SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2002 COMMISSION FILE NO. 1-6663 COLONIAL COMMERCIAL CORP. (Exact Name of Company as Specified in its Charter) NEW YORK 11-2037182 -------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 3601 HEMPSTEAD TURNPIKE, LEVITTOWN, NEW YORK 11756-1315 -------------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) Company's Telephone Number, Including Area Code: 516-796-8400 Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. Yes No X Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes No X Indicate the number of shares outstanding of the Company's Common Stock and Convertible Preferred Stock as of November 11, 2003. Common Stock, par value $.05 per share - 2,405,804 shares Convertible Preferred Stock, par value $.05 per share - 1,464,242 shares COLONIAL COMMERCIAL CORP. AND SUBSIDIARIES INDEX PAGE NO. PART I. FINANCIAL INFORMATION Item 1 - Financial Statements Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001 1 Consolidated Statements of Operations Three Months Ended June 30, 2002 and 2001 (unaudited) 2 Consolidated Statements of Operations Six Months ended June 30, 2002 and 2001 (unaudited) 3 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001 (unaudited) 4 Notes to Consolidated Financial Statements (unaudited) 5 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 18 Item 4 - Controls and Procedures 19 PART II. OTHER INFORMATION Item 1 - Legal Proceedings 19 Item 6 - Exhibits and Reports on Form 8-K 20 SIGNATURES AND CERTIFICATIONS 20 PART 1. FINANCIAL INFORMATION Item 1. Financial Statements -------------------------------------- COLONIAL COMMERCIAL CORP. AND SUBSIDIARIES Consolidated Balance Sheets June 30, 2002 and December 31, 2001 Assets 2002 2001 ---- ---- (Unaudited) Current assets: Cash and cash equivalents $ 698,047 576,514 Accounts receivable, net of allowance for doubtful accounts of $270,000 in 2002 and $253,000 in 2001, respectively 4,875,448 4,466,667 Inventory 6,108,318 6,314,546 Prepaid expenses and other current assets 493,840 376,838 ------------ ------------ Total current assets 12,175,653 11,734,565 Property and equipment, net 586,869 622,790 Goodwill 1,316,929 1,316,929 Other intangibles 106,666 128,700 Restricted investment securities -- 122,506 Other assets 100,000 -- ------------ ------------ $ 14,286,117 13,925,490 ============ ============ Liabilities and Stockholders' Equity (Deficit) Current liabilities: Accounts payable $ 3,504,354 2,422,802 Accrued liabilities 982,714 1,047,188 Income taxes payable 19,049 26,086 Borrowings under credit facility 7,720,189 7,929,576 Investment in unconsolidated subsidiary in bankruptcy, carried at cost 219,007 219,007 Guaranteed borrowings of unconsolidated subsidiary in bankruptcy 5,800,695 5,800,695 Notes payable - current portion 107,617 143,405 ------------ ------------ Total current liabilities 18,353,625 17,588,759 Notes payable, excluding current portion 46,157 90,495 Deferred compensation -- 122,506 ------------ ------------ Total liabilities 18,399,782 17,801,760 ------------ ------------ Stockholders' equity (deficit): Convertible preferred stock, $.05 par value, liquidation preference of $7,321,430 at June 30, 2002 and December 31, 2001, respectively, 2,468,860 shares authorized, 1,464,286 shares issued and outstanding at June 30, 2002 and December 31, 2001, respectively 73,214 73,214 Common stock, $.05 par value, 20,000,000 shares authorized, 1,603,760 shares issued and outstanding at June 30, 2002 and December 31, 2001, respectively 80,189 80,189 Additional paid-in capital 8,966,513 8,966,513 Accumulated deficit (13,233,581) (12,996,186) ------------ ------------ Total stockholders' deficit (4,113,665) (3,876,270) Commitments and contingencies $ 14,286,117 13,925,490 ============ ============ See accompanying notes to unaudited consolidated financial statements. Page 1 COLONIAL COMMERCIAL CORP. AND SUBSIDIARIES Consolidated Statements of Operations Three Months ended June 30, 2002 and 2001 (Unaudited) 2002 2001 ---- ---- Net sales $ 9,173,474 7,676,590 Cost of sales 6,528,148 5,359,452 ----------- ----------- Gross profit 2,645,326 2,317,138 Selling, general and administrative expenses, net 2,600,333 2,204,661 ----------- ----------- Operating income 44,993 112,477 Interest income 552 3,006 Other income 55,257 46,249 Interest expense (147,226) (170,424) ----------- ----------- Loss from continuing operations before income taxes (46,424) (8,692) Income taxes 1,707 20,100 ----------- ----------- Loss from continuing operations $ (48,131) (28,792) Net income from operations of discontinued segments -- 44,366 ----------- ----------- Net (loss) income $ (48,131) 15,574 =========== =========== Income (loss) per common share: Basic: Loss from continuing operations $ (0.03) (0.02) Income on discontinued operation -- 0.03 ----------- ----------- Net (loss) income per common share $ (0.03) 0.01 =========== =========== Diluted: Loss from continuing operations $ (0.03) (0.02) Income on discontinued operation -- 0.03 ----------- ----------- Net (loss) income per common share $ (0.03) 0.01 =========== =========== Weighted average shares outstanding: Basic 1,603,760 1,603,659 Diluted 1,603,760 1,603,659 See accompanying notes to unaudited consolidated financial statements. Page 2 COLONIAL COMMERCIAL CORP. AND SUBSIDIARIES Consolidated Statements of Operations Six Months ended June 30, 2002 and 2001 (Unaudited) 2002 2001 ---- ---- Net sales $ 16,404,400 14,280,766 Cost of sales 11,548,052 9,942,598 ------------ ------------ Gross profit 4,856,348 4,338,168 Selling, general and administrative expenses, net 4,903,768 4,445,654 ------------ ------------ Operating loss (47,420) (107,486) Interest income 1,155 7,689 Other income 93,705 86,116 Interest expense (283,128) (357,149) ------------ ------------ Loss from continuing operations before income taxes (235,688) (370,830) Income taxes (recovery) 1,707 (54,000) ------------ ------------ Loss from continuing operations $ (237,395) (316,830) Net income from operations of discontinued segments -- 358,891 ------------ ------------ Net (loss) income $ (237,395) 42,061 ============ ============ Income (loss) per common share: Basic: Loss from continuing operations $ (0.15) (0.20) Income on discontinued operation -- 0.23 ------------ ------------ Net (loss) income per common share $ (0.15) 0.03 ============ ============ Diluted: Loss from continuing operations $ (0.15) (0.20) Income on discontinued operation -- 0.23 ------------ ------------ Net (loss) income per common share $ (0.15) 0.03 ============ ============ Weighted average shares outstanding: Basic 1,603,760 1,602,629 Diluted 1,603,760 1,602,629 See accompanying notes to unaudited consolidated financial statements. Page 3 COLONIAL COMMERCIAL CORP. AND SUBSIDIARIES Consolidated Statements of Cash Flows Six Months Ended June 30, 2002 and 2001 (Unaudited) 2002 2001 ---- ---- Cash flows from operating activities: Net income (loss) $ (237,395) 42,061 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Income from discontinued operation -- (358,891) Provision for doubtful accounts 49,467 50,303 Depreciation 77,277 74,753 Amortization of intangibles 22,034 66,475 Changes in assets and liabilities, net of the effects of acquisitions: Accounts receivable (458,248) 563,244 Inventory 206,228 34,359 Prepaid expenses and other current assets (117,002) 125,847 Accounts payable 1,081,552 (455,589) Investment securities - trading 122,506 (22,103) Accrued liabilities (64,474) (478,963) Income taxes payable (7,037) (4,278) Deferred compensation (122,506) 22,103 ----------- ----------- Net cash provided by (used in) operating activities 552,402 (340,679) ----------- ----------- Cash flows from investing activities: Deposit payment for acquisition of Goldman Associates (100,000) -- Purchase of licensing agreement -- (4,800) Net additions to property and equipment (41,356) (57,572) ----------- ----------- Net cash used in investing activities (141,356) (62,372) ----------- ----------- Cash flow from financing activities: Net repayments on notes payable (80,126) (77,521) Net repayments under credit facility (209,387) (503,316) ----------- ----------- Net cash used in financing activities (289,513) (580,837) ----------- ----------- Net cash provided by discontinued operation -- 808,522 ----------- ----------- Increase (decrease) in cash and cash equivalents 121,533 (175,366) Cash and cash equivalents - beginning of period 576,514 803,012 ----------- ----------- Cash and cash equivalents - end of period $ 698,047 627,646 =========== =========== See accompanying notes to unaudited consolidated financial statements. Page 4 COLONIAL COMMERCIAL CORP. AND SUBSIDIARIES Notes To Consolidated Financial Statements June 30, 2002 (Unaudited) (1) Summary of Significant Accounting Policies and Practices The consolidated financial statements of Colonial Commercial Corp. and subsidiaries (the "Company") included herein have been prepared by the Company and are unaudited; however, such information reflects all adjust- ments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, and cash flows for the interim periods to which the report relates. The results of operations for the period ended June 30, 2002 are not necessarily indicative of the operating results that may be achieved for the full year. Certain information and footnote disclosures, normally included in con- solidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2001 Form 10-K. Certain reclassifications have been made to the three and six months ended June 30, 2001 information to conform to the current quarter presentation. The Company has one continuing industry segment - heating, ventilation and air conditioning. (2) Chapter 11 Reorganization On January 28, 2002, Atlantic Hardware & Supply Corporation ("Atlantic"), a wholly owned subsidiary of the Company, filed a voluntary petition with the U. S. Bankruptcy Court for the Eastern District of New York to reorganize under Chapter 11 of the U. S. Bankruptcy Code. As of the date of this filing, the proceedings are still on-going. Neither Colonial, nor Universal Supply Group, Inc. ("Universal"), is part of the Chapter 11 filing. The business of Atlantic is today conducted by one employee whose sole function is to collect on accounts receivables for the benefit of Atlantic's creditors, and the Company does not believe that Atlantic will emerge from the reorganization with any value for the Company. The Company was authorized by its Board to carry out the Chapter 11 filing in December 2001 and, since they no longer exercise significant influence Page 5 over Atlantic's operations and financial activities as of December 31, 2001, Atlantic has been unconsolidated in the Company's financial statements and its operations are being reported as "results from operations of discontinued segments." The Company's statements of operations for the three and six months ended June 30, 2001 and statements of cash flows for the six months ended June 30, 2001 include certain reclassifications in order to conform to this presentation. On November 21, 2002, the Company and Universal were released from their guarantees of the indebtedness (approximately $5,800,000) of Atlantic by Atlantic's lending bank, in return for the agreement by the Company and Universal to pay to the bank $2,500,000 as a five-year term loan under the Company's line of credit with the bank, or, if earlier, on demand by the bank. The Company's investment in Atlantic's common stock is being recognized at cost, $219,007 of guaranteed liabilities and $5,800,695 of guaranteed borrowings under a credit facility as of June 30, 2002. The Company has recognized liabilities of Atlantic only to the extent such liabilities are guaranteed by the Company because the Company believes that it is not responsible for any other liabilities of Atlantic as Atlantic's creditors will be able to look only to Atlantic's assets for recovery. The Company will continue to recognize the $219,007 of guaranteed liabilities of Atlantic until they are extinguished by Atlantic's bankruptcy proceedings or otherwise. (3) Intangible Assets Statement 142, "Goodwill and Other Intangible Assets," requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but rather will be tested for impairment at least annually. Statement 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment, in accordance with Statement No. 144, "Accounting for the Impairment of Long-Lived Assets." Upon adoption of Statement 142, the Company was required to perform an assessment of whether there is an indication that goodwill was impaired as of the date of adoption. To accomplish this, the Company had to identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. The Company adopted the provisions of Statement 142 effective January 1, 2002 and, accordingly, has ceased the amortization of the goodwill acquired in the acquisition of Universal. Upon adoption, there was no indication of impairment for goodwill acquired in prior business combinations. As required by the adoption of Statement No. 142, the Company also reassessed the useful lives and residual values of all acquired intangible assets to make any necessary amortization period adjustments. Based upon that assessment, no Page 6 adjustments were made to the amortization period of residual values of other intangible assets. The cost of other intangible assets are amortized on a straight-line basis over their respective lives. As of June 30, 2002 and December 31, 2001, the Company had intangible assets, subject to amortization of $231,667 and $236,467, respectively, and related accumulated amortization of $125,000 and $107,767, respectively, which pertained primarily to covenants not to compete. Amortization expense for intangible assets subject to amortization amounted to approximately $14,289 and $11,617 for the three months ended June 30, 2002 and 2001, respectively and $22,033 and $27,533 for the six months ended June 30, 2002 and 2001, respectively. The estimated aggregate amortization expense for each of the five succeeding years ending December 31, 2006 amounts to approximately $42,900, $41,700, $26,700, $11,700 and $5,800 in 2002, 2003, 2004, 2005 and 2006, respectively. As of June 30, 2002 and December 31, 2001, the Company had unamortized goodwill in the amount of $1,316,929. The following table shows the results of operations as if Statement 142 was applied to prior period: For the three For the six months ended months ended June 30, June 30, 2002 2001 2002 2001 Net income (loss), as reported $ (48,131) 15,574 (237,395) 42,061 Deduct: negative goodwill amortization, net -- (8,762) -- (17,525) ---------- --------- ---------- --------- Adjusted net income (loss) (48,131) 6,812 (237,395) 24,536 ========== ========= ========== ========= Income (loss) per share: Basic net income (loss), as reported $ (0.03) 0.01 (0.15) 0.03 Negative goodwill amortization, net -- (0.01) -- (0.01) ---------- --------- ---------- --------- Adjusted net income (loss) $ (0.03) (0.00) (0.15) (0.02) ========== ========= ========== ========= Diluted net income (loss), as reported $ (0.03) 0.01 (0.15) 0.03 Negative goodwill amortization, net -- (0.01) -- (0.01) ---------- --------- ---------- --------- Adjusted net income (loss) $ 0.03 (0.00) (0.15) 0.02 ========== ========= ========== ========= (4) Nasdaq The Company's shares were delisted from the Nasdaq SmallCap Market in June 2002 because (i) the Company failed to timely file its Form 10-Q for the fiscal quarter ended March 31, 2002 and its Form 10-K for 2001; (ii) the market value of its publicly held shares of common stock was less than the required $1 million, and (iii) the closing bid price of its common stock was less than $1 per share. Page 7 (5) Subsequent Event (a) Goldman Acquisition In July 2002, Universal acquired certain accounts receivable, inventory and other accessories from Goldman Associates of New York, Inc. ("Goldman"), relating to Goldman's HVAC business in New Jersey and certain areas of New York, for $670,981, of which $100,000 was paid as an up front deposit in June 2002. $570,981 of the purchase price was allocated to the above listed assets at their estimated fair values. The remaining $100,000 was recorded as goodwill and will be tested annually for impairment under the provisions of Statement 142. Pro forma results of operations are not provided, as the information is not material to the consolidated financial statements. (b) Release Of Guarantees On November 21, 2002, the Company and Universal were released from their guarantees of the indebtedness (approximately $5,800,000) by Atlantic to Colonial's and Atlantic's lending bank, in return for the agreement by the Company and Universal to pay to the bank $2,500,000 as a five-year term loan under the Company's line of credit with the bank, or, if earlier, on demand by the bank. The $3,300,000 difference between the total amount guaranteed ($5,800,000) and the amount the Company and Universal agreed to pay ($2,500,000) is reflected in the Company's 2002 statement of operations as income from the operations of discontinued segments. (c) Private Placement On July 16, 2003, the Company completed a private placement, pursuant to Regulation D of the Securities Exchange Act of 1933. The Company raised $240,600 through the issuance of 802,000 shares of Common Stock at $0.30 per share. The stock was sold to officers and directors of the Company and one private investor. The proceeds of the private placement will be used for general working capital purposes. The stock cannot be sold, transferred or otherwise disposed of, unless subsequently registered under the Securities Act of 1933 and applicable state securities or Blue Sky laws, or pursuant to an exemption from such registration, which is available at the time of desired sale, and will bear a legend to that effect. (d) RAL Acquisition On September 30, 2003, RAL Purchasing, Inc., a newly formed, wholly owned subsidiary of Colonial, purchased substantially all of the assets and certain Page 8 liabilities of RAL Supply Group, Inc. ("RAL") for a price of $3,838,521. $2,447,061 of the purchase price was paid in cash to the seller at the time of purchase. The remaining $1,391,460 was in the form of liabilities assumed by RAL Purchasing, Inc. The cash paid at the time of purchase was funded as follows: Borrowings on Colonial's credit facility $2,147,061 5-Year unsecured notes issued by RAL Purchasing, Inc. to a third party, at annual rate of 9% $ 300,000 ---------- Total outlay $2,447,061 ========== In connection with this acquisition, Colonial's limit on its credit facility was increased by $2,000,000 to $14,000,000. All borrowings under the credit facility are secured by substantially all of the assets of RAL and Universal. In addition, the 5-year notes are guaranteed by Universal. As a result of this acquisition, liabilities were assumed as follows: Fair value of assets acquired $ 3,838,521 Cash paid $ 2,447,061 ------------ Fair value of liabilities assumed $ 1,391,460 ============ RAL is a distributor of heating and cooling equipment and high-end plumbing fixtures with six locations, servicing Orange, Rockland, Ulster and Sullivan counties in New York. Four locations have showrooms. RAL's products are marketed primarily to contractors, consumers, builders and the commercial sector. Initial purchase price allocations are not yet available as the acquisition was recently completed. The results of operations of RAL will be included in the consolidated results from the date of acquisition. (6) Supplemental Cash Flow Information The following is supplemental information relating to the consolidated statements of cash flows: Six Months Ended June 30,2002 June 30, 2001 ------------ ------------- Cash paid during the period for: Interest $ 246,439 $ 358,836 Income taxes $ 8,744 $ 7,700 Page 9 Non-cash transactions: During 2001, notes payable of $18,493 were incurred for the purchase of automobiles. During the six months ended June 30, 2001, the Company retired 2,064 shares, of convertible preferred stock, which were converted to a similar number of common shares. During 2002, no such shares were retired. (7) Comprehensive Income (Loss) The Company has no items of other comprehensive income; therefore, there is no difference between the Company's comprehensive income (loss) and net income (loss) for the periods presented. (8) Net Income (Loss) Per Common Share A reconciliation between the numerators and denominators of the basic and diluted income (loss) per common share is as follows: Six Months Ended June 30, Three Months Ended June 30, 2002 2001 2002 2001 ---- ---- ---- ---- Net (loss) income numerator $ (237,395) 42,061 (48,131) 15,574 Weighted average common shares (denominator for basic income per share) 1,603,760 1,602,629 1,603,760 1,603,659 Effect of dilutive securities: Convertible preferred stock -- -- -- -- Employee stock options -- -- -- -- ----------- ----------- ----------- ----------- Weighted average common and potential common shares outstanding (denominator for diluted income per share) 1,603,760 1,602,029 1,603,760 1,603,659 =========== =========== =========== =========== Basic (loss) income per share (0.15) 0.03 (0.03) 0.01 =========== =========== =========== =========== Diluted (loss) income per share (0.15) 0.03 (0.03) 0.01 =========== =========== =========== =========== Employee stock options totaling 281,400 and 281,000 for the three and six months ended June 30, 2002 and 300,600 and 295,200 for the three and six months ended June 30, 2001, respectively, were not included in the income per share calculation because their effect would have been anti-dilutive. Convertible Page 10 preferred stock totaling 1,464,286 for the three and six months ended June 30, 2002 and 1,464,387 and 1,465,417 for the three and six months ended June 30, 2001, respectively, were not included in the net loss per share because their effect would have been anti-dilutive. (9) NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations". Statement 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The Company is required to adopt Statement 143, on January 1, 2003. Adoption of Statement 143 did not have a material impact on the Company's consolidated operations or financial position. In July 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". Statement 146 will spread out the reporting of expenses related to restructurings initiated after 2002, because commitment to a plan to exit an activity or dispose of long-lived assets will no longer be enough to record a liability for the anticipated costs. Instead, exit and disposal costs are to be recorded when they are "incurred" and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flows. The Company is required to adopt the provisions of Statement 146 as of January 1, 2003. The Company adopted Statement 146 on January 1, 2003. Adoption of Statement 146 did not have an impact on the Company's consolidated results of operations or its financial position. In December 2002, the FASB issued Statement No. 148, Accounting for Stock- Based Compensation-Transition and Disclosure. Statement No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation as originally provided by the FASB issued Statement No. 123, Accounting for Stock-Based Compensation. Additionally, Statement No. 148 amends the disclosure requirements of Statement No. 123 in both annual and interim financial statements. The disclosure requirements have been adopted as of the period ended December 31, 2002. The Company intends to continue to apply the intrinsic value method of accounting for stock-based employee compensation. The adoption of this pronouncement will not have any impact on the Company's consolidated financial position or results of operations. In November 2002, the FASB issued FASB interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires that upon Page 11 issuance of guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 will be effective for any guarantees that are issued or modified after December 31, 2002. The adoption of FIN 45 did not have an impact on the Company's consolidated financial statements. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51". FIN 46 addresses the consolidation by business enterprises of variable interest entities, as defined in the Interpretation. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim period beginning after June 15, 2003. The Company does not believe that the adoption of FIN 46 will have any impact on the Company's consolidated financial statements. In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." Statement No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." Statement No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. The adoption of this pronouncement will not have any impact on the Company's financial position and results of operations. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." Statement No. 150 changes the accounting guidance for certain financial instruments that, under previous guidance, could be classified as equity or "mezzanine" equity by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position. Further, Statement No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. Statement No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2002 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this pronouncement will not have any impact on the Company's financial position and results of operations. Page 12 In January 1, 2003 the Company adopted the FASB's Emerging Issue Task Force (EITF) Issue No. 02-16 "Accounting by a Reseller for Cash Consideration Received from a Vendor" ("EITF 02-16"). The consensus reached by the EITF addressed the accounting for "Cash Consideration" (which includes slotting fees, cooperative advertising payments, etc.). The consensus of the EITF establishes an overall presumption that the cash received from vendors is a reduction in the price of vendor's products and should be recognized accordingly as a reduction in the cost of sales at the time the related inventory is sold. Some consideration could be characterized as a reduction of expense if the cash received represents a reimbursement of specific, incremental, identifiable costs incurred by the retailer to sell the vendor's products. The Company is in the process of assessing the impact, if any, of adopting EITF 02-16. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-looking Statements This Report on Form 10-Q contains forward-looking statements relating to such matters as anticipated financial performance and business prospects. When used in this Report, the words "anticipates," "expects," "believes," "may," "intends" and similar expressions are intended to be among the statements that identify forward-looking statements. From time to time, the Company may also publish forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. Forward-looking statements involve risks and uncertainties, including, but not limited to, the consummation of certain events referred to in this report, the ability to continue as a going concern, the availability of financing, the impact of the bankruptcy of Atlantic on a go-forward basis, technological changes, competitive factors, maintaining customer and vendor relationships, inventory obsolescence and availability, and other risks detailed in the Company's periodic filings with the Securities and Exchange Commission, which could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. Results of Operations - Three Months Ended June 30, 2002 and 2001 The Company reported a net loss of $48,131 for the three months ended June 30, 2002, as compared to net income of $15,574, including net income from discontinued operations of $44,366 in the 2001 quarter. The operations of Atlantic Hardware & Supply Corporation ("Atlantic") were discontinued at December 31, 2001. The Company had a loss from continuing operations, before taxes of $48,131 in the second quarter of 2002, compared with a loss of $28,792 in 2001. Page 13 For the second quarter of 2001, the Company reported income from the discontinued operations of Atlantic of $44,366. During the second quarter Atlantic's sales decreased $879,763 due to the timing of shipments. The Company also recorded a tax benefit related to Atlantic for the second quarter of 2001 totaling $50,000. Net sales increased $1,496,884 due primarily to favorable weather conditions, the opening of a new branch in Pennsylvania and the expansion of the North Brunswick location, as well as an overall increase in market penetration. Gross margins on sales during the same period decreased by 1.4% to 28.8% due to product mix. Selling, general and administrative expenses increased $395,672 primarily due to professional and other fees relating to the Company's secured credit line and its guarantee of the credit line obligations of Atlantic. Interest expense decreased $23,198 due to decreased prime rates and consignment arrangements with certain suppliers. During the second quarter of 2002, the Company recorded a state tax provision of $1,707, based on Universal's taxable income. For federal purposes, although the Company was in a federal tax loss position at June 30, 2002, a benefit was not recorded, as the Company did not expect to be able to realize such a benefit by the end of 2002. This compares to the second quarter of 2001 when the Company reversed $20,100 of the federal tax benefit recorded in the first quarter, and recorded no state tax provision. Results of Operations - Six Months Ended June 30, 2002 and 2001 The Company reported a net loss of $237,395 for the first half of 2002, as compared to net income of $42,061, which is net of income from the discontinued operations of Atlantic of $358,891. The Company had a loss from continuing operations, before taxes of $235,688 in the first half of 2002, compared with a loss of $370,830 in 2001. For the first half of 2001, the Company reported income from the discontinued operations of Atlantic of $358,891. This income was primarily due to an increase in sales at Atlantic of $1,881,929 due to the timing of shipments. Net sales from continuing operations increased $2,123,634, as a result of favorable weather conditions, the opening of a new branch in Pennsylvania and the expansion of the North Brunswick location, as well as an overall increase in market penetration. Gross margins decreased 0.8% to 29.6% due to product mix. Selling, general and administrative expenses increased $458,114, primarily due to professional and other fees relating to the Company's secured credit line and its guarantee of the credit line obligations of Atlantic. Interest expense decreased $74,021 mainly as a result of decreased prime rates and consignment arrangements with certain suppliers. Page 14 The Company recorded a state tax provision of $1,707 for the six months ended June 30, 2002, based on Universal's taxable income. For federal purposes, although the Company was in a federal tax loss position at June 30, 2002, a benefit was not recorded as the Company did not expect to be able to realize such a benefit by the end of 2002. This compares to the first half of 2001, when the Company recorded a federal tax benefit of $54,000 for their continuing operations. Liquidity and Capital Resources As of June 30, 2002, the Company had $698,047 in cash and cash equivalents compared with $576,514 at December 31, 2001. Between December 31, 2001 and June 30, 2002, there were no material changes in obligations associated with operating agreements, obligations to financial institutions and other long-term debt obligations. Cash flows provided by operations were $552,402 during the six months ended June 30, 2002. Accounts payable increased due, primarily, to extended payment terms with Universal's vendors. Inventory decreased due, primarily, to the fact that, as of November 2001, Universal has been gradually taking in Amana and Goodman inventory on consignment. These factors were offset by the fact that accounts receivable increased due to an increase in sales in the second quarter of 2002 and timing of customer payments. Cash flows used in investing activities of $141,356 during the six months ended June 30, 2002 were due to $41,356 for the purchase of property and equipment and a $100,000 deposit for the purchase of certain assets of Goldman Associates. The cash flows used in financing activities of $289,513 were for net repayments made on the credit facility of $209,387, as well as net repayments on notes payable of $80,126. This compares to the prior year when $580,837 of cash flows were used for financing activities, of which $503,316 was used for net repayments on the credit facility and $77,521 was used for net repayments on notes payable. The net cash provided by discontinued operations during the six months ended June 30, 2001 of $808,522 is made up of net cash provided by the operations and liquidation of Atlantic of $1,411,932, offset by the cash used for the disposal of Well-Bilt of $603,410. On January 28, 2002, Atlantic, a wholly-owned subsidiary of the Company, filed a voluntary petition with the U. S. Bankruptcy Court for the Eastern District of New York to reorganize under Chapter 11 of the U. S. Bankruptcy Code. As of the date of this filing, the proceedings are still on-going Colonial and its other operations are not part of the Chapter 11 filing. The business of Atlantic is today conducted by one employee, whose sole function is to collect on accounts receivables for the benefit of Atlantic's creditors, and the Company does not believe that Atlantic will emerge from the Page 15 reorganization with any value for the Company. On November 21, 2002, the Company and Universal were released from their guarantees of the indebtedness (approximately $5,800,000 by Atlantic to Colonial's and Atlantic's lending bank, in return for the agreement by the Company and Universal to pay to the bank $2,500,000 as a five-year term loan under the Company's line of credit with the bank, or, if earlier, on demand by the bank. At June 30, 2002, amounts outstanding under the credit facility were $7,720,189, of which $457,000 represents amounts under a term loan, payable in 22 equal monthly installments of approximately $21,000. Although the term loan is payable over 22 months, the Bank can demand payment at any time. As monthly repayments are made on the term loan, the available line of credit portion of the facility increases by the amount of the principal payment. The Company believes that the credit facility is sufficient to finance its current operating needs. On September 30, 2003, Colonial, through its newly formed, wholly owned subsidiary, RAL Purchasing, Inc., purchased substantially all of the assets and certain liabilities of RAL Supply Group, Inc. ("RAL"). The purchase price of $3,838,521 was in the form of $2,447,061 of cash paid to the seller at the time of purchase with the remaining $1,391,460 in the form of liabilities assumed by RAL Purchasing, Inc. The $2,447,061 of cash paid at the time of purchase was funded by $2,147,061 of borrowings on the Company's credit facility and 5-year, 9% notes issued by RAL Purchasing, Inc. to a third party in the amount of $300,000. The 5-year notes are guaranteed by Universal. Colonial's limit on its credit facility was increased by $2,000,000 to $14,000,000, as a result of the acquisition. The Company expects to meet its liquidity needs going forward through a combination of cash from operations, amounts available under its credit facility and the issuance of stock through a private placement. On July 16, 2003, Colonial completed a private placement pursuant to Regulation D of the Securities Exchange act of 1933. Colonial raised $240,600 through the issuance of 802,000 shares of Common Stock at $0.30 per share. The stock was sold to officers and directors of the Company and one private investor. The proceeds of the private placement will be used for general working capital purposes. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued Statement No. 143, "Accounting for Asset Retirement Obligations". Statement 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result Page 16 from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The Company is required to adopt Statement 143, on January 1, 2003. Adoption of Statement 143 did not have a material impact on the Company's consolidated operations or financial position. In July 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". Statement 146 will spread out the reporting of expenses related to restructurings initiated after 2002, because commitment to a plan to exit an activity or dispose of long-lived assets will no longer be enough to record a liability for the anticipated costs. Instead, exit and disposal costs are to be recorded when they are "incurred" and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flows. The Company adopted Statement 146 on January 1, 2003. Adoption of Statement 146 did not have an impact on the Company's consolidated results of operations or its financial position. In December 2002, the FASB issued Statement No. 148, "Accounting for Stock- Based Compensation-Transition and Disclosure". Statement No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation as originally provided by the FASB issued Statement No. 123, Accounting for Stock-Based Compensation. Additionally, Statement No. 148 amends the disclosure requirements of Statement No. 123 in both annual and interim financial statements. The disclosure requirements have been adopted as of the period ended December 31, 2002. The Company intends to continue to apply the intrinsic value method of accounting for stock-based employee compensation. The adoption of this pronouncement will not have any impact on the Company's consolidated financial position or results of operations. In November 2002, the FASB issued FASB interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires that upon issuance of guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 will be effective for any guarantees that are issued or modified after December 31, 2002. The adoption of FIN 45 did not have an impact on the Company's consolidated financial statements. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51". FIN 46 addresses the consolidation by business enterprises of variable interest entities, as defined in the Interpretation. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim period beginning after June 15, 2003. The Company does not believe that the adoption of FIN 46 will have any impact on the Company's consolidated financial statements. Page 17 In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." Statement No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." Statement No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. The adoption of this pronouncement will not have any impact on the Company's financial position and results of operations. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." Statement No. 150 changes the accounting guidance for certain financial instruments that, under previous guidance, could be classified as equity or "mezzanine" equity by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position. Further, Statement No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. Statement No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2002 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this pronouncement will not have any impact on the Company's financial position and results of operations. In January 1, 2003 the Company adopted the FASB's Emerging Issue Task Force (EITF) Issue No. 02-16 "Accounting by a Reseller for Cash Consideration Received from a Vendor" ("EITF 02-16"). The consensus reached by the EITF addressed the accounting for "Cash Consideration" (which includes slotting fees, cooperative advertising payments, etc.). The consensus of the EITF establishes an overall presumption that the cash received from vendors is a reduction in the price of vendor's products and should be recognized accordingly as a reduction in the cost of sales at the time the related inventory is sold. Some consideration could be characterized as a reduction of expense if the cash received represents a reimbursement of specific, incremental, identifiable costs incurred by the retailer to sell the vendor's products. The Company is in the process of assessing the impact, if any, of adopting EITF 02-16. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company's pre-tax earnings and cash flow are exposed to changes in interest rates as borrowings under its credit facility bear interest at the prime rate, plus 2%. A hypothetical 10% adverse change in such rates would reduce pre-tax earnings and cash flow by approximately $52,000 over a one-year period, assuming the borrowing level remains consistent with the outstanding borrowings as of June 30, 2002. The fair value of the borrowings under the credit facility is not affected by changes in market interest rates. Page 18 The Company's remaining interest-bearing obligations are at fixed rates of interest and as such do not expose pre-tax earnings and cash flows to changes in market interest rates. The change in fair value of the Company's fixed rate obligations resulting from a hypothetical 10% adverse change in interest rates would not be material. Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures The Company's senior management is responsible for establishing and maintaining a system of disclosure controls and procedures (as defined in Rule 13a-14 and 15d-14 under the Securities Exchange Act of 1934 (the "Exchange Act")) designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported as specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer's management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow them to make informed decisions regarding required disclosure. The Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures under the supervision of and with the participation of management, including the Chief Executive Officer and Chief Financial Officer within 90 days prior to the filing date of this report. Based on that evaluation our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in alerting them to material information required to be included in our periodic Securities and Exchange Commission filings. (b) Changes in Internal Controls Subsequent to that evaluation, there have been no significant changes in our internal controls or other factors that could significantly affect these controls after such evaluation. PART II. OTHER INFORMATION Item 1. Legal Proceedings On January 28, 2002, Atlantic, a wholly-owned subsidiary of the Company, filed a voluntary petition with the U. S. Bankruptcy Court for the Eastern District of New York to reorganize under Chapter 11 of the U. S. Bankruptcy Code. As of the date of this Page 19 filing, the proceedings are still on-going. Colonial and its other operations are not part of the Chapter 11 filing. The business of Atlantic is today conducted by one employee, whose sole function is to collect on accounts receivables for the benefit of Atlantic's creditors, and the Company does not believe that Atlantic will emerge from the reorganization with any value for the Company. Item 6. Exhibits and Reports on Form 8-K a. Exhibits: 31.1 Certification of Chief Executive Officer Pursuant to Rule 15d-14 of the Securities and Exchange Act of 1934, as amended, as Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 31.2 Certification of Chief Financial Officer Pursuant to Rule 15d-14 of the Securities and Exchange Act of 1934, as amended, as Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 32-1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32-2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 b. Reports on Form 8-K: None SIGNATURES Pursuant to the requirements 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. Dated: November 14, 2003 COLONIAL COMMERCIAL CORP. /S/ BERNARD KORN ---------------- Bernard Korn, Chairman of the Board and President /S/ JAMES W. STEWART -------------------- James W. Stewart, Executive Vice President and Treasurer Page 20