussion and analysis of financial condition and results of operations This Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Act of 1995. The Company's future results of operations, as compared to those forward-looking statements, is subject to and will be affected by certain risks and uncertainties. As a result the Company's actual operations may differ significantly from those discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, leverage, capital requirements, demand for the Company's products and services, dependence on manufacturers and suppliers, relationships with customers, dependence on key operating personnel, uncertainties related to the Company's growth strategies and those discussed below. The following discussion of the financial condition and results of operations of the Company relates to the six and three months ended June 30, 2000 and 2001 and should be read in conjunction with the financial statements and notes thereto included elsewhere in this Report. The discussion of results includes discussions regarding EBITDA. EBITDA is used by management as a measure of performance and is defined as operating income plus amortization and depreciation. Management believes it is meaningful to readers as a measure of liquidity and allows investors to evaluate the Company's liquidity using the same measure that is used by the Company's management. The Company's calculation of EBITDA may or may not be consistent with the calculation of EBITDA by other public companies. Management views EBITDA as a meaningful supplemental measure to, but not a replacement of, the primary measures of financial condition and results of operations and accordingly, management's discussion of EBITDA should not be viewed as an alternative to the discussions of results of operations or cash flows as measured or presented under generally accepted accounting principles. In addition, EBITDA does not take into effect changes in certain assets and liabilities which can affect cash flow. Results of Operations Six Months Ended June 30, 2000 and June 30, 2001. Total revenues increased by $106,249 from $30,029,526 for the six months ended June 30, 2000 to $30,135,775 for the six months ended June 30, 2001, representing an increase of 1%. The components of this increase are as follows: Residential Contract $ (124,000) Residential Replacement 536,725 Commercial 102,993 Other (409,469) --------------- $ 106,249 =============== The increase in Residential Replacement was due primarily due to the opening of the Myrtle Beach location in July, 2000. This increase in Residential Replacement was substantially offset by the decrease in other revenues, which is primarily comprised of window coverings and wall tile. The primary reason for the decrease in other revenues was due to a reduction of marketing and management resources allocated in these areas. Gross profit decreased by $77,058 from $7,398,235 for the six months ended June 30, 2000 to $7,321,177 for the six months ended June 30, 2001, representing an decrease of 1%. The Company's gross profit percentage decreased to 24.3% in 2001 from 24.6% in 2000. Selling, general and administrative expenses decreased by $123,458 from $6,614,832 for the six months ended June 30, 2000 to $6,491,374 for the six months ended June 30, 2001. The decrease was comprised primarily of approximate decreases in salaries and benefits of $159,000, professional fees of $169,000, and office supplies and expense of $52,000 partially offset by approximate increases in third party finance charges of $61,000, rent of $116,000 and advertising of $71,000. As a percentage of sales, selling, general and administrative expenses decreased from 22.0% in 2000 to 21.5% in 2001. Amortization and depreciation expense decreased from $685,617 in 2000 to $616,675 in 2001, due to certain intangible assets becoming fully amortized in the second quarter of 2000. As a result of the above changes operating income increased by $115,342 from $97,786 for the six months ended June 30, 2000 to $213,128 for the six months ended June 30, 2001. Interest expense increased by $50,506 from $555,202 for the six months ended June 30, 2000 to $605,708 for the six months ended June 30, 2001. The primary reasons for the increase in interest expense was the consolidation of advances to Branin into an interest 13 bearing note in August 2000, and the accruing of interest on the Credit Facility at the higher default rates. Income tax benefit changed by $9,000 from $144,000 in 2000 to $135,000 in 2001 due to the decrease in loss before income taxes. Net loss changed by $63,656 from $321,036 for the six months ended June 30, 2000 to $257,380 for the six months ended June 30, 2001. EBITDA increased by $46,400 from $783,403 for the six months ended June 30, 2000 to $829,803 for the six months ended June 30, 2001. This increase in EBITDA was due primarily to the decrease in selling, general and administrative expenses of $123,458 offset by a decrease in gross profit of $77,058. Fiscal Quarters ended June 30, 2000 and June 30, 2001. Total revenues decreased by $756,343 to $14,993,492 for the three months ended June 30, 2001 from $15,749,835 for the three months ended June 30, 2000, representing a decrease of 4.8%. The components of this decrease are as follows: Residential Contract $ (313,437) Residential Replacement (91,640) Commercial (63,095) Other (288,171) ------------------- $ (756,343) =================== The primary reason for the decline in Residential Contract Sales is the slowing down and closing out of certain developments under contract with several of the Company's builders. The Company is focusing its marketing efforts in the near term on obtaining new developments with both existing and new builders. However, there can be no assurance that the Company will be able to obtain new business to offset this decline. The primary reason for the decrease in other revenues was due to a reduction of marketing and management resources allocated specifically to generating other revenues. Gross profit decreased by $454,717 to $3,579,270 for the three months ended June 30, 2001 from $4,033,987 for the three months ended June 30, 2000, representing a decrease of 11.8%. The Company's gross profit percentage decreased to 23.9% in 2001 from 25.6% in 2000. The decline in gross profit primarily results from the decrease in Residential Contract Sales discussed above, the majority of which sales were in housing developments which carry higher then average margins. Selling, general and administrative expenses decreased by $273,353 to $3,244,715 for the three months ended June 30, 2001 from $3,518,068 for the three months ended June 30, 2000. This decrease was comprised primarily of approximate decreases in salaries and benefits of $165,000 and professional fees of $101,000. The decrease in salaries and benefits are the results of cost reductions that are expected to continue until any further acquisitions, if any, are completed. As a percentage of sales, selling, general and administrative expenses decreased to 21.6% in 2001 from 22.3% in 2000. Amortization and depreciation expense decreased to $310,174 in 2001 from $330,698 in 2000, due to certain intangible assets becoming fully amortized in the second quarter of 2000. As a result of the above changes operating income decreased by $160,840 to $24,381 for the three months ended June 30, 2001 from $185,221 for the three months ended June 30, 2000. Interest expense increased by $5,706 to $297,921 for the three months ended June 30, 2001 from $292,215 for the three months ended June 30, 2000. The primary reasons for the increase in interest expense was the consolidation of advances to Branin into and interest bearing note in August 2000, and the accruing of interest on the Credit Facility at the higher default rates. Income tax benefit increased by $119,000 to $93,000 in 2001 from $26,000 in 2000 due to the increase in loss before income taxes. Net loss increased by $90,056 to $180,493 for the three months ended June 30, 2001 from $90,437 for the three months ended June 30, 2000. EBITDA decreased by $181,364 to $334,555 for the three months ended June 30, 2001 from $515,919 for the three months ended June 30, 2000. This decrease in EBITDA was due primarily to the decrease in sales and related gross profit partially offset by a decrease in selling, general and administrative expenses. 14 Liquidity and Capital Resources Cash provided by operating activities was $1,027,402 and $348,324 for the six months ended June 30, 2000 and 2001 respectively. Cash flows from operations differed significantly from the net loss in both periods due to significant non-cash charges and certain significant changes in working capital items. The changes in the working capital resulted in a working capital deficit of $5,807,101 at June 30, 2001. For 2001, net loss included significant non-cash charges of amortization of $411,680 and depreciation of $204,994. Additionally, cash was provided by increases in accounts payable of $1,479,543. The increase in accounts payable reflects the use of trade credit to partially finance the net loss for the six months ended June 30, 2001. These sources of cash from operations were partially offset by the use of cash to increase inventory by $476,886, accounts receivable by $777,900 and to reduce accrued expenses by $243,687. The increase in accounts receivable was due to a temporary slowdown in the collection on open accounts. The increase in inventory was partially due to the conversion of one of the Las Vegas retail stores into a warehouse outlet. Coupled with the use of cash reserves in the amount of $382,878, the Company used its operating cash flows of $348,324 for the six months ended June 30, 2001 principally to make net reductions of $302,892 in notes payable and long term debt, fund the payment of $309,600 of preferred dividends, and fund $113,710 of capital additions. For 2000, net income included significant non-cash charges of amortization of $475,710 and depreciation of $209,907. Additionally, cash was provided by increases in accounts payable of $1,567,970, accrued expenses of $308,847, customer deposits of $224,933 and increases in the amount owed to the Company's principal stockholder. These sources of cash from operations were partially offset by the increase in accounts receivable, inventory and prepaids to reflect increased operations in 2000. Accounts payable increased as the Company's borrowings under its revolving line of credit approached its $5,000,000 limit. The Company used the operating cash flows of $1,027,402 for the six months ended June 30, 2000 principally to make net reductions of $184,879 in note payable and long-term debt, fund the payment of $309,600 of preferred stock dividends, fund $377,239 of capital additions and increase cash reserves by $125,190. During 2000, the Company opened one location in Myrtle Beach, S.C. The Company funded this new location with its existing working capital. A portion of the initial capital costs for this location was provided by the Company's suppliers in exchange for agreements by the Company to feature the suppliers' products at this facility. The Company anticipates that a portion of the capital requirements for any new locations will be funded by its suppliers, although there can be no assurance that the Company will be able to effect such an arrangement. Any new facilities will require additional resources until they become profitable, and there can be no assurance as to the amount of time required before they can become profitable, if ever. Recently, the Company has been successful in meeting its current cash flow needs through operations and its existing credit arrangements. However, the Company believes it will have challenges in funding its operating cash needs in the near term due to the recent decline in revenues and margins coupled with increases in accounts receivable and inventories. In addition, restrictions of the Company's eligible borrowing base assets, as defined, have further reduced its cash availability under its Credit Facility, resulting in decreasing resources to fund near term operating cash needs. The Company is addressing these cash flow needs by focusing its marketing efforts to acquire new development contracts with both existing and new builders, and to improve its margins on both existing and new developments. The Company is also implementing actions that it believes will result in an improvement in near term cash flows through aggressive collections of its existing trade accounts receivable, reductions in inventory levels, and minimizing cash expenditures not necessary to support near term operating needs. Coupled with continuing implementation of operational efficiencies and cost reductions, the Company believes it will be able to generate sufficient operating cash flows to meet the near term operating cash needs. In the event that these efforts do not produce sufficient increases in near term cash flows, the Company believes it can supplement the operating cash flows through additional debt or equity financing to meet its operating cash needs in the near term. The Company is also actively seeking a credit relationship to replace the Fleet Credit Facility and to provide the company with additional working capital. In the event the Company is unsuccessful in the near term in securing such a replacement credit facility, it is likely the company will need to secure additional equity investment to meet its operating cash needs. However there can be no assurances that the Company will be successful in the above efforts. The Company also recognizes that additional capital will be needed to fund its acquisition and growth strategy as well as any longer term working capital requirements not provided through operations, its current credit facility or other near term equity investment. Accordingly, the Company is seeking to raise equity funds to further its acquisition strategy and fund its longer-term working capital needs. On March 22, 2001, the Company signed an agreement with an underwriter to use its best efforts in a proposed $1,000,000 private placement of convertible debt, 15 to be followed by a public offering with expected gross proceeds of approximately $15,000,000. There can be no assurance that any of these efforts will be successful. Other The Company believes that its revenues are not materially affected by inflation and that any increased expenses due to inflationary pressures will be offset, over time, by corresponding increases in prices it charges to its customers. Item 3 Quantitative and Qualitative Disclosures about Market Risk Like virtually all commercial enterprises, the Company is exposed to the risk ("market risk") that the cash flows to be received or paid relating to certain financial instruments could change as a result of changes in interest rate, exchange rates, commodity prices, equity prices and other market changes. Market risk is attributed to all market risk sensitive financial instruments, including long term debt. The Company does not engage in trading activities and does not utilize interest rate swaps or other derivative financial instruments or buy or sell foreign currency, commodity or stock indexed futures or options. Additionally, with the exception of the Fleet credit facility, the interest on all of the Company's debt is payable at fixed interest rates. Accordingly, the Company's exposure to market risk is limited to the potential affect of changes in interest rates on the cash flows (payments) relating to its variable rate debt with is its debt with Fleet. Based upon the balance of the Fleet debt at June 30, 2001, a hypothetical immediate and sustained increase of 1% in Fleet's announced rate (which generally varies with the interest rates established by the Federal Reserve Bank) would have the affect of increasing the Company's interest expense by approximately $72,000 per year. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In December, 1999, BankBoston Development Company, LLC ("BankBoston"), an affiliate of Fleet Boston Financial, filed a lawsuit in the United States District Court for the District of Massachusetts against Philip Herman (former Chairman of the Board and President of the Company), Branin Investments, Inc. (Branin) (100% owned by Philip A. Herman) and the Company. In its complaint, BankBoston alleges, purportedly on behalf of itself and other stockholders of Millennium Services Corporation ("Millennium"), a company the majority of whose common stock is owned by Branin, that Mr. Herman breached his fiduciary duties to BankBoston in connection with BankBoston's $500,000 investment in Millennium, that Branin and the Company aided and abetted this breach and that all the defendants engaged in fraudulent activities under federal securities laws, common law and the Massachusetts blue sky laws in connection with the investment. The complaint seeks damages of $1.5 million on the fiduciary duty claims and $500,000 on the fraud claims, together with treble damages on the Massachusetts blue sky law claim, interest, attorneys' fees and costs. The Company has filed an answer denying the principal allegations in the complaint. The case is in the discovery stage, but the Company believes it has meritorious defenses to the allegations in the complaint and intends to defend against such allegations vigorously. Therefore, no liability has been recorded in the consolidated financial statements as of December 31, 2000 and June 30, 2001. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None (b) Reports on Form 8-K. None 16 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant had duly caused this report to be signed by the undersigned, thereunto duly authorized. August 17, 2001 /s/ Facundo Bacardi ------------------------------------- Facundo Bacardi Chairman of the Board and President (Principal Executive Officer) August 17, 2001 /s/ William V. Poccia ------------------------------------- William V. Poccia Executive Vice President of Finance and Secretary (Principal Financial and Accounting Officer) 17

NATIONS FLOORING INC 10-Q